Hurricane Harvey devastated the Houston area (and economy), and, while Irma could have been much worse, it still left significant destruction in Florida and the southeast. What we can say for sure is that the monetary impact of Harvey alone would have been the largest natural disaster in U.S. history, and now we must add on the monetary impact of Irma. And the hurricane season still has another month and a half to go. These two natural disasters are likely to shave a significant amount of growth off of Q3’s GDP (I’ve seen estimates of as much as 1.5 percentage points). It is even possible that Q3 GDP growth will be negative. Historically, exogenous events like these have often been the catalysts that actually push the economy into recession.
Here is my view of the way a near zero Q3 GDP growth rate is likely to play in the media come the initial growth announcement at the end of October:
The weakness in Q3’s real GDP growth is totally attributable to Hurricanes Harvey, Irma, etc.; the underlying economy remains strong and robust, and we expect a strong bounce-back once the reconstruction from the hurricane damage begins.
When you hear or read something like this, you should defer to the underlying data, some of which is detailed below.
Employment
The August 156,000 seasonally adjusted net new job creation (Establishment Survey) disappointed to begin with, but the underlying detail showed real weakness:
• Jobs for the prior two months were adjusted downward by 41,000;
• The not-seasonally adjusted data showing a gain of 211,000 jobs was composed of 108,000 jobs that were actually counted (large and medium sized businesses) and a 103,000 plug number from the BLS’s “birth/death” model for small businesses (they don’t actually survey or count small business jobs);
• The Household Survey showed job losses of -74,000 (they actually count these). Because the unemployment rate (U3) is calculated from this survey, it actually rose to 4.4% from 4.3%;
• The workweek fell from 34.5 hours to 35.4 hours. Doesn’t look like much, but this is equivalent to about 400,000 jobs;
• 151,000 joined the unemployment rolls;
• The Household Survey showed a loss of -166,000 full time positions (July was -54,000). When one loses a full-time job, one often has to take 2 part-time jobs to make ends meet; this could explain the rise in employment in the Establishment Survey as it counts full-time and part-time jobs as equivalent;
• People with college degrees or some college lost jobs in August while those with high school degrees or less gained jobs; this partly explains the lack of upward wage pressures in the economy;
• Employment in the prime working years (ages 25-54) fell -47,000; there has been no growth in this age category from April through August.
Autos, Homes, Loans
The economy ordinarily performs when big-ticket items like autos and homes are selling well. Both of these indicators have clearly peaked for this business cycle with autos barely breaking above 16 million units (seasonally adjusted annual rate) in August (was 18 million units as late as last December). July new home sales were down -9.4% from June and existing home sales fell -1.3% over that same time frame. Bank lending has become soft, and a graph of its growth shows that it is on a significant downtrend from Q3 and Q4 of 2016. The growth of business-oriented commercial and industrial loans, including new issues of non-financial commercial paper, is next to nothing using Q4 as a base.
The Bond Market Smells a Rat; Stocks Ain’t So Good Either
Bond market behavior should not be ignored. At the beginning of the year, both the Fed and the Street forecast the 10-Year Treasury Note yield to be significantly above 3% by now. Just a little over a week ago, it was flirting with 2.0%! The bond market clearly sees a slowing economy. And, from an historical perspective, the bond market is a much better predictor of economic activity than is the stock market.
Despite the fact that the major indexes remain buoyant, most individual stocks are not doing all that well. It is also telling that, during earnings season, on average, those companies that beat both top and bottom lines actually saw their stock prices fall in the next market session. Investors should take note!
Also remember, the indexes are capitalization weighted meaning that the larger companies have more weight in the index. A few large cap companies can keep the indexes high while the average stock stagnates. At this writing:
• The median DOW stock is down about 4% from its 52 week high; the median S&P 500 is off more than 7%;
• Only half of stocks are above their 50 day moving average; normally it is not a good sign when a stock pierces its 50 day moving average to the downside, much less half of the index!
Reconstruction
To the question of future growth fueled by reconstruction from the hurricanes:
• While rebuilding occurs, the economic activity that was there before is still non-existent;
• Reconstruction always takes longer than expected and has less of an impact than anticipated, oftentimes due to government (all levels) red-tape;
• There are a lack of construction workers currently holding housing back; where are such workers going to come from to rebuild Houston and the destruction on the east coast?
Conclusions
• The underlying economy is much weaker than the media admit; recent employment data, housing sales, auto sales, and bank lending bear this out;
• Q3 will show very weak economic growth, perhaps even negative;
• The bond market, usually a more reliable indicator of economic activity, is signaling a weakening economy;
• The internals of the stock market do not portend a continuation of the bull market;
• Those relying on reconstruction of hurricane damage to spur economic growth are likely to be disappointed.
Robert Barone, Ph.D.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Fieldstone Financial. www.FieldstoneFinancial.com .
He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (a AAA company) where he chairs the Finance and Investment Committee. Robert leads the investment governance program at Fieldstone Financial and is the head of Fieldstone Research www.FieldstoneResearch.com
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information
