Hurricane Harvey To Impact GDP

We are in a new world this year in terms of the economic recovery. This year we’ve seen earnings beating the estimates from before the bar was lowered a few weeks before the reports. For the past few years we saw estimates lowered and the lowered estimates beaten. It was a game of misdirection as the beats were meaningless because the bar was lowered so much. The improvement this year makes this recovery seem real after it was phony for so long.

We saw the same downgrades to expectations for GDP reports in the past few years as you can see in the chart below. The estimate for 2015 GDP growth was an unrealistic 3.5% before tumbling down to 2.5%. Now, for the first time in 4 years, the GDP estimates are increasing for both 2017 and 2018. The estimates for 2018 are tough to put much weight on because it’s so far in the future. However, the 2017 estimates are real as the Q2 GDP revision came out today showing GDP grew 3.0% instead of the 2.6% initially reported. You can argue this means the initial guesses in March about Q2 GDP were right, but that’s a false comparison because the projections are for the first estimate of GDP. It’s a silly way of looking at GDP because the third revision tells us the real numbers. The reason it’s done this way is instant gratification. If the projection was for the third revision, you’d need to wait 3 months to see if the prediction was accurate.

This means about half of the GDP information is in which makes the 2017 estimate for 3% GDP growth seem achievable. Bears are now saying the first half GDP growth was 2.14% and the average from 2010 to 2016 was 2.14%. That is accurate, but it ignores the large turnaround from last year and the heightened expectations for Q3 growth. If 2H GDP is 2.15% or higher, this year will see above average growth. There’s still a lot of information left to be reported, but it would be wrong to ignore the recent acceleration in growth. The only obstacle in the way of a great year is the possible effects which might be coming from Hurricane Harvey.

Let’s now take a dive into what the hurricane’s economic effects will be. As previously mentioned, the Houston area represents 3% of the American economy. The table below shows the breakdown of the areas affected and their contributions to the economy’s total employment and GDP. The biggest determining factor for how much of an impact this storm will have on the economy is how long it takes to rebound from it. That’s the biggest unknown because it hasn’t happened yet. The Corpus Christi area should be the quickest to rebound because it dealt with more of the wind impact and less of the flooding impact which takes longer to recover from as the water needs to recede. Unfortunately for the economy, Corpus Christi has a small share. The Houston area, which has the largest economic impact, also has the most work to do to rebound as it dealt with some of the highest rain totals.

Citi estimates that if the affected areas shut down for a week, that would be a 0.06% impact on GDP. On an annualized quarter over quarter basis, the impact would be from 0.2% to 0.3%. This estimate is intentionally low because it’s impossible for the impacted areas to fully recover in one week. There will be a few months where the economy is running below full capacity. Insurance firms have said the property destroyed is equal to $20 billion or 0.1% of GDP. AccuWeather says the storm will have a $160 billion impact which is 0.8% of the economy. That estimate would be over several quarters.

It’s important to recognize that GDP impacts aren’t the main area of concern as a result of this storm because GDP will eventually rebound and even be boosted sometime in 2018 from rebuilding efforts. If GDP growth were to come in below 2% in Q4 because of the storm, stocks would recognize that it is temporary and not selloff. The biggest issue is getting people’s standard of living back to normal and limiting the shutdowns refineries are seeing to keep the energy market flowing. Currently we’re seeing a divergence between Brent and WTI as WTI is being hit by the fact that much of the oil in Texas can’t be exported.

Just because GDP doesn’t reflect the economic damage from the storm doesn’t mean it’s not important. Let’s review the changes in the latest Q2 revision. As you can see from the chart below, there were upward revisions to PCE and nonresidential fixed investment. There were downward revisions to state and local government spending. As you can see, this was the fastest GDP growth rate in two years. There still might be more revisions, but this is a decent depiction of where the economy was in Q2. Just to be clear, the consensus estimate was a revision to 2.8%, so this update beat that guess.

Conclusion

The economy is in great shape as of August, but we will begin to see the hurricane affecting reports soon. One big issue which I didn’t mention is that there might be a labor shortage in Texas as far as getting enough workers to rebuild the area. Obviously, there will be some volunteers, but much of the work will be done by construction companies. Houston already had a tight labor market before this storm, so it will only get tighter. There also will be some people who can’t work because they don’t have adequate transportation.

In terms of the stock market, part of the reason the main indices have been moving higher is because Apple stock has been skyrocketing. Apple is an $815 billion behemoth, so it moves the market when it rallies. There’s not much to say about it as it’s rallying on the hype surrounding the new iPhone which will be announced in two weeks. It’s probably time to take profits in the next few days since the unveiling is close. Usually it sells off after the announcement.

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