September 2017
Market Update
(all values as of 10.30.2020)

Stock Indices:

Dow Jones 26,501
S&P 500 3,269
Nasdaq 10,911

Bond Sector Yields:

2 Yr Treasury 0.14%
10 Yr Treasury 0.88%
10 Yr Municipal 0.94%
High Yield 5.72%

YTD Market Returns:

Dow Jones -7.14%
S&P 500 1.21%
Nasdaq 21.61%
MSCI-EAFE -12.61%
MSCI-Europe -15.66%
MSCI-Pacific -7.42%
MSCI-Emg Mkt -1.00%
 
US Agg Bond 6.32%
US Corp Bond 6.45%
US Gov’t Bond 7.40%

Commodity Prices:

Gold 1,878
Silver 23.72
Oil (WTI) 35.71

Currencies:

Dollar / Euro 1.17
Dollar / Pound 1.29
Yen / Dollar 104.44
Dollar / Canadian 0.75
 

Macro Overview

Hurricane Harvey prompted an agreement between the President and congressional leaders to increase the politically charged debt ceiling in order to help fund repair efforts in Texas. The agreement will avert a government shutdown until mid-December, providing essential funds for ongoing government operations.

On track to be one of the most costly natural disasters in U.S. history, Hurricane Harvey is expected to be a catalyst for economic expansion as the clean up and rebuilding process begins. Such an effort, as occurred in Louisiana following Katrina, will involve concrete, lumber, plumbing, and electrical components from all over the United States.

The hurricane affected and closed an estimated quarter of all U.S. refining capacity. Harvey’s impact on the price of refined crude oil products, such as gasoline and jet fuel, validates how crucial the Gulf Coast and Texas are to the global energy markets. Ever since Congress lifted the oil export ban in December 2015, almost all exports of U.S. oil are shipped from ports in Texas. Department of Energy data shows that U.S. refiners were using 96.6% of their available capacity before Hurricane Harvey hit, the highest rate since 2005.

Unemployment has fluctuated between 4.3% and 4.4% over the past three months, with the most recent data lifting the unemployment rate to 4.4%. Even with such a low unemployment rate, the growing concern among economists and analysts is that wage growth is essentially stagnant, with less than 0.1% growth in August as reported by the Labor Department. Year-over-year growth for hourly earnings has been stuck at 2.5%, which means that American workers are barely keeping ahead of the current annualized inflation rate of 2.0%.

There are several suggestions as to why wage growth has remained stagnate. Ever since the crisis of 2008/2009, companies have embraced profound cost reductions, while also grappling with demographical constraints. Downward pressure on wages has also been a result of older (baby boom) workers retiring and being replaced by younger, lower paid workers.

For the prior year, the rising costs of health care and housing accounted for roughly 40% of growth in consumer spending. The two prominent age groups affected are seniors subject to rising healthcare costs, and younger consumers that struggle to purchase a home.

 It is expected that the Federal Reserve will finally decide to start paring its $4.4 trillion balance sheet of mortgage and government bonds this fall, following its two-day September policy meeting. No one truly knows how that will unravel, since it has never actually occurred to this magnitude.

Equity markets continued their resilient climb in August, with the Dow Jones Industrial Index reaching 22,000 for the first time. Geopolitical risks with North Korea helped drive government bond yields lower, as risk adverse tactics evolved. (Sources: Department of Labor, Department of Energy, Dow Jones, NOAA)

 

 

 
The Dow Jones Average Index Reached 22,000 For The First Time

Yields Hold Steady – Fixed Income Update

Heightened geopolitical tensions drove the demand for government bonds as investors allocated to safe havens driving bond prices higher and rates lower.

Several large U.S. corporations raised capital in the debt markets in August, taking advantage of the low rate environment. Apple and Tesla both borrowed through the debt markets at ultra low interest rates.

The national municipal bond market is bracing for the effects of Hurricane Harvey and Hurricane Irma, as municipalities assess the fragility of their tax base during the aftermath of the storms.

Bonds across most fixed income segments advanced modestly following tepid remarks by the Fed regarding economic data and inflation numbers. (Sources: Fed, Reuters, Bloomberg)

Equities Remain Immune To Geopolitical Events – Global Equity Markets

Equity markets were resilient in August to geopolitical events as major indices rose to higher levels. The Dow Jones Industrial Index reached 22,000 for the first time.

Emerging markets continued to experience the benefit of a weakening U.S. dollar, with a rise in August. For emerging markets, a weaker dollar makes it easier for those holding debt denominated in U.S. dollars to repay them. This is a significant factor since emerging markets carry a large amount of debt. A weaker dollar also helps exporters of commodities, as a weak dollar tends to boost commodity prices.

Companies are already struggling with tight margins so any increase in expenses would further reduce margins unless higher costs are passed onto consumers in the form of higher prices. (Sources: Bloomberg, Reuters, Dow Jones)

More Homes For Sale, Less Homes Sold – Housing Market Update

Dynamics within the housing market are a result of wages, consumer sentiment, interest rates, and the economic environment. Over the past year, the number of homes for sale and the number of homes sold has diverged. The U.S. Department of Housing and Urban Development carefully tracks all home listings and sales on a monthly basis. The most recent data available reveals that for the past year, as of July 2017, there was an increase in the number of homes for sale and a decrease in the number of homes sold. At the end of July, there were 276,000 homes for sale while there were 571,000 homes sold. July 2016 saw 627,000 homes sold with only 237,000 homes for sale nationwide. (Sources: U.S. Census Bureau, HUD)

 

 
Hurricane Harvey Is Estimated To Cost Over $75 Billion In Losses

Costliest Hurricanes – Historical Note

As flood waters recede in Texas, Hurricane Harvey is on track to be one of the costliest natural disasters in U.S. history. Not since Hurricane Katrina, which ravaged Louisiana in 2005, and Gustav & Ike in 2008, have insurance companies been levied with billions of dollars in settlement claims. Fortunately, nearly nine years absent of a significant natural disaster has allowed insurance carriers nationwide to fortify reserves and issue new policies.

Moody’s estimates that property losses from Hurricane Harvey will total between $45 billion to $65 billion, while economic losses will add $6 billion to $10 billion, totaling $75 billion. Other insurance industry estimates run as high as $100 billion, including uninsured businesses and individuals.

Historically, rebuilding efforts following natural disasters such as hurricanes, has led to pockets of economic growth. The enormous cost of Katrina in 2005 led to hundreds of millions of dollars for rebuilding homes, roads, buildings, and re-establishing businesses. (Sources: NOAA, Dept of Commerce, Moody’s, NASA)

Hurricane Economics

The hits keep coming.  Hurricane Harvey left destruction in its wake, and now, Hurricane Irma has Florida in its sights.

It’s been five years since Hurricane Sandy, nine years since Ike and twelve years since Katrina.  As with all major weather events, personal tragedy, pain, suffering, and loss are left in their wake.  We have prayed, and continue to pray, for those affected.  But at the same time, in our job as economists we look toward rebuilding and economic restoration.  This is where investors often make two different mistakes about how these massive weather events will affect the economy and markets.

Some might think that, as did Nouriel Roubini after Katrina, the damage itself will cause a recession.  Others take the opposite tack and think rebuilding efforts might actually help the economy.  Neither are correct.  By themselves, the storms will not push the economy off its Plow Horse path.

In the face of disasters we should all be thankful for the (mostly) free markets that help the U.S. respond.  These markets allow accumulated wealth and know-how to focus on recovery.  The losses will never be fully replaced, but the sheer size and flexibility of the U.S.’s capitalist system allows resources to be shifted and directed toward recovery.  The price system makes this happen.  While some think no profit should be made from a disaster, it is those profits which allow overall “economic” recovery to occur in relatively quick order.

Some estimate that damage from Harvey could be close to the $108 billion estimate for Katrina (2005), certainly above the $75 billion cost of Hurricane Sandy (2012).

 
Hurricane Economics

 

Neither of these previous storms caused a recession, and at the same time, the data show no real acceleration in growth either.   Real GDP grew 4.9% at an annual rate in the first quarter of 2006 after Katrina, but never accelerated above 3% in the first two quarters after Sandy.  For six and nine month periods before and after these storms, growth rates were similar.  In other words, it’s hard to separate the impact of Katrina or Sandy from normal statistical noise.  The U.S. grew over 4% annualized in Q1 2005 and in Q3 2014, with no major weather impact.

But even if the bump in real GDP growth in the first quarter of 2006 was due to Katrina, that doesn’t mean it was good news.  It would be what Henry Hazlitt in his book “Economics in One Lesson” called the “fallacy of the broken window” – which we recommend all investors read.

Hazlitt told a story about a vandal who broke a shopkeeper’s window, which caused a glassmaker to get an additional order.  But the shopkeeper was planning on eventually using that same money to buy a new suit, so the tailor lost an order.  In other words, even though rebuilding appears to create new economic activity, fixing things that have been destroyed actually robs an economy over time of the benefits of growth.  Repairing physical capital does not generate new wealth, it only replaces old wealth.

Before Harvey, the market consensus was that automakers would sell cars and light trucks at a 16.6 million annual rate in August.  Instead, automakers reported late on Friday that they only sold at a 16.1 million rate.  Harvey hit an area that represents about 5% of US auto demand and it did so for about 20% of August.  This suggests Harvey cut roughly 1% off of August sales nationwide, or that autos would have sold at a 16.3 million annual pace in the absence of the storm.

Automakers should make those sales back up in the next few months.  In addition, reports suggest the storms destroyed about 500,000 autos, which will also generate additional sales in the months ahead.

These sales might help make the GDP numbers look better late this year or early next year, but it just represents demand that would have eventually appeared elsewhere in other sectors.

The lesson is that these disasters, while a tragedy in so many ways, do not shift the fundamental path of the U.S. economy.  Some think socialist economies can respond better, but this is not true; markets are the most efficient system for guiding resources to areas in need.  Free people that get hit with a disaster will overcome and reach new highs, because that’s what people do when they’re free, disaster or not.  Godspeed to all those affected directly, and to those helping in recovery.

Brian S. Wesbury – Chief Economist
Robert Stein, CFA – Deputy Chief Economist