Looking Beyond the Hurricanes
Hurricanes Harvey and Irma are devastating. Our hearts go out to those impacted by them.
Our job is to look beyond the near-term negative implications of the hurricanes and focus on the longer term economic, political and investment impacts of not only hurricanes but of all events. So, let’s do that.
The early estimates are that the combined amount needed to rebuild from the devastation of both hurricanes could easily exceed $300 billion and that does not include loss of work, like a plant or a business shut down for weeks or months. Rebuilding will take years.
While the near-term negative impact will be swift and will penalize growth over the next few quarters, the economic gain will gradually build and offset the loss to growth most likely by the beginning of next year and grow beyond adding to economic growth in 2018, 2019 and even 2020. Most importantly, these events increase the odds of Trump passing his tax reform bill and infrastructure programs. Already we have seen the continuing resolution passed tied to an initial Hurricane relief bill as we anticipated last week. It is important to note that Trump reached out to the Democrats for support and received it rather than from the hard right wing Conservative Republicans. Maybe this is a sign of things to come!
The financial markets paused last week to recalibrate considering the anticipated impact of Harvey and Irma on our economy and the financial markets. As you would expect the bond market rallied due to the near-term negative impact to growth from the storms. The dollar weakened too for the same reason and there was continued rotation in the stock market. The Fed clearly is on hold for now assessing the impact of both hurricanes on the domestic economy.
Paix et Prospérité continued to outperform last week. For example, we had bought back Home Depot a few weeks ago. We took advantage of the market over-reaction to Sears selling its appliances over Amazon and bought Home Depot down around $145/share. It is now $160 with more gains to come. Taking advantage of market foolishness is what we do best. We even did not anticipate the hurricanes at the time but no company stands to benefit more from them than Home Depot.
Let’s take a look at what occurred economically, financially and politically around the globe and the implications for successful investing:
- Economic data reported for the U.S. last week was on the whole quite strong: August Non-Manufacturing Index grew for the 92nd consecutive month to 55.3%; business activity index increased to 57.4%: new orders index rose to 57/1%; the Employment Index rose to 56.2% and even the Price Index increased by 2 percentage points to 55.7 percent. It gets even better as the IHS Market Services index hit a 21-month high of 56.0. On the other hand, the U.S. trade gap widened slightly to $43.7 billion in July as exports fell 0.3% while imports declined 0.2%. Also wholesale inventories rose more than expected in July such that the inventory to sales ratio rose. Finally there was a slight bump up in second-quarter productivity to a 1.5% gain.
The Fed’s Beige Book came out and supported continued economic growth albeit with low inflation and more moderate employment gains. Before the impact of the hurricanes, it appeared that third-quarter growth would be about 3% but that will most likely be reduced as well as fourth-quarter growth as business is penalized in Texas and Florida. I expect the Fed to be on hold for the rest of the year, but it is now a flip of the coin whether they begin to slowly unwind their balance sheet in September as many assume.
- Draghi and the ECB face a difficult situation as economic growth is coming in above initial forecasts for 2017 but inflation is falling far short. The real issue facing the ECB is the strength of the Euro, up 14% year to date versus the dollar and its potential dampening effect on future growth and inflation if it continues to gain further. The ECB raised its growth forecast for 2017 to 2.2% but lowered its inflation forecast for 2018 to 1.2%, which is well below the ECB target of 2.0%. Eurozone growth is projected to be 1.8% in 2018 and 1.7% in 2019 with inflation rising to only 1.5% by the end of 2019. Near-term economic weakness in the U.S. due to the hurricane impacts can only exacerbate the ECB dilemma as the Euro can rally further for now. The ECB is on hold!
- China’s economic data continues to support growth over 6.5% in 2017. The yuan has continued to rise this year, which should put to bed Trump’s view that the government was pushing it down to support its exports. It is not surprising that August imports beat expectations while exports fell slightly short of forecasts although still rising 5.5% year over year in dollar terms and 6.9% in yuan terms. China’s trade surplus was nearly $46 billion for August. China’s service index rose to a multi-month high of 52.7 in August while the composite manufacturing/service index increased to a six-month high. Don’t cry for China as the country is in great shape.
What are the investment implications of all of the above?
It is clear the U.S. economy will be negatively impacted near term by the hurricanes over the remainder of the year, but the rebuilding of both Texas and Florida will add to growth over the next few years. It also means that the Fed is on hold for now. We don’t expect another rate hike until the beginning of 2018, which will put added pressure on the dollar.
Corporate profits will be hurt on one hand by the slowing near term in the domestic economy but the multinationals will gain even more from a weakening dollar in translation of foreign profits. Clearly all stocks are not equal and there will be winners and losers due to the hurricane and its many implications for investing. For instance, while the financials may suffer from a flattening of the yield curve near term, growth in lending from rebuilding Texas and Florida will boost loan growth and the yield curve will begin to steepen as the net economic gains from the hurricanes more than offset the near-term weakness.
Trump and all members of Congress must come together and address the need to rebuild Texas and Florida. It will be very difficult for any member of Congress to vote against a tax or infrastructure bill that will assist our economy, create jobs and rebuild a stronger America under the guise of the punitive impacts to our economy caused by the hurricanes. Trump reached out to the Democrats to get the continuing resolution passed to the consternation of the far right and he might do the same to get votes to pass his pro-growth, pro-business agenda too. How could any Congressman vote against it now and run for office in 2018?
A successful investor must look beyond the near-term negative impacts to our domestic economy caused by the hurricanes and look instead over the valley at the potential real gains that are likely to occur. Look through that windshield rather than back through the rear-view mirror. The likely beneficiaries remain the large, city centered banks, the U.S. domiciled global industrials; low cost industrial commodity companies benefiting from growth in demand, little capacity additions and a weak dollar; technology at a fair valuation and special situations that are one off like Home Depot.
So remember to review all the facts; step back, pause, reflect and consider mindset shifts; analyze your asset composition and risk controls; do independent fundamental research and…
Paix et Prospérité LLC