“By Monday, the third straight day of flooding, the aftermath of Hurricane Harvey had left much of the region underwater, and the city of Houston looked like a sea dotted by small islands. ’This event is unprecedented,’ the National Weather Service tweeted. ‘All impacts are unknown and beyond anything experienced.’”
This summary from the New York Times gives some idea of the immensity of the storm that struck large parts of Texas/Louisiana last week, including the 4th largest city in the US. And this was before the second stage of the storm.
I worked in Houston for 2 years, living alongside the Buffalo Bayou which flooded so spectacularly last week. The photo above from the Houston Chronicle shows the area around our former home on Saturday, still surrounded by water. Today, as the rest of America celebrates the Labor Day holiday, the devastated areas in Texas and Louisiana will be starting to count the cost of rebuilding their lives and starting out anew:
Some parts of the Houston economy will recover remarkably quickly. It is a place where people aim to get things done, and don’t just sit around waiting for others to do the heavy lifting
But as Texas Governor Abbott has warned, Harvey is “one of the largest disasters America has ever faced. We need to recognize it will be a new normal, a new and different normal for this entire region.”
The key issue is that the Houston metro area alone is larger in size than the economies of Sweden or Poland. And as Harris County Flood Control District meteorologist Jeff Lindner tweeted:
“An estimated 70% of the 1,800-square-mile county (2700 sq km), which includes Houston, was covered with 1½ feet (46cm) of water”
Already the costs are mounting. Abbott’s current estimate is that Federal funding needs alone will be “far in excess of $125bn“, easily topping the costs of 2005′s Hurricane Katrina in New Orleans. And, of course, that does not include the cost, and pain, suffered by the majority of homeowners – who have no flood insurance – or the one-third of auto owners who don’t have comprehensive insurance. They will likely receive nothing towards the costs of cleaning up.
SOME PARTS OF THE ECONOMY HAVE THE POTENTIAL FOR A QUICK RECOVERY
Companies owning the large refineries and petrochemical plants in the affected region have all invested in the maximum amount of flood protection following Katrina, when some were offline for 18 months
Oil platforms in the Gulf of Mexico are used to hurricanes and are already coming back – Reuters reports that only around 6% of production is still offline, down from a peak of 25% at the height of the storm
It is hard currently to estimate the impact on shale oil/gas output in the Eagle Ford basin, but the Oil & Gas Journal reports that 300 – 500 kb/d of oil production is shut-in, and 3bcf/d of gas production
ExxonMobil is now restarting the country’s second-biggest refinery at Baytown, and Phillips 66 and Valero are also restarting some operations, whilst ICIS reports that a number of major petrochemical plants are now being inspected in the expectation that they can soon be restarted
Encouragingly also, it seems that insurance companies are planning to speed up inspections of flooded properties by using drone technology, which should help to process claims more quickly. Loss adjusters using drones can inspect 3 homes an hour, compared to the hour taken to inspect on roof manually. But even Farmers Insurance, one of the top Texas insurers, only has 7 drones available – and has already received over 14000 claims.
RECOVERY FOR MOST PEOPLE AND BUSINESSES WILL TAKE MUCH LONGER
For the 45 or more people who have died in the floods, there will be no recovery.
Among the living, 1 million people have been displaced and up to 500k cars destroyed. 481k people have so far requested housing assistance and 25% of Houston’s schools have suffered severe or extensive flood damage.
These alarming statistics highlight why clean-up after Harvey will take a long time. Basic services such as water and sewage are massively contaminated, with residents being told to boil water in many areas. The “hundreds of thousands of people across the 38 Texas counties affected by Harvey” using their own wells are particularly at risk.
And as the New York Times adds:
“Flooded sewers are stoking fears of cholera, typhoid and other infectious diseases. Runoff from the city’s sprawling petroleum and chemicals complex contains any number of hazardous compounds. Lead, arsenic and other toxic and carcinogenic elements may be leaching from some two dozen Superfund sites in the Houston area”
FEW IN HOUSTON HAVE FLOOD INSURANCE
Then there is the issue that, as the chart from the New York Times shows, most of those affected by Harvey don’t have home insurance policies that cover flood damage. Similarly, a survey in April by insurer Aon found that:
“Less than one-sixth of homes in Harris County, Texas, whose county seat is Houston, currently have active National Flood Insurance Program policies. The county has about 1.8 million housing units.”
As the Associated Press adds:
“Experts say another reason for lack of coverage in the Houston area was that the last big storm, Tropical Storm Allison, was 16 years ago. As a result, people had stopped worrying and decided to use money they would have spent for insurance premiums on other items.”
Even those with insurance will get hit by the low levels of coverage – just $250k for a house and $100k for contents. Businesses carrying insurance also face problems, according to the Wall Street Journal, as they depend on the same Federal insurance scheme, which:
“Was primarily designed for homeowners and has had few updates since the 1970s. Standard protections for small businesses, including costs of business interruption and significant disaster preparation, aren’t covered, and maximum payouts for damages haven’t risen since 1994.
The maximum coverage for business property is $500k, and the same cap applies to equipment and other contents, far below many businesses’ needs. And even those with insurance find it difficult to claim, according to a study by the University of Pennsylvania and the Federal Reserve Bank of New York after Hurricane Sandy in 2012:
“More than half of small businesses in New York, New Jersey and Connecticut that had flood insurance and suffered damages received no insurance payout. Another 31% recouped only some of their losses.”
Auto insurance is a similar story. Only those with comprehensive auto insurance are likely to be covered for their loss – and even then, people will still suffer deductions for depreciation. According to the Insurance Council of Texas:
“15% of motorists have no car insurance, and of those who do, (only) 75% have comprehensive insurance. That leaves a lot of car owners without any protection.”
In other words, around 1/3rd of car owners probably have no insurance cover against which to claim for flood damage.
HARVEY’S IMPACT WILL BE LONG-TERM
It is clearly too early, with flood waters still rising in some areas, to be definitive about the implications of Hurricane Harvey for Houston and the affected areas in Texas and Louisiana.
Of course there are supply shortages today, and the task of replacement will created new demand for housing and autos. But over the medium to longer term, 3 key impacts seem likely to occur:
It will take time for the supply of oil, gas, gasoline and other refinery products, petrochemicals and polymers to fully recover. There will inevitably also be some short-term shortages in some value chains. But within 1 – 3 months, most if not all of the major plants will probably be back online
It will take a lot longer for most people affected by Harvey to recover their losses. Some may never be able to do this, especially if they have no insurance to cover their flooded house or car. And those working in the gig economy have little fall-back when their employers have no need for their services
The US economy will also be impacted, as Slate magazine warned a week ago, even before the full magnitude of the catastrophe became apparent:
“For the U.S. economy to lose Houston for a couple of weeks is a human disaster—and an economic disaster, too….Given that supply chains rely on a huge number of shipments making their connections with precision, the disruption to the region’s shipping, trucking, and rail infrastructure will have far-reaching effects.”
US home ownership is back at levels seen briefly in the mid-1980s, and before that in the mid-1960s. One key issue today is that while the US population is still growing, the younger population has quite a different profile from the Boomer generation, as the Pew Institute have reported.
- In 1980, only 1 in 10 young Boomers were still living at home with parents
- But today we are “going back to the future”, with 1 in 5 young adults living at home with their parents, due to economic pressures
In addition, there is a growing trend for retiring Boomers to reverse the “flight to the suburbs” that they undertook in the 1960s/1970s, and instead return to apartment living in the cities.
As the second chart confirms, these trends are steadily reducing the demand for single family homes. Multi-family units are now (as in the pre-Boomer SuperCycle era) around one-third of total housing starts, and are likely set for further increases. This is not good news for industries or companies focused supplying the housing industry, as it means they are being hit by 2 adverse trends:
- Contrary to policymaker promises, housing starts have not bounced back quickly to subprime highs. In fact, they are continuing to disappoint as the support for new home building from shale gas and oil-related development disappears as migrant workers return to their home state. This is a major reversal for petrochemical demand as the average new home uses around $15,000 of petrochemical products. At its peak (when housing starts reached 2.1m in 2005) the US housing market was worth $31bn to the industry
- Even worse from the demand viewpoint is that the SuperCycle trend towards single family homes has sharply reversed. Starts for apartment living have doubled as a percentage of the total back to around a third, equal to levels seen 40 years ago. This trend towards apartment living further reduces potential chemical and polymer demand. Although no detailed analysis yet exists on this factor, due to its relatively recent appearance, estimates suggest each apartment only uses around 50% of the materials required for a single-family home.
The combination of these factors has had a major impact on US home-ownership rates. These were given a major boost under President Clinton in 1995, when he introduced his major housing initiative as follows:
“The goal of this strategy, to boost home ownership to 67.5% by the year 2000, would take us to an all-time high, helping as many as 8 million American families across that threshold”.
This target was maintained by President George W Bush. And in the subprime bubble, home ownership rose beyond Clinton’s target to reach 69.2% in 2005. But it has since fallen back to pre-1995 levels and the current figure of under 64% equals 1964 levels.
A major part of the problem is simple affordability. Younger people are the key demographic for home buying, as they constitute the critical first-time buyer group. But Pew data shows that 92% of recent population growth has been in minority communities, whose earnings are generally less than those of the white population.
US Bureau of Labor Statistics data show that while average annual US earnings were around $42,000 in 2015, there was a wide variation between the main racial groups:
- Whites earned $43,000 on average, and Asians $51,000
- But Blacks earned $32,000 on average and Hispanics $31,000
This means that the average ratio of house prices to earnings of 9.0x disguises a wide variation. Whites are close to the average at 8.7x, while Asians are below it at 7.4x. But for the younger Black and Hispanic populations, which are critical for driving first-time home buyer sales, the ratio rises to 11.6x for Blacks and 12.0x for Hispanics, based on US Census Bureau data for new home prices.
Unsurprisingly, latest National Association of Realtors data show the share of first-time home buyers is now at its lowest level since 1987 at just 32%, having fallen for the past 3 years.
What are companies and investors to do? As the infographic below describes, they have a clear choice ahead:
- They can either hope that somehow new stimulus policies will succeed despite past failure
- Or, they can join the Winners who are now starting to develop new revenue and profit growth by adopting demand-led strategies
These are the issues that we focus on in the Demand – the New Direction for Profit study. And since we published this just 2 months ago, it has become clear that the risks of assuming stimulus programmes will deliver their promised results are rising all the time.
US house prices have recovering for 3 years, as the chart from the Wall Street Journal confirms. It shows two lines:
- The dark blue line is money of the day: prices rose steadily from 1989, peaking in 2006 at 141% of 1989 value
- The grey line adjusts for inflation: “real prices” were negative until 2000, and peaked 51% higher in 2006
- Both prices then fell until 2012, since when they have staged a modest recovery, but are still below 2006 peaks
- Nominal prices are 8% below their peak, and inflation-adjusted prices are 21% lower
- Overall, the inflation-adjusted price of the average house has risen by just 20% over the 26 years since 1989
These, of course, are national figures, and the picture for individual cities can be different. Equally, other national indices such as those from the National Association of Realtors and the Federal Housing Finance Agency have different methodologies and provide slightly different results.
But this does not mean that today’s US housing market is the same as it was pre-2009:
- One key issue is that starts have virtually halved from their 2.3m peak in January 2006, to 1.2m in June
- A second is that the price data masks the changes that are taking place in the size of single-family homes
- A third is that the S&P index only measures single-family home prices, yet the trend is to multi-home living
SOMETHING QUITE FUNDAMENTAL HAS CHANGED IN US HOUSING MARKETS
These changes have gone largely unremarked by investors and companies supplying the housing industry. Yet they have enormous implications for future demand. They also help to explain the subdued nature of the recovery in US GDP growth since 2008, as housing is such a key part of the economy.
They are another sign of the major paradigm shift now underway in most consumer markets. The middle ground of “affordable luxury” is fast disappearing, as markets return to being segmented between high-cost luxury and and low-cost mass-market.
The size of the median US single-family home today is 20% larger than in 2000, at 2400 square feet (220 square metres), and 10% larger than in 2006. Builders of single-family homes have been responding to changes in demand, where sales of homes priced above $600k have trebled, whilst sales of those priced below $400k are down 16%.
The middle market is thus being squeezed quite hard, as the second chart confirms:
- It shows that a remarkable increase has taken place in the ratio of multi-home starts to single family home starts
- In 1989, this ratio was around 21%, meaning that 4 out of 5 starts were of single family homes
- The ratio then dropped to an all-time low of 9% in 1992, when 9 out 10 starts were single family
- Last month, however the ratio soared to 41% – if this trend continues, half of all starts will soon be multi-home
The future of the US housing market will thus be quite different from the past. Luxury homes are getting larger and more expensive: mass-market homes are more likely to be smaller – quite probably apartments – and less expensive.
And, of course, the new home market itself remains close to all-time lows. 2014′s volume of just 437k equaled 1981 levels, and was just a third of 2005′s peak of 1.283m.
Previous chairs of the US Federal Reserve had a poor record when it came to forecasting key events:
- Alan Greenspan, at the peak of the subprime housing bubble in 2005, published a detailed analysis that emphasised how house prices had never declined on a national basis
- Ben Bernanke, at the start of the financial crisis in 2007, reassured everyone that at worst, the cost would be no more than $100bn
So we must hope that current chair, Janet Yellen, has better luck with her forecast last week that:
“Looking forward, prospects are favorable for further improvement in the U.S. labor market and the economy more broadly”
The chart above will be key to the answer, as the outlook for the economy greatly depends on developments in the auto and housing markets:
Auto markets. From the outside, these seem to have recovered well since the 2008 financial crisis. But the National Auto Dealers Association suggested this month that sales have likely peaked, warning – “This is a cyclical industry, and there is no escaping the consumer cycle”. Prices also look to have peaked, with JD Power reporting these averaged $30,452. Buyers are only able to afford these prices due to the combination of low interest rates and extended loan terms, which now average a record 67.9 months.
A further threat to the market comes from increasing availability of used cars. Around 40 million of these are normally sold each year, dwarfing the new car market. But used cars have been in short short supply until recently, due to the post-Crisis collapse of new car sales in 2009-10. Today, however, used car availability is booming after the bumper new car sales of recent years, as a major dealer told the Houston Chronicle:
“Right now there are a substantial number of cars coming off lease, which is very good for us because at long last we have a nice supply of what we call lower-mileage pre-owned cars.”
Housing. As the chart confirms, home starts have not recovered to previous levels, but are less than half previous peaks. The reason is demographics – the purple period from 1973 – 1984 saw vast numbers of BabyBoomers buying their first houses, having children, and then buying larger houses. Greenspan’s ill-advised low interest rate policy in the 2000s failed to replicate this type of sustainable demand – instead, it simply allowed poorer people with poor credit ratings to buy houses they couldn’t afford, and ended up losing to foreclosure.
The latest data confirms that now a new trend is underway, where the Boomers downsize and move back into the cities from the suburbs. 41% of new home starts in June were multi-unit rather than single family, a near-record high, as Boomers and young people found condominium living more affordable. Even worse from Ms Yellen’s viewpoint is that the home ownership rate continues to fall, and at 63.7% is back at levels last seen 20 years ago. The rate for minorities is even lower at just 47.2%, and for Afro-Americans it is only 43.8%.
Ms Yellen’s problem is therefore two-fold:
- She desperately needs to raise rates in September, to avoid becoming involved in the political debate when the Presidential primary season starts new year. Yet both the IMF and World Bank have warned this would put the recovery at risk by causing the dollar to rise even further, thus reducing exports
- Her underlying theories on the economy continue to take no account of demographic changes. Common sense tells us that the arrival of a generation of 65-year-old Boomers with 20 years’ life expectancy must considerably change US growth potential. Equally important is that US fertility rates have been below replacement level since 1970 – meaning there are now relatively few people in the peak spending 25 – 54 Wealth Creator generation.
It therefore seems very likely that Ms Yellen has offered a hostage to fortune when forecasting that the economy will now finally recover.
Past performance is not always a good guide to the future, but it is the best that we have. Prudent companies and investors will therefore want to ensure they are not caught out a 3rd time if the Fed’s forecasts turn out to be wrong again.
Data over the past month continues to confirm my fears that the US housing recovery is going into reverse. The argument was summed up yesterday by S&P’s chairman, when reporting Case/Shiller housing price data for December:
“The housing recovery is faltering. While prices and sales of existing homes are close to normal, construction and new home sales remain weak. Before the current business cycle, any time housing starts were at their current level of about one million at annual rates, the economy was in a recession”.
Last month should have been a good month for the housing market, as January 2014 was marked by some of the worst winter weather ever seen in the US. Yet existing home sales last month were up just 3.2% versus 2014, and even fell 4.9% versus December’s already weak figure.
A survey by the National Association of Realtors highlights one key reason, that homeowners now tend to stay 10 years in a home before moving, rather the 7 years that was common in the past. The problem is that prices are too expensive for younger people, and so the percentage of first time buyers is now down to 28%, compared to the 40%+ level common when the market was booming.
Another key element is in the chart above, which shows home ownership rates since 1980 from the US Census Bureau. It highlights how increased home ownership became a national policy under President Clinton. He consciously aimed to boost home ownership, as he set out in 1995 when launching the new policy:
“It seems to me that we have a serious, serious unmet obligation to try to reverse these trends (of lower home ownership). As Secretary Cisneros says, this drop in home ownership means 1.5 million families who would now be in their own homes if the 46 years of home ownership expansion had not been reversed in the 1980′s.
Now we have begun to expand it again. Since 1993, nearly 2.8 million new households have joined the ranks of America’s homeowners, nearly twice as many as in the previous 2 years. But we have to do a lot better. The goal of this strategy, to boost home ownership to 67.5 percent by the year 2000, would take us to an all-time high, helping as many as 8 million American families across that threshold”.
The policy was continued after Clinton, as subprime lending to lower income groups took a major role in the housing market. But the peak home ownership rate proved to be 69% in 2004-5. Since then it has been sliding steadily downwards, and was back at 1995′s rate of 64% in Q4 last year.
It seems safe to assume this decline will continue. As January’s housing start data confirmed, there is now a clear new trend, towards multi-family housing, which is now 36% of the total – double the percentage in 1995. The BabyBoomers are moving back to the cities as they retire, and the decline in fertility rates means younger people have less reason to need a family-size home in the suburbs.
Some of these trends were obscured during the energy bubble of the past few years. Hundreds of thousands moved to work in the oil and gas producing states, and naturally created major demand for new housing. But now even that support is being reversed as well, as I discussed last month, as oil prices return to historical levels.
We now have full US Census Bureau data for housing starts in 2014, which shows:
- Starts returned to the 1m level for the first time since 2007
- They were also nearly double the low of 554k seen in 2009
- But at 1.006m, they were less than half of the 2.068m peak in 2005
The data also confirms the dramatic swing away from single-family homes towards multi-family apartments. These were one-third of total starts in 2014, around double the average seen between 1989 – 2007, and back to levels last seen around 40 years ago – before the BabyBoomer home boom began.
The data is also a sign of the overall decline in home ownership levels, which at 64.4% are back to 1995 levels, when records first began. As with employment, there is also a major divide between ownership rates for the relatively wealthy White population at 72.6%, and those for the poorer Hispanic (45.6%) and Black populations (42.9).
Equally significant is the data for the major regions in the US since 2009, as the chart above shows:
- The largest gain has been in the South, which averaged 500k starts in 2014 versus 260k in 2009
- The West also saw a large percentage gain, with starts doubling to 235k in 2014 versus 115k in 2009
- Gains in the North East and Mid-West were more modest at 50k and 65k respectively
As the map from the US Energy Information Agency on the right shows, 3 of these regions have also seen strong growth in oil/shale gas-related activity.
It highlights the 7 most prolific areas, responsible for all domestic natural gas production growth, and 95% of all domestic oil production growth, between 2011-2013.
Clearly it would need more detailed study to directly link this data with growth in housing starts. But we do know that workers have flocked to these regions in search of jobs.
Separate Census data shows that Houston had the 2nd fastest growth in population in 2013 (after New York), and Texas had 3 of the top 10 cities in the list of fastest growing cities.
And according to the Census, Texas added more housing units than any other state as a result.
But now, the boom is turning to bust, and companies are laying off workers – particularly in labour-intensive areas such as drilling and support services. Major job losses are already underway at Schlumberger and other key employers.
We won’t know till March or April just how bad the hit will be to housing. But it seems more than likely it will end the recent recovery in housing starts, taking 2015 levels back below the 1m level again.