So What’s Happening to the Economy?

 - October 18, 2006, 5:27 AM

Unlike physics, economic forecasting is not an exact science, and significant natural disasters have a way of scattering the tea leaves. Nevertheless, it might be worthwhile to see what two experts are saying.

Bill Hackney, managing partner of Atlantic Capital Management of Atlanta (an investment company for institutional clients), said in a special review published on the company’s Web site in late September that people learned four key economic lessons after 9/11.

First, investors tend to overreact to unexpected bad news, which can cause wide swings in stock and bond prices. Second, disasters rarely turn out as bad economically as many people initially predict. As an example, he said the estimates of the total losses of 9/11 were as much as $40 billion, but the final results were between $25 and $30 billion for non-life losses.

Third, while a disaster results in loss of wealth, it does little to dampen the growth rate of the national economy. And fourth, it is not a foregone conclusion that a disaster will change the course of prevailing economic and market trends, though it could reinforce trends already in place.

Specifically regarding the effects of Hurricane Katrina, he said that although it will have a severe wealth effect on corporate profits, personal savings, housing and loan and underwriting losses, he thinks it will have a modest effect on the trajectory of economic growth.

That growth will change, however, with increased investment spending associated with repairs and rebuilding in the hurricane-damaged areas and slower consumer spending. He said Katrina, with its possible effect on consumer psychology, “could be just the thing that starts to let the air out of the nation’s housing bubble.”

Hackney said he’s not overly worried about oil prices. “Worldwide energy consumption was beginning to slow in the months before Katrina as high prices dampened demand,” he said. “With slower growth ahead and the approach of fall, a seasonally weak period for oil prices, the Katrina-induced spike to $70 per barrel should represent a near-term peak.” At press time it was at $64.

He expects the Federal Reserve Board will “continue to ratchet up short-term interest rates (between now and year-end) by at least two 25 basis point hikes to put the federal funds rate at 4 percent.” Because, he said, “the Fed realizes that [natural disasters] have only a small and brief impact on the national economy,” he foresees “yields on 10-year Treasuries staying within their current trading band of 4 percent to 4.5 percent.”

Finally, Hackney said Hurricane Katrina has not changed his company’s “bullish outlook” on the equity markets. “Over the next 12 months,” he added, “we believe that the S&P 500 Index (now about 1,230) can trade up to between 1,300 and 1,350. That would produce a total return (including dividend) of about 8 percent to 12 percent. We foresee a similar return potential for smaller capitalization indices such as the Russell 2000.”

Another Viewpoint

Michael Kahn, who writes the “Getting Technical” column for Barron’s Online, looked at the situation from a different perspective. “There are two major trends to watch at this time,” he said early last month. “The first is the long-term trend from the March 2003 low. The cyclical bull market, though two-and-a-half years old, is still in force. That’s good news for long-term investors whose patience has been tried over and over all year.”

The second trend to watch, he said, is the short-term trend from the April 2005 lows. On the Standard & Poor’s 500 Index, still considered the benchmark index for the stock market, “the trend line has been broken to the downside and has survived a corrective rally. The conclusion is that the market is in some sort of sideways pattern as it decides whether it wants to break the long-term trend line or not. In round numbers, a dip below 1,200 would be a bad thing.” [The S&P 500 closed below 1,180 in mid-October.–Ed.]

He said, “Market breadth has weakened to the point that the number of stocks reaching 52-week lows is challenging the number of stocks making new highs. That means that a good chunk of the market is already falling, even though the indices are not following suit. That is clearly not good.”

So for Kahn, “the evidence is clearly leaning toward bearish, but not quite conclusively. If, in the coming month, we see the S&P break 1,200, energy and utility stocks break down, the number of new 52-week highs dry up or any combination of the three, then we’ll know that the market has decided to call it a day and go home.” However, he wrote, “should the major indices garner enough buying to reach new highs above those set in July [roughly 1,246 for the S&P 500], then we have to accept that the tide has turned and there is still a little life left in the old bull.”

Concluding, he said, “Will that happen? We cannot know that in advance. The bears have presented a pretty good case before the jury, and deliberations are now under way.”