Storm Casts Uncertainty Over Markets
When investment advisor Ross Gerber of Santa Monica met with a client on the morning of Aug. 29, he offered an optimistic outlook on the U.S. stock market for the coming months.
“But I always tell people, ‘It’s so hard to predict the future,’ ” said Gerber, vice president of Independent Capital Management Inc.
In the hours after that meeting, it slowly became clear that Hurricane Katrina was far more devastating than initially thought -- underscoring Gerber’s point.
“Everybody in my business has thrown out their predictions,” he said. “The entire structure of the economy has changed overnight.”
As the stock market enters the final months of 2005 with the major indexes almost flat year to date, the only consensus on Wall Street seems to be that all bets are off.
By one estimate, Katrina will result in economic losses of $100 billion. Whatever the ultimate toll, analysts say it is sure to affect three of the key factors driving this year’s choppy stock market -- energy prices, corporate earnings and interest rates. How deeply, and for how long, remain to be seen.
Even before Katrina, which left energy production and refining facilities in the region out of commission, economists and investment strategists were wondering how U.S. consumers would react to oil at $65 to $70 a barrel and gasoline prices at the pump above $3 in some areas.
Now, if supply shortages caused by the disaster push crude oil toward $80, there is a growing likelihood that consumers will be forced to curtail spending in other areas, said Barry Hyman, strategist at investment firm Ehrenkrantz King Nussbaum Inc. in New York.
Households will be further pressured by winter heating bills that are likely to be twice as steep as last year’s, along with price hikes caused by hurricane-related shortages in other commodities such as coffee, Hyman said.
“It’s way too early to talk about recession, but an economic slowdown is a real possibility,” Hyman said.
Analysts will be awaiting word from government officials and from energy producers, refiners and utility companies in the coming weeks, both on the extent of Katrina’s effect and on the progress of recovery efforts.
“This is probably the biggest challenge the energy sector has faced in its history, including the Arab oil embargo of the 1970s or the 9/11 terrorist attacks,” said Bernard Baumohl, executive director of Economic Outlook Group, an economic forecasting firm in Princeton Junction, N.J.
The hurricane is expected to further boost profits for companies in the energy sector, but its broader effect on corporate earnings is harder to gauge. In the long haul, the rebuilding effort could be a net plus for the economy, but for now, many businesses face massive disruptions.
Consensus estimates from Wall Street brokerage analysts call for double-digit earnings growth to continue for companies overall in the blue-chip Standard & Poor’s 500 index through 2006, and those expectations held steady last week, said David Dropsey, research analyst at Thomson Financial in Boston.
For the current quarter, analysts expect overall operating earnings for S&P; 500 members to soar 16.5%. That would top the 12% growth reported in the second quarter, with most companies’ earnings already reported.
But Dropsey said the profit outlook could change radically this week as Wall Street analysts return from summer vacations and assess the hurricane’s toll. Then at mid-month, “pre-announcement” season begins, when companies typically acknowledge likely earnings shortfalls.
Revisions are a certainty in the insurance industry, Dropsey said. Allstate Corp., for example, is expected to earn $1.45 a share in the third quarter, he said, but that target could fall as the company pays Katrina-related claims. Some analysts expect the industry overall to face as much as $35 billion in claims.
Even so, given the volatile nature of the insurance business, investors are unlikely to be surprised if Katrina cuts deeply into earnings expectations over the next two quarters, Dropsey said.
More broadly, the effect of higher oil prices on U.S. consumers could crimp earnings across a range of industries.
“If you’re spending more on gas, you’re spending less at Wal-Mart,” Dropsey said.
Companies, meanwhile, may be forced to pay more for supplies and shipping, but, because of a strapped consumer base and global competition, they would be hard-pressed to pass along increases to their customers, said Liz Ann Sonders, chief investment strategist at Charles Schwab Corp. in New York.
“Profit-margin pressure could be the story for the next quarter or two,” Sonders said.
Hyman echoed that concern.
“This almost assures knocking earnings growth into single digits next year -- maybe even this year -- and the stock market will only go as high as earnings can take it,” he said. Downward revisions could keep Wall Street stuck in a “trading range” for months, Hyman added.
Stock traders placed early bets last week involving companies whose profits could be affected by the tragedy.
Shares of Harrah’s Entertainment Inc., which operates several casinos in the area, fell 4.6% in the week ended Friday. Tenet Healthcare Corp., whose hospitals were shut down, dropped 6%.
A rally in several real estate investment trusts, whose apartment properties were expected to benefit from the mass relocation of hurricane victims, lifted the S&P; REIT index 2.6% for the week.
With information so sketchy, Sonders cautioned against “playing the hurricane” as an investment. Schwab has not changed any of its sector or industry recommendations, she said.
Few investment pros are watching the tragedy’s fallout as closely as the Federal Reserve.
Before Katrina, most analysts expected the Fed to continue its credit-tightening campaign at least through the end of this year.
Now, many expect the central bankers, who have lifted their key short-term interest rate to 3.5% from 1% through a series of 10 quarter-point rate hikes since summer 2004, to shift gears and take no action at their next meeting Sept. 20.
That’s how bond traders have bet: They drove down the yield on the benchmark 10-year Treasury note to 4.03% last week, from 4.18%, and the two-year yield to 3.75% from 4.06%.
The Fed has been tightening credit relentlessly in an effort to stave off inflation amid a sizzling housing market, but some analysts say the combination of hurricane damage and more rate hikes could slam the economy into a recession.
In the wake of other disasters, such as the Sept. 11 terrorist attacks, “liquidity” in the form of interest rate cuts has helped minimize the economic damage, they said.
Fed Chairman Alan Greenspan, whose term is nearing its end, met with President Bush on Thursday, but neither party revealed what was discussed or signaled what the central bankers might do.
Others, however, have been vocal in their opinions.
“The Fed should take a hiatus to measure the impact of this disaster,” Hyman said.
“I don’t think Alan Greenspan wants to ruin his legacy,” Gerber said. “He doesn’t want to be remembered for being the guy who put the U.S. into a recession.”
More important than any potential “public relations disaster,” Baumohl said, was the lack of post-hurricane economic data. He said the Fed might have to wait until its Dec. 13 meeting to get a handle on how badly the economy was shaken.
Along with the fundamentals, investor psychology will play a hand in whether Wall Street can manage a third straight year of gains.
Investors in the U.S. and abroad will be watching to see how effectively state and federal officials handle the continuing chaos in New Orleans and elsewhere.
“The next few weeks will be critical: Can the leaders regain control, restore order and begin to repair the damage?” Baumohl said. “If confidence in the U.S. is ruptured, that could have serious consequences for the stock market and the bond market.”
Although the disaster recovery could benefit the economy and the stock market in the longer term, Gerber is among those girding for a period of volatility.
“Before the hurricane, I had thought we’d finish the year up 8% to 10% on the major averages,” he said. “Now I’d be happy if we stayed where we are.”
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Small gains, apart from energy
Energy stocks have rocketed this year, but most broad market indexes have shown relatively little change.
Gain/loss of selected stock market indexes year to date:
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NYSE energy index: +31.8%
S&P; 400 mid-cap: +6.7
S&P; 600 small-cap: +5.1
NYSE composite: +3.9
Russell 2000: +1.8
S&P; 500: +0.5
Nasdaq composite: -1.6
Dow Jones industrials: -3.1
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Source: Bloomberg News
