2017/08/31 Commentary: When It Rains…
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Extended Trend Assessments reserved for Gold and Platinum Subscribers
Commentary: Thursday, August 31, 2017
When It Rains…
…as the old saying goes, “…it pours.” And if you happened to be in Houston, Texas over the past week it pours and pours and pours. That was due to Hurricane Harvey making landfall last Saturday morning only to get stuck between eastern and northern high pressure areas, and hover over the southeast Texas coastal around Houston. Yet its impact as a hurricane was only a relatively modest beginning of overall highly destructive activity. Because this is not hot news, we will be brief with summary details that led to some conclusions about the markets we will explore first, and return to more discussion of the somewhat horrific facts concerning Tropical Storm Harvey (which it became once it stalled after making landfall.) However, before returning to those details the opening graphic (courtesy of Photo Grid) speaks volumes about just how much water was dropped on the Greater Houston area and some key points east.
In fact, the US National Weather Service had to upgrade the color coding on its maps of actual and predicted rainfall amounts. As it noted on Monday, “We've had to update the color charts on our precipitation graphics in order to effectively map [Tropical Storm Harvey]." It added that the new scale “…resets that dark purple color to denote 15-20 inches of rain — and tacks on two more lighter shades of purple to denote 20-30 inches and greater than 30 inches." It is important to keep in mind those are for daily rainfall, and cumulative totals in Houston reached a record of over 50 inches.
Yet market responses are not necessarily consistent between asset classes, especially on the US equities taking the long view of Hurricane Harvey’s impact as it evolved into a sustained tropical storm. They seem to reflect the likely economic strength to follow on a major rebuilding effort. Yet that has not weighed very much on govvies, which seem to be more so discounting the likelihood of near term economic weakness on the struggle to rebound from damage to a significant portion of the fourth largest US city. While the US dollar recovery seemed to reflect economic strength from major rebuilding, late week it is fizzling into nothing more than a bounce from key support (more below.)
Authorized Silver and Sterling Subscribers click ‘Read more…’ (below) to access the balance of the opening discussion. Non-subscribers click the top menu Subscription Echelons & Fees tab to review your options. Authorized Gold and Platinum Subscribers click ‘Read more…’ (below) to also access the Extended Trend Assessment as well.
NOTE: REVISED 2017-08-31: Like many others, we were encouraged by the likelihood the US economy would get the structural reform we (along with Mario Draghi and others) had been loudly complaining was not forthcoming since our dual It’s Lack of Reform, Stupid posts in January 2015. Since our December 8, 2015 Extended Perspective Commentary we were concerned about various factors that included continued high taxes and more regulation (i.e. under Clinton) that might have meant a continued weak, or even weaker, US economy. It was hoped Donald Trump’s election would change that. However, much like the estimable Ray Dalio (see our August 24th Commentary: Trump Troika post) and others, we are now very concerned that the US President’s diminished relationship with the Republican Congress will mean his tax reform and infrastructure spending agenda will have trouble getting passed into law. And that will quite possibly be a problem for any US economic acceleration, and high-priced US equities.
[Thanks to Photo Grid for use of the opening graphic.]
▪ As a summary view on an influence for all EQUITIES, US equities getting back up near their all-time highs after pushing above post-Yellen Congressional testimony push to a new high, September S&P 500 future exceeded June’s 2,451-46 congestion highs and held it as support into mid-July. As recent trading has confirmed, 2,451-46 congestion (also weekly MA-9 & MA-13) remains a key area, and pushing back above it late Wednesday is a constructive sign.
Yet as noted previous, there is now heavier higher resistance from three weeks ago after the failure from above the previous 2,475-80 resistance left a fresh weekly DOWN Closing Price Reversal (CPR.) That reinforced the importance of the 2,475-80 resistance at which it has failed repeatedly in the short term. The previous week’s 2,472 Close is the DOWN CPR signal, with a Tolerance to the 2,480.50 late-July trading high.
As also noted previous, there always were more major lower supports. The most prominent among them is 2,405-00 late-February through mid-May congestion, which would also be a retest of the major top from the March trading high. Along the way there is also weekly chart up channel support (from the late-March low) at 2,420 tested last week, and up to 2,425 this week that held on Tuesday.
▪ The GOVVIES are also very interesting, as weaker sister September T-note future once again lagged by only testing its mid-June 127-18 high on Tuesday morning’s squeeze prior to falling back. Yet even it is still holding above previous resistance in the 127-00 area. And the indication of its greater resilience on the current equities rally is clear from that activity into no worse than the 127-00 area. The last time the September S&P 500 future was into this higher resistance the September T-note future was down in the low 126-00 area. As noted above, this is likely due to the govvies discounting the near term US economic weakness from the Tropical Storm Harvey impact.
And upside leader September Bund future remains well out above 164.00-.50 congestion even if it only neared the major 166.00-.50 congestion on Tuesday morning’s squeeze to the new high for this rally. The continued aggressive ECB asset purchase program means that the Bund is likely to be well-supported on selloffs. And there is now 163.50-.00 interim support this side of 162.50-.00.
▪ FOREIGN EXCHANGE remains a critical area as well. Most interesting is the US Dollar Index holding a new low for the current overall selloff on Tuesday morning which was below its 2.5 year .9191 May 2016 trading low. Since then it has rebounded to higher on the week (i.e. above last week’s .9252 Close), creating the potential for an UP Closing Price Reversal (CPR) from that level if it can remain well above it for this week’s Close.
And the operative term there is of course “well above.” After trading almost a full point lower on the week into that Tuesday morning new low for the current overall selloff, it rallied to .80 higher on the week this morning. Yet it faded to Close Thursday no better than marginally higher on the week. If it can strengthen back above .9300 for Friday’s Close, it would seem to be a somewhat credible UP CPR. Yet if it is only marginally higher on the week by Friday’s Close (or even worse down into lower on the week), the attempted upside reversal will be suspect as only a nervous bounce from the major low.
Similarly, upside leader EUR/USD rallied to next resistance in the 1.2000 area Tuesday morning after pushing up out of its several week consolidation in the 1.1800 area. Yet it is also now back below last week’s 1.1920 Close, yet not by that much as it attempts a (mirror image to the US Dollar Index) DOWN CPR if it remains well below it for this week’s Close. Yet there is quite a bit of lower support, especially into the violated 1.1700 area August 2015 2.5 year high that was not quite reached on the early August correction. While the other developed economy currencies and emerging currencies are also experiencing downside reactions against the greenback, these are also not definitive trend reversals for now.
The Full Harvey Impact
While we will be extensively exploring various subsets below, the most major aspects that will affect the southeast Texas recovery from Harvey are residential housing and small business problems. Yet to be fair, we must first make clear that roughly 85% of Houston is in fine shape, and did not experience any flooding. That may sound odd in the context of media coverage and extent to which some major businesses (like oil refining) are based in the heavily impacted areas that may take weeks or longer to fully recover.
In fact, due to southeast Texas (and especially the Houston area) being a regional watershed where much of the excess area rainfall drains, the problems in its lowest environs will surely last for another 2-4 weeks. This is why even after Houston skies turned sunny into Thursday, additional areas that did not flood during the record heavy rainfall were issued evacuation orders.
That is due to the overall water flow over filling various reservoirs as water flowed in from points north, causing levees and nearby rivers to overflow into previously spared neighborhoods. And areas of Houston and southeast Texas that had never flooded previous did so during Tropical Storm Harvey, including some fairly up market neighborhoods in addition to middle- and lower-class housing.
And in those ‘never flooded before’ areas we can be sure of one thing: nobody there had flood insurance, because their area was not rated for it. That is in addition to the fact that based on the historic record it is probable that nobody in those areas would have bought it, because they had no reason to suspect they needed it.
‘Housing Destroyed’ Likely to Climb
The early estimates were that roughly 50,000 homes would be damaged by Tropical Strom Harvey (TSH.) Yet based on the additional flooding due to reservoir levee overflows and rivers spilling over their banks that is now up to 100,000 homes damaged, and there is already an acknowledgement that 7,000 homes have been destroyed.
Yet that latter number is based mostly on what was damaged during the category 4 hurricane phase of this storm making landfall, and the homes that were hit so hard by the winds of 100 miles per hour and more. However, when we noted above that the problems in its lowest areas will surely last for another 2-4 weeks, that includes some degree of continued flooding that leaves homes and businesses with significant standing water.
And while it does indeed sound odd that weeks after a storm the water levels could remain that high, once again this includes the southward flow of the flood waters that are going to continue to impact Houston and the southeast Texas coast areas. So let’s consider a few things about standing water and typical housing and business building construction. (This excludes the more major industrial facilities like refineries, where the corporations were enlightened enough to spend the money on ‘hardening’ their sites against the remote potential for the ‘1000 year flood’.)
Concrete is wonderful stuff. Extremely durable under most conditions, it has been used from as far back as the Roman Empire to construct major, lasting buildings. While quite a bit of the fancy marble cladding was removed over the centuries, the Coliseum in Rome was basically built of concrete. The roman’s breakthrough was to add volcanic ash that prevents cracks from spreading. While modern concrete is somewhat different, it is still used because of its durability.
Modern concrete based on Portland cement is also very durable, yet is based more so on readily available, cheap limestone and other shales, sand and gravel. However, it is more vulnerable to weakening if there is prolonged full saturation with water. Especially any building foundations or elevated structures which happen to have any cracks (which quite a few foundations develop) are prone to erosion of concrete that weakens the structure.
So in the case of the areas of Houston experiencing sustained flooding there will be a question over whether the foundations of those residences and commercial buildings are sound enough to allow for the renovation or reconstruction of the rest of the structure. While not meaning to play Cassandra on this, if the foundation is significantly weakened, the entire building is useless, as no upper level repairs are worth making.
In that case the entire building right down to the foundation must be demolished to make way for a complete replacement, literally from the ground up. Even getting enough professional inspectors into the area to perform the necessary tests is going to be a real challenge if the estimate of 100,000 damaged homes (and we presume that does not include commercial structures) is accurate. The inspections and tests will take months after the water recedes. Yet even if there are a relatively small percentage of foundations and elevated concrete structures that are classified as failed and needing to be demolished (i.e. the building moves into the ‘destroyed’ category), there are even more prominent problems and pervasive risks…
Mold and Mosquitos
We need to allow that any home or commercial building which needs to be taken fully down to the studs to be rehabilitated after water damage has not indeed been ‘destroyed’ as such. Yet in those cases (which are very widespread) as well there are considerations of whether it can indeed be ‘cured’ of the problems associated with sustained soaking in standing water. And as was the case when Hurricane Katrina impacted New Orleans and the surrounding area, this is the South and it is still late summer… and hot.
Take a mix of water saturation and heat and what do you get? Mold. Anyone doubting the potential for this merely needs to reference the short term Houston weather forecast. Not surprisingly into early September the daily highs will be in the mid 80 degrees Fahrenheit to 90 degrees, which will also cause a major mosquito population surge. That will be another challenge facing any returning residents or reclamation workers. One of the main staples the community is asking for from donations is bug spray to ward off mosquito-borne illnesses like West Nile Virus.
And mold is extremely pernicious in terms of its resilience and negative impact on human beings’ health. It is such a key element of the viability of any hole that almost all jurisdictions in the US require homeowners to reveal any episodes with it when they got to sell their homes, and any credible house inspector who suspects it is present will run tests for it. The bottom line is that nobody would want to live in a house that has a mold problem, and any residence or commercial property with it cannot be sold.
It basically diminishes the values of those structures in way that effectively means they have effectively also been moved into the ‘destroyed’ category. Even allowing there are methods to ‘treat’ mold in most buildings, that is more problematic where the wood of the building frame has been immersed in water to the point where it remains wet. And even in those cases where the mold mitigation can be performed, it is a very extensive and expensive repair to take the building down to the studs (effectively eliminating everything except the frame and exterior walls) prior to effective mold treatment.
Contaminated Water
The other compounding toxicity factor is contaminated water. It’s kind of disgusting to think about it, but along with other industrial facilities sewage treatment plants were also completely flooded by TSH. And as such, there are the typical contaminants from effluents in all of that standing water in addition to the various chemicals from major plants as well as local sources. That includes petrochemicals as well as simple things like home and commercial detergents, solvents and other chemicals.
Those can also be mitigated once the true recovery effort begins. Yet that likely includes additional remediation steps in addition to the mold treatment, and once again that means more time prior to full recovery for the 15% of the Houston area and even higher percentages of the heavily inundated towns to the east (more below.) So the question is how many of these buildings that have extensive sustained standing water much of which is contaminated are going to be saved?
And how much of this will effectively represent a time consuming and expensive decontamination and complete rebuilding of the structure, even if that is outside of having a failed foundation that would add that building to the ‘destroyed’ category? The answer is almost all buildings that are now either totally or partially under water. And that is quite a few when one considers that…
Houston Is Not New Orleans
The lack of preparation and effective response from local and federal authorities when Hurricane Katrina hit New Orleans twelve years ago turned it into an immediately worse human tragedy than TSH. Due to the rapid flooding during the initial phase of Katrina there were initially 1,400 deaths. That grew to roughly 1,800 across time. By comparison TSH has only caused approximately 40 deaths so far.
Even though that number is expected to rise, the heroic evacuation and rescue efforts of the local, state and federal authorities have stopped this from being much worse. And the efforts of local neighbors along with the assistance from good Samaritans from other states (especially Louisiana’s ‘Cajun Navy’ of private boaters) have been of great assistance to the authorities whose teams had more than they could handle due to the sheer extent of the rainfall and rising water levels.
While Katrina caused massive flooding in a local area when a levee was breeched, once that was repaired and the pumps were able to remove the water, there was the opportunity for a fairly rapid recovery. And in any event, New Orleans is a much smaller city.
Its population has just recently grown back to the pre-Katrina level of almost 400,000, with a metropolitan area of roughly 1.25 million people. On the other hand, the city of Houston has a population of 2.3 million people with a metropolitan area population that expands that to 6.5 million folks. And this does not include other important southeast Texas coastal cities like the also heavily flooded Beaumont and Port Arthur roughly 90 miles to the east of Houston (where much of the TSH damage occurred.) That adds another couple of hundred thousand people as well as key businesses.
Major Business Impact
Which gets to the point of the sheer major business impact of the combined area, even if that may be addressed in a relatively short time (estimated to be 2-4 weeks.) This is not to diminish the importance of the TSH impact on all of the small and medium size businesses in Houston and southeast Texas, which will weaken the economic performance of that region as they either struggle to reopen, or decide it is not worth it and close for good.
Yet on the major business front that impacts the rest of Texas, the US and the global economy, there is Exxon-Mobil’s Port Arthur Motiva refinery. That is the largest in the world, processing 600,000 barrels of crude oil per day. It is now completely shut down, and the company says it will remain closed for up to two weeks. The French-owned Arkema chemicals plant 20 miles northeast of Houston is warning of explosions of its organic peroxides inventory after three different power backups failed. That is causing temperatures to rise to levels where these chemicals are unstable.
And the story is repeated again and again in the refining industry, as various plants are closing to prevent damage to equipment and risk to staff. The area has such a concentration of major refiners that their rightful precautionary steps leaves 25% of US crude oil refining still shut down even as the sunshine returns to Houston. In addition to the impact on the Houston area, it significantly limits gasoline and airplane fuel supplies to the rest of the US where prices are already rising.
The Cost-Benefit Analysis
That is a bit of a tongue-in-cheek title for this section, because there is obviously no outright benefit to this situation… only costs in the near term. Yet as part of totaling the costs the benefit side that the equities seem to be counting on as the major silver lining for what was a massive dark becomes clear as well. So just how destructive has Hurricane and Tropical Storm Harvey actually been with its all-time record US storm rainfall of 51.88 inches?
[First a brief as anecdote on just how shocking this was. When various veteran media meteorologists cited the potential for even 40 inches of rail due to the heavily predicted nature of the storm, many of the regular news people on those shows seemed a bit shocked, and mentioned they had never heard anything like that.
And they were right insofar as previous hurricanes and storms that were predicted to drop between 15 and 20 inches of rain had always been considered as massive and potentially catastrophic. And the response of the veteran meteorologists who had been in business for 20 or 30 years was they had never heard of anything like this either. Hence the need for the US National Weather Service to revise rainfall level map colors as noted above.]
When Hurricane Harvey first hit the economic loss estimates were in the vicinity of $70 billion due to initial rainfalls and the wind damage associated with a category 4 hurricane. However, as the rainfall totals rose as aggressively and more so than the TSH estimates, those estimates ratcheted higher. At the time of this writing (late Thursday afternoon) the economic loss estimate is $190 billion.
By comparison the total economic loss bill for Hurricane Katrina was $108 billion (in part as noted above due to New Orleans smaller size), while Superstorm Sandy reconstruction cost $65 billion. It is therefore most interesting that the massive rainfall from TSH has incurred more estimated damage than the combined total for Katrina and Sandy. Yet that is what seems to be buoying the equities at present on the expectation of that massive rebuilding effort to replace most of that loss.
Considering the factors noted above, the TSH damage and cost is no surprise in the context of 500,000 people being displaced from flooded homes; leaving room for that total to rise on additional rescues and evacuations of folks still trapped in their homes or neighborhoods. And in addition to the great amounts wiped out through the impact on housing and business structures, estimates for the destruction of cars and vans is currently also at 500,000 with a likelihood that will rise as well.
This will amount to a massive bill for not just the extended reconstruction and relocation, as while those lengthy efforts are in process all of those displaced people will need to be housed and fed and provided living essentials. This is the first phase of what one disaster relief official summarized as the hierarchy of sustenance, power (as in restore electricity and natural gas availability), cleanup and rebuild.
Stimulus By Any Other Name
And guess who gets to pay for all this: the US government. There will be some squabbles in Congress over whether some relief and rebuilding funding is not being well spent. However, in the final analysis Houston will not be abandoned by the US government. It is far too important an industrial and refining center and transshipment point for the global energy business to even consider for a moment it can be allowed to be diminished.
And as all of this now ties in directly to the need for the administration and Congress to meet critical deadlines, expect the initial phase of federal relief for Houston to be passed without any problem. And most critically that will be linked to a temporary US budget agreement to allow Congress more time to finalize the actual budget for the year, and also the next rise in the US Debt Ceiling.
There is aversion to a ‘clean’ debt ceiling increase by Republican fiscal conservatives, who want to require some spending reductions as the price for the hike. Yet under the circumstances (including Congress having wasted so much time responding to the bombastic pronouncements of the President we have noted previous) all of these imminent deadlines mean there will not be enough time to work out more elaborate compromises which might reduce spending. And the Democrats are of course adamantly opposed to that in any event.
And the other factor playing into the ultimate amount of US federal spending or low-cost loans through the Federal Emergency Management Agency (FEMA) is the degree to which insurance will not cover any major portion of the damage. Even for those who have flood insurance, the coverage tops out at $250,000. That is not enough to replace most middle market homes in a strong housing market like Houston and southeast Texas.
And as noted above, there are very many folks who through both a lack of availability and perceived lack of need in areas that had never ever flooded before that do not have any flood insurance at all. And this is especially in pricier home areas, which were in part so attractive because they were not affected in previous hurricanes and storms. And while that cost of remediation (as example for $1,000,000 homes) will be borne by the owners, that will be with low interest rate loans that create a cost for the US government.
While the loss is indeed catastrophic, and it may take some time for the southeast Texas economy to return to ‘normal’, there is that ‘benefit’ along the way. It is the form of all that additional spending by the US government to underwrite the process of getting folks into reasonable living situations (pending possible return to their permanent residences) and back to work at their reclaimed businesses.
That is likely the reason gold is back above $1,300 per ounce, with the Fed quietly cheering from the sidelines even as the near term economic drag leaves it more circumspect at present. Yet for now expect the market tendencies noted above to prevail on the equities expecting that government spending surge and more circumspect Fed to continue to fuel the last eight years of the financial bull. Yet the short-term drags are also keeping govvies firm, and US dollar problematic as questions on the economy remain.
▪ The Extended Trend Assessment with full Market Observations will be updated after Monday’s European Close to fully assess how various markets perform in the wake of any further developments over the long US Labor Day holiday weekend. That will obviously include any further developments on Harvey’s impact on southeast Texas, any potential intensified return of the North Korean situation and the somewhat less critical impact of Friday’s extensive economic data that includes both global Manufacturing PMI’s and the US Employment report.
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