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MARKET COMMENTARY


Hurricaneomics: Weathering Today's Financial Storms

10/11/05 03:16:27 PM PST
by Darrell Jobman

Will a disaster thousands of miles away have an effect on your wallet?

Say you're in the middle of Pennsylvania -- or California or Colorado. You haven't been affected that much by hurricanes Katrina and Rita, right? Sure, those $3-plus per gallon prices for gasoline are annoying, and you may have contributed a few bucks to disaster relief efforts. But beyond that, you may feel that the hurricanes haven't had much of an impact on your personal life or your pocketbook.

Welcome to "Hurricaneomics," a term coined recently by Louis B. Mendelsohn, who is perhaps best known in the financial industry for his pioneering work on the intermarket effects that occur within global financial markets (www.hurricaneomics.com). Hurricaneomics deals with that imprecise slice of economics that suggests that disasters of the magnitude of Katrina and Rita will have an effect on every US citizen no matter where they live, and on many different markets, reinforcing the significance of intermarket relationships.

In fact, Hurricaneomics, in its broadest sense, addresses the impact that events such as these two hurricanes as well as terrorist attacks such as 9/11 have on global financial markets and how a domino effect can be set into motion, according to Mendelsohn. In this domino action, markets react and affect each other as the ripple effects from these events work their way through the financial system and global economy.

ENERGY
Disasters like Katrina and Rita have the most direct impact on energy markets because of the damage to producing, refining, and shipping facilities in the Gulf Coast region. As a result, the jump to more than $70 a barrel for crude oil futures in the hurricanes' immediate aftermath is no surprise, as traders anticipated supply would tighten while demand continued.

Although oil and gasoline prices have gone back down in the days and weeks after the hurricanes, high energy costs will not go away in the foreseeable future. No new refineries have been built in the United States in 30 years, and none are scheduled to be. Even if they were, it would be years before new facilities could be online and processing oil into gasoline products.

If more crude oil were available and US refining capacity returned to normal quickly, it still would not be sufficient to meet projected rising demand unless consumers take President Bush's call to conserve fuel seriously. So far, other than complaining about high gasoline prices, SUV owners and other drivers don't appear to be heeding that advice. As long as demand persists and consumers are willing to pay higher prices, high fuel prices for the available supply will not go away anytime soon.

CONSUMER, CORPORATE BURDEN
The gas pump is not the only place where consumers are paying the price of Katrina/Rita. US utilities and government agencies are warning that prices for natural gas to heat homes and businesses this winter will be sharply higher. That means prices for alternative heating sources will rise, too, provided that users even have the flexibility to switch.

In the world of Hurricaneomics, higher fuel prices to ship merchandise or to heat or cool businesses will have repercussions throughout the US and global economy. Every form of transportation ranging from cab fares to freight rates will become more expensive, and the operating cost of running a business, whether small or large, will rise as higher fuel prices eat into profits or divert expenditures away from adding or improving equipment or facilities.

Several major domestic airlines have already filed bankruptcy petitions, citing high fuel costs, and that was before the latest round of price hikes. Airlines such as Southwest and JetBlue, which were wise enough to hedge their fuel costs, will eventually have to pay more, so higher prices for airline tickets in general will likely be one lingering remnant of these two hurricanes.

LEANING ON TAXPAYERS
The impact of higher energy costs is just one aspect of Hurricaneomics. Some claim the $62.3 billion -- or more -- that the federal government will spend on recovery and reconstruction efforts will stimulate the US economy. That sounds good, but remember: Government spending is not likely to occur in the most economically sensible manner and is subject to fraud and waste on a massive scale, especially if used for short-term fixes and not longer-term infrastructure improvements.

Not only that, the funds, created out of thin air, will add to the national debt and interest expenses for taxpayers for years if not decades to come. Can the taxpayers afford another guns-and-butter conflict similar to the 1960s, when it was Great Society welfare and the Vietnam conflict?

The Hurricaneomic effects of Katrina/Rita have made an estimated 400,000 jobs disappear in the Gulf Coast region. Some economists assert that rebuilding New Orleans and other areas damaged by the hurricanes and floods will spur demand for commodity products such as lumber, concrete, copper and other materials, boosting prices in those commodities and stimulating jobs in related areas such as home construction. Conferences or tourist travels scheduled for New Orleans will have to move to other cities such as St. Louis or Las Vegas. This is good for those cities. So some areas could indeed benefit from the Gulf Coast's recent losses.

NO NET POSITIVE
But overall, the outcome from such natural disasters is never net positive. Money and resources have simply been diverted from one area to another, and productivity from the job losses cannot be replaced. Money that might have been spent to support a growing economy now must be spent on rebuilding. Instead of having both an undamaged New Orleans and building materials, only the building materials remain.

Although St. Louis, for example, may gain from a conference that New Orleans loses, the gain will be more than offset by the higher prices for energy and building materials that residents of St. Louis will have to pay due to the hurricanes.

As a result, the figure for the US Gross Domestic Product (GDP), reported as 3.3% annual growth for the second quarter of 2005, will undoubtedly shrink for the third and fourth quarters. As one of the best measures of a nation's economic health, the GDP number has an important bearing on the value of the US dollar, which could weaken in the eyes of financial traders and US government bond investors worldwide.

Further, with some companies losing production from Gulf Coast facilities and with higher energy prices for all companies, corporate profits are also likely to dwindle, which could send prices of stocks and stock indexes lower. That effect of Hurricaneomics could be felt by millions of Americans who are participants in corporate pension plans or investors in mutual funds.

HIGHER INFLATION?
There may be an even bigger effect on the economy. According to columnist Alan Reynolds at conservative movement website Townhall.com, if energy is included, inflation in the Consumer Price Index (CPI) has been one percentage point higher than non-energy since 2003.

"The only other times we have seen that wide a gap between CPI inflation and non-energy inflation were in 1974, 1979-80, and 1990-91," Reynolds points out. "At those times, the Fed pushed the fed funds rate far above non-energy inflation -- 2.5 percentage points higher in 1991 and 1.8 points in 1981. The economy suffered high real interest rates and high energy prices simultaneously -- and recessions."

Could higher energy costs raise the inflation rate? Some think it could, but others note that when people spend more disposable income in one sector, they tighten their belts and spend less in other areas, thereby depressing prices in those areas. That's deflationary. In any case, higher energy prices and rising interest rates together would be a difficult double whammy for the economy to overcome.

TRADE IMPACT
Aside from high energy prices and the effect of Hurricaneomics on the US dollar, interest rates, and the economy in general, some markets have been affected directly by the hurricanes' devastation because of Gulf ports' role in US trade.

A large share of US exports of grains and soybeans goes through these ports, for example. The Congressional Budget Office says the New Orleans port will be at 30-40% of normal operations in a month and 80% by the end of the year. With the heaviest flow of grain from the autumn harvest coming up, the slower pace of exports may weigh on grain prices all the way back to the farmers' local elevator and cause problems in storing the crop.

Coffee futures markets have also been thrown into disarray, with most of coffee stocks certified by the New York Board of Trade located in New Orleans storage houses needing to be inspected and certified again. In addition, coffee roasting facilities are concentrated in that area and have had their production disrupted, which could mean higher prices for the next cup of coffee you drink.

Finally, we have had back-to-back disastrous hurricane seasons. Who knows whether next year could bring a three-peat before the nation has even recovered from this season, which still has a couple of months to go?

Darrell Jobman, senior market analyst for www.TradingEducation.com, is an acknowledged authority on financial markets and has been writing about them for more than 35 years.

Note: "Hurricaneomics" is a trademark of Louis B. Mendelsohn.

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.



Darrell Jobman

Darrell Jobman is editor-in-chief of www.TradingEducation.com, a website providing free information and education to traders. He is an acknowledged authority on the financial markets and has been writing about them for more than 35 years.

www.TradingEducation.com has not added any product or service information to TRADERS' RESOURCE.
Title: Senior Market Analyst
Company: www.TradingEducation.com
E-mail address: DarrellJ@tradertech.com

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