Jeff Saut Presents "Katrinanomics"
By now, Wall Street's finest have sharpened their collective pencils and calculated Hurricane Katrina's economic "fallout" to the second decimal point. The media is replete with their conclusions, most of which have been gleaned from the shared experience of Hurricane Andrew. Recall that Andrew was also a Category 4 hurricane that slammed into South Florida during August of 1992, causing 15 deaths directly, 25 deaths indirectly, and $30 billion in property damage. According to the St. Petersburg Times, it also created 30 years worth of debris. While we hope Wall Street's pundits are correct in their economic comparisons to Andrew, we are less sanguine because New Orleans is still 30% UNDERWATER. Moreover, the tragic death toll has already far exceeded Hurricane Andrew, the toxin levels are rising as the flood waters recede, the property damage far exceeds Andrew, and the list goes on and on.
To quote just a few of the involved officials: "This is one of the biggest environmental challenges in our agency's history. Since we haven't seen anything of this scale before, it's hard to make specific predictions," said Eryn Witcher, an EPA spokesperson. Or how about the CEO of MidSouth Bank, who stated, "For many bankers, 30% to 60% of loans are in jeopardy," which elicited this comment from Rep. Richard Baker (R-LA), "If the insurers have to pay, they may become insolvent. This is dangerous territory. The collateral, and customers, of (many) banks may be gone. I'm afraid this will go on for decades." Then there was Fed President Moskow's comment that, "At this time it is very difficult to say how the national economy will be affected," followed by Ben Bernanke's notion that Katrina will have a "palpable" effect on the economy.
Obviously we agree with these folks and have repeatedly noted that to attempt to peg the precise fallout from Katrina's carnage at this point in time is much too premature.
Nevertheless, last week there was a lot of lip service paid to the fact that "one" ship had been unloaded and reloaded at the Port of New Orleans. While this symbolic gesture is certainly a moral victory, the Panglossian pundits' spin that things will be normal soon just doesn't "foot" with what we are hearing from the port's workers, who suggest it will be many months, if not a year, before the port of New Orleans is fully operational. Manifestly, how can a port be fully operational when there is no place to live for the workers needed to operate said port?! Moreover, there is clearly rising collateral damage. Consider this email from last week:
"Jeff, I took a few days off in order to spend time with old friends from our Hawaiian days, so I hadn't read your strategy column for a few weeks until today. Your comments about Katrina's 'tail' being longer than most think resonated with me. Yesterday, I crossed the Mississippi River twice - first at Dubuque and then at the Quad Cities area in NW Illinois. Normally one sees at least one string of barges, maybe two or three. Yesterday there may have been one at Dubuque just under the bridge as we drove across it. Aside from that; there were none! We then crossed the Illinois River at Peoria and there were no barges in sight. The Mississippi and Illinois rivers are vital carriers of Midwest grain, coal, and various industrial products. Until the river is repaired in the New Orleans area, the impact will probably be very significant to the overall economy."
"Significant" indeed . . . for as we have argued; $3.00 per gallon gasoline is potentially the 'tipping point' for an over-leveraged, savings-short, American consumer. And that sense was reinforced last weekend by a visit to our local Jiffy Lube. The day began with me calling Jiffy Lube and asking if I could bring my car in for servicing. Receiving an affirmative response, I asked for the $4.00 coupon I normally get in the mail. "Can't do it," was the response, "That coupon comes from corporate." "I guess I'll have to take my car somewhere else," I said . . . to which the manager replied, "Come on in and I'll give you the $4.00 off coupon." Ten minutes later I was at the store. It was Saturday morning and I was the ONLY customer there! "What gives?" I asked the mechanic, "Don't know," was his response, "But it has been like this for the past few weeks ... I guess folks can postpone serving their cars in the wake of $3.00 a gallon gasoline."
Clearly, the public's attention is currently focused on gasoline, but in a few months that focus will be on "winter" and the doubling in price of what it's going to cost to heat homes. Of course all of this comes as adjustable-rate mortgage payments are ratcheting higher, minimum payments on credit cards are by law set to double, insurance premiums are increasing, the alternative minimum tax is engulfing more and more of the middle-class, etc. Additionally, the economy was already slowing before "Katrina's Karnage" with real GDP growth year-over-year peaking in 1Q04 at 4.7% and slowing to 3.6% in 2Q05. And that economic slowing, combined with Katrinanomics, has caused the government to do what it always does - throw more money at the situation! However, there are two kinds of "money." Money that comes from excess savings and money that comes from additional borrowing. Given this nation's negative savings rate, it is obvious where Katrina's money will be derived. Yet, there is something more concerning than this.
Ladies and gentlemen, the secular "bull market" in stocks was ushered "in" by Ronald Reagan and his promise to shrink BIG government. As stated in the first tenet of the Republican's "Contract with America" titled: "The Fiscal Responsibility Act: A balanced budget/tax limitation amendment and a legislative line-item veto to restore fiscal responsibility to an out-of-control Congress requiring them to live under the same budget constraints as families and businesses." Plainly this tenet has been forgotten by a President we voted for, and continue to like, but who has not vetoed a single spending bill and has presided over the largest increase in government spending in history!
Regrettably, the government is about to spend even more money given Katrina, and the ongoing wars, which have serious implications for the deficits, interest rates and inflation.
We have suggested the U.S. government's "liquidity injections" were going to foster an attendant inflationary-scare and last week the precious metals markets seemed to "sniff" this out as gold rallied over $10 per ounce. Obviously that was good for our metal-stock investment positions, as chronicled in last week's strategy report titled "Why Own Gold." Said "monetary injections" seemed to have also found their way into the equity markets, yet we think that upside move (read: rally) is ephemeral and expect the equity markets to struggle (going forward) as they eventually adjust for the inflationary impacted earnings environment. So who else benefits from the current environment? We think it is Canada, as well as the Canadian dollar (i.e., the Looney), given Canada's positive current account surplus, its agricultural exports, its lumber exports, and its Canadian Oil Sands energy projects, in which we remain heavily invested. And that is why we are off to Canada this week to speak at a conference, and to survey Canada's economic landscape, as we contemplate our longstanding "Buy Canada" recommendation. We will chronicle the results of our sojourn next week . . . stayed tuned!
The call for this week: Consistent with the trading strategy laid out in these missives over the past few weeks, last week we sold one-third of the long trading positions that were bought August 29/30th on the Katrina-induced market weakness. Stop-loss points have been raised on the remaining two-thirds of those positions since history shows that if the first half of September is "up" the second half of September tends to be down. As for the investment side of the portfolio, we continue to embrace the views of Charles Knott, eponymous captain of Knott Capital Management, who recently noted:
"Our risk-adverse and conservative nature forces us to maintain a 'predominantly defensive' investment stance. Investors shouldn't have a highly optimistic or hardened pessimistic mindset. Proper sector-selection is the best tactic to achieve above-average investment results. We favor those industry groups where valuations are reasonable, pricing power is formidable, and earnings growth seems assured. We continue to sell-on strength and buy-on-weakness. This defensive tactic is flexible and adjusts to the market's volatility. It also allows gains to accrue as 'money is taken off the table.'"
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