Katrina--the Tipping Point?
by Comstock Partners, Inc.
Thursday, September 1, 2005
Our thoughts today are with all of the victims of Katrina. We hope that the survivors get all the help they need and that they will be able to resume their normal lives as soon as possible.
In the aftermath of hurricane Katrina it is still too soon to assess the near-term and long-term effects on the economy and the markets. There is still too much that is unknown, both about the extent of the damage and the time it will take to bring everything back on line. Having said that, however, what we do know is that the damage is extensive and that things will not return to normal for a long time. Since the storm, stocks have moved in a narrow range as bulls and bears appear to be about evenly split. Those who were bullish before tend to remain bullish, stating that the negative effects, like those of previous natural disasters, will be temporary; that the economy had been exhibiting strong momentum: that the money pumped in for reconstruction will be a positive; and that the Fed could help by not raising rates at its next meeting.
In our view the bullish case is just too good to be true. We believe that prior to the storm the economy was already on a slippery slope. The Fed was in a tightening mode that was reflected in the more than tripling of the funds rate (albeit from a low base), a substantial narrowing of the yield curve and a sharp drop in money supply growth. This is a lethal combination that has almost always led to a significant decline in growth or an outright recession. In addition energy costs were already rising sharply, housing is beginning to soften, consumer confidence is down, and auto sales are almost sure to drop substantially with the employee discount incentive losing its clout. Add to this mixture Greenspan’s increasing concern about soaring asset prices and his recent statement at Jackson Hole that “history has not dealt kindly with the aftermath of protracted low risk premiums”.
As for the view that the storm dislocations are temporary, it is too soon to say. Maybe that will be the case, but when we hear about the devastation to the oil refineries and all of the infrastructure involved in both manufacturing and distribution, it seems that we will not know how it will turn out for some time. The jury is also still out about any FOMC decision to delay or halt the rate hikes. In terms of impact Katrina is no ordinary storm, but is more like the oil supply shock of 1973 when OPEC cut off supplies. Since Fed action on rates can only influence demand, it can do nothing to alleviate the supply shortage—and jumpstarting demand in a supply-restricted situation can lead to increased inflation. We also do not buy the argument of those who point out how well the stock market has been holding up in face of the storm. As we recall, after OPEC shut the faucet in 1973, the market held up for three or four weeks and then collapsed by 19% over the next few weeks.
All in all, we believe this outside shock comes at a particularly inopportune time, when a number of factors were already indicating that the market was at an extremely risky juncture. While there’s still a lot of uncertainty about the post-storm situation, Katrina may well turn out to be the tipping point that trips up both the economy and the market.
© 2005 Comstock Partners, Inc.
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