An Economic Reassessment

09/16/2005 12:00 am EST

Focus:

Joe Battipaglia

Market Strategist-Private Client Group, Stifel Nicolaus

While fully recognizing the personal loss to individuals from Hurricane Katrina, Joe Battipaglia of Ryan, Beck & Co. has issued a report to help investors understand the financial implications of the disaster and the impact it will have on the overall economic outlook.

"Financial markets, with the obvious exception of affected commodities, have held steady as an unprecedented (for the US) rescue, relief, then reconstruction effort unfolds. Beyond the incalculable loss of life and current human suffering, it may well be years and many billions of dollars before anything close to ‘normal everyday life’ returns to the Gulf Coast. Fortunately, the US economy is of such size and breadth that the costs of rebuilding non-energy-related infrastructure will be taken in stride.

"Speaking in the stark terms of economics and business, the Gulf Coast states of Mississippi, Louisiana, and Alabama account for approximately 2% of US economic output, which translates into just a mild ripple on the economic waters during the waning months of 2005. However, while the costs of rebuilding are more readily quantifiable and the money to do it with is lining up quickly (Federal disaster relief, insurance proceeds, etc.), the unanswered question is how long will the trade flows and oil and gas flows be interrupted.

"Lost oil production is equal to 1.4 million barrels per day or 10% of total US daily demand. Also shut in is 78% of the Gulf’s natural gas capacity. Most importantly, about 50% of the nation's refining capacity is in the Gulf and one million barrels of that refined capacity has been shut in. These one million barrels of refined product represent approximately 10% of total daily demand for gasoline—a significant drop given the inelasticity of the market and already tight supply conditions in some local markets from the Midwest to the East Coast. Crude inventories are in better shape, which could explain why crude has backed off from the $70 level.

"Timely restoration of both output and processing has been established by authorities as a high priority item. The next several weeks will see the infamous driving season come to an end and hopefully a steady string of reopening announcements bringing back more refining capacity and offshore production. We will be looking for a return of workers to the refineries, a return of electricity to those same refineries, the resumption of oil flows through the pipeline network, and the completion of damage assessment, and facility repairs to proceed on a fast-track timeline.

"In this scenario we would not anticipate a recession to emerge from this but rather a temporary drop in consumption and GDP growth through the remainder of the third quarter. Fourth and first quarter 2006 GDP data will include rebuilding efforts, construction jobs, and materials demand. Job and income gains along with a favorable interest rate environment should mitigate the spike in energy costs. However, consumer confidence will slip and inflation readings will worsen. This inflation spike will be carefully analyzed by the Fed in its deliberations on further rate hikes.

"A pause in September perhaps through year-end in reaction to the dislocation is a possibility. A resumption of rate hikes and credit tightening in 2006 to suppress inflationary tendencies would occur so long as the economy resumes its pre-hurricane trajectory. Alternatively, if a longer-term failure of the US energy infrastructure cannot be avoided, the economic expansion will be stopped in its tracks. Thus, in the light of recent developments, we find risk levels for equity asset classes elevated."

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