The US economy is clearly slowing down.  Actually, it was already slowing down before the twin hurricane disasters.  Gross Domestic Product growth slowed to 3.2% in the 2Q, down from 3.8% in the 1Q and 4.2% for all of last year.  Consumer confidence plunged in September, with the largest monthly drop in over 15 years.  Personal consumption spending also fell by 0.5% in August (latest data available), the largest monthly decline in over four years.   I fully expect spending will be worse when we get the report for September. Retailers are now bracing for a poor holiday shopping season.  Remember that consumer spending accounts for almost 70% of GDP.

So, the question is, are we facing a recession?  Most of my sources, including The Bank Credit Analyst, do not believe we are headed for a recession.  Most believe we are facing a couple of sub-par quarters in which GDP growth will be in the 2% range or a little lower.  The pattern in the last three major hurricanes (Andrew, Georges and Ivan) was a brief economic slowdown over several months, followed by a strong rebound in the economy.  Unlike those previous major hurricanes, this time we face sky-high energy prices.  As a result, the economy is likely to face a longer recovery from the latest natural disaster.  At the same time, the inflation numbers continue to look troubling, and this means the Fed is likely to continue raising rates.  This also is not good for the economy.

My investment advice is unchanged from last month.  While the stock markets have held up better than I expected following the hurricanes, I would use this opportunity to reduce your exposure to equities, unless they are professionally managed.  Bond yields have been rising over the last month, and I would expect this to continue.  So I would recommend below average positions in bonds as well. 

Gold has risen to new highs near $475 as this is written, largely in response to the higher inflation numbers.  However, with the economy slowing down, I would not chase this rally in gold.   The inflation numbers are likely to slow down as the economy sags over the next several months.

In this issue, I include some interesting analysis by Dr. George Friedman of Stratfor.com regarding the economic impacts of the hurricanes.  Specifically, Dr. Friedman discusses the state of the Gulf Coast ports and the importance of the Mississippi River to US commerce.  In light of this, there should be a lot of volatility in the commodities markets for the foreseeable future, and hopefully this will mean good news for our futures funds.

Introduction

In this issue, we will focus initially on the latest economic indicators, the outlook for the next 6-12 months, and the latest thinking from The Bank Credit Analyst.  We have seen several troubling economic reports over the last couple of weeks.  As examples, consumer confidence and new home sales have both plunged much lower than expected.

The $64,000 question is whether the economy is headed for a recession following the hurricane national disaster, or are we looking at only a moderate slowdown for a few months, followed by another surge in growth sometime next year as the rebuilding of the Gulf Coast shifts into high gear?    The answer is not entirely clear just yet.  I’ll tell you why below.

What are the implications for the investment markets?  The stock markets have held up exceptionally well in light of skyrocketing oil and gas prices and two of the worst hurricanes in history back-to-back, but I still expect to see more weakness to come.  Bond yields have risen more than expected over the last couple of months as inflation fears are rising, and I expect rates to climb even more for the balance of this year.

The Economy Slows Following The Hurricanes

Literally everyone in the forecasting business is trying to figure out just how negative the effects of two of the worst hurricanes in history will be on the US economy.  Obviously, a starting point is to look back at other major natural disasters to look for parallels.  And that is easy enough to do if you have plenty of time, resources and money.

Fortunately, The Bank Credit Analyst did just such an analysis and published it in their latest October issue.  They looked at the economic impacts of hurricanes Andrew, Georges and Ivan.  Immediately following each of those major hurricanes, we saw a sharp drop in consumer confidence, a decrease in personal spending and a significant drop in manufacturing and construction.  There is no reason to expect otherwise following hurricanes Katrina and Rita.

The good news, however, is that within a few months of those hurricanes, the economy recovered quite strongly.  That data would suggest that perhaps we will see the same pattern this time, and that after several months of slowdown in the economy, we should expect it to rebound very strongly.  Unfortunately, there are several reasons why the next rebound may not be so quick or so strong, if at all.

First of all, we’ve never had two monster hurricanes hit the oil and gas-laden Gulf Coast so close together.  We’ve all heard that it will cost $200 billion or more to rebuild New Orleans alone, perhaps another $100 billion to rebuild the rest of the Gulf Coast, and another $50-$100 billion to rebuild western Louisiana and eastern Texas following Rita.  We’ve never seen numbers like that before.  And all of this is on top of our record large budget deficit.

Second, these previous disasters did not occur with a simultaneous huge spike in energy prices.  As we all know, soaring gasoline prices are taking a big bite out of our collective wallets, and that is money we would otherwise be spending into the economy or saving.  As I wrote in my August 30 E-Letter, many economists estimate that GDP will be cut by around 1% (or more) due to oil prices being at $60-$70 per barrel.

Third, the largest seaport in the nation is still operating at a mere fraction of what it was before Katrina.  At the end of this economic analysis, Iwill reprint an excellent analysis by Dr. George Friedman of Stratfor.com on how the reduction in traffic through the ports and along the Mississippi River will negatively impact the economy overall.  See below.

The bottom line is that the economy is likely to get hit harder this time around, and take longer to recover, than in the three previous major hurricanes.  Between the energy price spike, the plunge in consumer confidence and restricted traffic at the ports and on the river, I believe we could see GDP drop to 2% or even lower for the next several quarters.

The Latest Economic Data - Not So Good

Earlier this month, the Commerce Department confirmed that GDP grew at an annual rate of 3.2% in the 2Q, down from 3.8% in the 1Q, and down from 4.2% for all of 2004.  So the economy was already slowing down before the hurricanes.  The Index of Leading Economic Indicators fell 0.2% in August (latest data available) for the second consecutive month.

Also troubling, the Consumer Confidence Index plunged from 105.5 in August to 86.6 in September.  This is the largest monthly drop in 15 years, putting the index at its lowest point in over two years.  Personal consumption spending also fell by 0.5% in August, the largest monthly decline in over four years.   I fully expect spending will be worse when we get the report for September. Retailers are now bracing for a poor holiday shopping season.

Remember that consumer spending accounts for almost 70% of GDP.  Most forecasters assume that consumer confidence plunged simply because of the hurricanes, and that it will rebound strongly in another month or two, as it has following past hurricanes.  I don’t agree.  I’ll tell you why below. 

The ISM manufacturing index fell to 53.6 in August from 56.6 in July.  The index is down from its peak (for this cycle) of 59.1 a year ago.

New home sales dropped a surprising 9.9% in August, over double analysts’ expectations.  Housing starts fell 1.3% in August.  Fortunately, existing home sales remained strong in August.  There is no question that we are in a housing bubble, and there is no question, in my mind at least, that the slowdown in the economy is going to take some air out of that bubble.  The only question is how much? 

Historically, most bubbles do not end pretty.  This is why I continue to recommend that you consider unloading real estate or houses that you may be holding for speculative/investment purposes.  If I’m wrong and the bubble continues for another year or two, feel free to give me grief about it.  But I would take profits now if you can.

Finally, economic reports weren’t all bad in the last few weeks.  Durable goods orders rose 3.3% in August and have been up in four of the last five months.  The ISM Index rebounded in September as many companies boosted orders, but this was primarily due to fears of hurricane-related shortages in the next several months. 

Yet the bad news definitely outweighed the good, at least recently.

The Fed Trudges Onward & Upward

On September 20, Greenspan & Company raised the Fed Funds rate for the 11th consecutive time to 3.75%.  Many had hoped the Fed would take a break in light of the twin hurricane disasters.  But not only did they raise the rate, they stuck to their policy language indicating additional rate hikes at a “measured” pace.

There are many, including The Bank Credit Analyst, who believe that the Fed is going to overshoot on the upside.  The Fed has a long history of over-reacting both on the upside and the downside.  The risk, of course, is that they raise rates too much, and this causes the economy to go into a recession.

The Fed really is in a “conundrum.”  On the one hand, they see soaring energy prices and a Consumer Price Index that rose 0.5% in August and is up 3.6% year over year.  They also see the Producer Price Index that is up 5.5% year over year.  Remember, Alan Greenspan’s main purpose in life (he thinks) is to keep inflation under control.

On the other hand, the Fed is also very concerned that deflation could well unfold whenever we hit the next recession.  I absolutely agree!  This fear makes them want to raise short-term rates as much as they can, so that they have some ammunition - in the form of interest rate cuts - to fight the next recession.

So don't be surprised if we get yet another rate hike on November 1.  Not good for the economy, especially if the Fed hints of yet another rate hike in December.  

Are We Headed For A Recession?

Most of the sources I respect do not believe that the hurricanes and Fed policy will push the economy into a recession.  The latest survey of leading economists suggests that the economy will have only a mild slowdown in the aftermath of the hurricanes.  The latest survey from the National Association of Business Economists saw an average cut in GDP estimates by less than one-half a percent over the next two quarters, as reported by the Wall Street Journal last week.

Estimates like these (large groups of economists) are almost always too optimistic.  These numbers are almost certain to come down more - probably a lot more - over the next couple of months.  As noted above, I see GDP growth dropping to an annual rate of 2% or less as the damages from the hurricanes are quantified, especially if gas prices remain as high as they are today.

The Bank Credit Analyst has a similar view as mine.  They expect GDP growth will fall below 3% for several months.  They had been predicting a slowdown in consumer spending even before the hurricanes hit.  But they do not believe the economy is headed into a recession.  They say: “The bottom line is that the economy may remain more subdued than generally expected early next year, but a recession still has low odds.”

Most forecasters, including BCA, believe that the economy can rebound strongly after a couple of weak quarters, especially if President Big Spender (oops, I mean Bush) and Congress spend several hundred billion on hurricane rebuilding.

But let us not forget: Americans in general are in a really FOUL MOOD!  The latest FOX Opinion Dynamics poll showed that 85% of Americans are fed-up with soaring gasoline prices.  This will only get worse as the weather turns colder and people have to pay sky-high prices to heat their homes. 

77% of Americans, based on this poll, are also fed-up with partisan bickering in Washington. Surprisingly, more respondents said they prefer that Democrats regain control of Congress in the 2006 elections than those who want the Republicans to remain in the majority.  This is troubling!

58% said they are now against the war in Iraq.  This is the highest anti-war reading we have seen.  President Bush’s approval ratings remain in the dumps, lower than Bill Clinton’s ratings ever were.

For all these reasons and others, there is NO guarantee that consumer confidence is going to rebound anytime soon, as it has after past disasters, and it could get even worse.  If consumer spending continues to fall, the slowdown in the economy will be considerably worse than most analysts are currently predicting.

Not A Good Environment For The Stock Markets

Last month, I strongly recommended that you take profits in most of your stock investments (unless professionally managed) and move to an under-weight position in equities.  After being a stock bull for many years, I have turned much more cautious for reasons noted above and others.  I have not changed that view, even though the equity markets have held up quite well despite two national disasters and more Fed rate hikes.

Disappointing economic news is very likely to continue for the next 3-6 months or longer.  As discussed above, consumer confidence and spending may not rebound sharply anytime soon.  And it appears a given that the Fed will continue to hike rates, at least for a while.  None of this is good for stocks in general.

I’m not predicting a bear market in equities, but I believe the most likely scenario is that stocks break out of the 18-month trading range to the downside.  If correct, it remains to be seen just how much selling will result, but I can assure you that it could be significant.  So I continue to recommend that you move to an under-weight position in your equity portfolio.

Obviously, if most of your equity portfolio is managed by professional “active” managers, then you do not need to reduce your positions - provided, that is, that your manager(s) has a good track record of getting out of the way of major market downturns.

As noted above, most bonds have already begun to move lower, and this could well continue.  With inflation numbers clearly on the rise, bonds will likely continue to move lower.  On the other hand, with the economy due to slow down - and for longer than most analysts expect - this should serve to limit losses in bonds.  Net result: a continued trading range, most likely.

Don't Get Blown Away By Hurricane Scams

As always, there are those who are peddling new scams to take advantage of good-hearted folks who want to help the hurricane victims along the Gulf Coast.  Beware of any group that is calling you to donate money for hurricane relief, unless it’s the American Red Cross or the Salvation Army or some other well-known charitable group.

[By the way, if you get lots of unsolicited sales calls at home, as we do at the Halbert house, here’s a tip.  Rather than just say no, or hang up on them, be sure to ask: Do you have a “do-not-call list”?   Telemarketers are required by law to have such a list.  When they answer yes, then say: Put my name on your do-not-call list.  They’re required to do so.]

In addition to the new hurricane scams out there, the “gloom-and-doom” crowd is having a field-day in the wake of the twin disasters.  Now, their predictions of gloom are even more shrill than ever.  Stocks are going to hell in a handbasket, so sell everything you own; inflation is going to explode; interest rates will double; precious metals will skyrocket; and of course, the US economy is headed for a depression.  And on and on.

Yet what you will notice in almost all of the gloom-and-doom pieces is an offer to sell you something to protect you from the guaranteed horrors that lie ahead.  These people have no shame.  They will try to capitalize on any opportunity to: 1) pump you with fear; and 2) then suck you in with fear.  Just say no!

Dr. George Friedman of Stratfor.com
On The Seriousness of The Gulf Ports Situation

QUOTE: “The ports of South Louisiana and New Orleans, which run north and south of the city, are as important today as at any point during the history of the republic. On its own merit, the Port of South Louisiana is the largest port in the United States by tonnage and the fifth-largest in the world. It exports more than 52 million tons a year, of which more than half are agricultural products -- corn, soybeans and so on. A larger proportion of U.S. agriculture flows out of the port. Almost as much cargo, nearly 57 million tons, comes in through the port -- including not only crude oil, but chemicals and fertilizers, coal, concrete and so on.

A simple way to think about the New Orleans port complex is that it is where the bulk commodities of agriculture go out to the world and the bulk commodities of industrialism come in. The commodity chain of the global food industry starts here, as does that of American industrialism. If these facilities are gone, more than the price of goods shifts: The very physical structure of the global economy would have to be reshaped. Consider the impact to the U.S. auto industry if steel doesn't come up the river, or the effect on global food supplies if U.S. corn and soybeans don't get to the markets.

The problem is that there are no good shipping alternatives. River transport is cheap, and most of the commodities we are discussing have low value-to-weight ratios. The U.S. transport system was built on the assumption that these commodities would travel to and from New Orleans by barge, where they would be loaded on ships or offloaded. Apart from port capacity elsewhere in the United States, there aren't enough trucks or rail cars to handle the long-distance hauling of these enormous quantities -- assuming for the moment that the economics could be managed, which they can't be.

The focus in the media has been on the oil industry in Louisiana and Mississippi. This is not a trivial question, but in a certain sense, it is dwarfed by the shipping issue. First, Louisiana is the source of about 15 percent of U.S.-produced petroleum, much of it from the Gulf. The local refineries are critical to American infrastructure. Were all of these facilities to be lost, the effect on the price of oil worldwide would be extraordinarily painful. If the river itself became unnavigable or if the ports are no longer functioning, however, the impact to the wider economy would be significantly more severe. In a sense, there is more flexibility in oil than in the physical transport of these other commodities.

There is clearly good news as information comes in. By all accounts, the Louisiana Offshore Oil Port, which services supertankers in the Gulf, is intact. Port Fourchon, which is the center of extraction operations in the Gulf, has sustained damage but is recoverable. The status of the oil platforms is unclear and it is not known what the underwater systems look like, but on the surface, the damage -- though not trivial -- is manageable.

The news on the river is also far better than would have been expected on Sunday. The river has not changed its course. No major levees containing the river have burst. The Mississippi apparently has not silted up to such an extent that massive dredging would be required to render it navigable. Even the port facilities, although apparently damaged in many places and destroyed in few, are still there. The river, as transport corridor, has not been lost.

What has been lost is the city of New Orleans and many of the residential suburban areas around it. The population has fled, leaving behind a relatively small number of people in desperate straits. Some are dead, others are dying, and the magnitude of the situation dwarfs the resources required to ameliorate their condition. But it is not the population that is trapped in New Orleans that is of geopolitical significance: It is the population that has left and has nowhere to return to.

The oil fields, pipelines and ports required a skilled workforce in order to operate. That workforce requires homes. They require stores to buy food and other supplies. Hospitals and doctors. Schools for their children. In other words, in order to operate the facilities critical to the United States, you need a workforce to do it -- and that workforce is gone. Unlike in other disasters, that workforce cannot return to the region because they have no place to live. New Orleans is gone, and the metropolitan area surrounding New Orleans is either gone or so badly damaged that it will not be inhabitable for a long time.

It is possible to jury-rig around this problem for a short time. But the fact is that those who have left the area have gone to live with relatives and friends. Those who had the ability to leave also had networks of relationships and resources to manage their exile. But those resources are not infinite -- and as it becomes apparent that these people will not be returning to New Orleans any time soon, they will be enrolling their children in new schools, finding new jobs, finding new accommodations. If they have any insurance money coming, they will collect it. If they have none, then -- whatever emotional connections they may have to their home -- their economic connection to it has been severed. In a very short time, these people will be making decisions that will start to reshape population and workforce patterns in the region.

A city is a complex and ongoing process - one that requires physical infrastructure to support the people who live in it and people to operate that physical infrastructure. We don't simply mean power plants or sewage treatment facilities, although they are critical. Someone has to be able to sell a bottle of milk or a new shirt. Someone has to be able to repair a car or do surgery. And the people who do those things, along with the infrastructure that supports them, are gone -- and they are not coming back anytime soon.

It is in this sense, then, that it seems almost as if a nuclear weapon went off in New Orleans. The people mostly have fled rather than died, but they are gone. Not all of the facilities are destroyed, but most are. It appears to us that New Orleans and its environs have passed the point of recoverability. The area can recover, to be sure, but only with the commitment of massive resources from outside -- and those resources would always be at risk to another Katrina.

The displacement of population is the crisis that New Orleans faces. It is also a national crisis, because the largest port in the United States cannot function without a city around it. The physical and business processes of a port cannot occur in a ghost town, and right now, that is what New Orleans is. It is not about the facilities, and it is not about the oil. It is about the loss of a city's population and the paralysis of the largest port in the United States.”  END QUOTE.

While the ports are slowly reopening, it will be months before traffic is remotely back to normal.  As Dr. Friedman explains, this will not be good for the economy.

Will New Orleans Residents Return?

People don’t want to talk about it, but one obvious question is whether to rebuild New Orleans or not.  The politicians, including President Bush, all assure us that New Orleans will be rebuilt, and it certainly appears that Congress is prepared to fork over the hundreds of billions that will surely be required to do so.

But there is a major problem.  The apprx. 500,000 residents of metropolitan New Orleans are  still largely gone, and many will never return.  Hundreds, if not thousands, of New Orleans business owners will never be able to rebuild their businesses.

We had apprx. 4,000 evacuees here in Austin just after Katrina.  The caregivers and Red Cross officials here tell the local media that well over half of the evacuees do not want to return to New Orleans.  They want to stay here in Austin or go live with family somewhere else in the country.   As Dr. Friedman points out, New Orleans is still a city without a significant part of its former population. 

This is a serious issue and one which must be considered carefully before we spend the hundreds of billions it will take to rebuild New Orleans.

Political Fallout From The Hurricanes

Our hearts and prayers continue to go out to the victims of hurricanes Katrina and Rita, America’s worst national disasters in history.  It has been heartwarming to see the massive national outpouring of support.  I am particularly proud of Texas, which  opened its arms to tens of thousands of evacuees.  Within three weeks of Katrina, the American Red Cross had received over $500 million in cash donations from the public.

Yet it was disgusting that at a time when all politicians should have been standing shoulder-to-shoulder, and doing everything in their power to expedite the search-and-rescue efforts and in sending needed resources to the region, the political situation quickly  devolved into the “blame-game.”   Both political parties were guilty of this.

Clearly, there is plenty of blame to go around for ALL government agencies – federal, state and local.  Louisiana Governor Blanco and New Orleans Mayor Nagin blamed the Bush administration and FEMA for not providing enough relief.  While FEMA did not perform well in New Orleans and elsewhere after Katrina, the governor of Louisiana and the mayor of New Orleans share plenty of blame themselves.

The fact is, everyone screwed up to one degree or another.  I will leave the parsing of the correct amount of blame on the correct heads to others in the investigations that are to follow.  But after reading the various timelines on the tragedy (including some that are slanted so as to lay the blame at one political party or the other), I have just one main question:

WHY WERE THERE NO BUSES TO TAKE EVACUEES OUT OFNEWORLEANS?

The New Orleans disaster emergency plan, which reportedly had a trial run last year to rave reviews, clearly enunciated that the city would have to evacuate people via buses to higher ground.  There were over 10,000 buses in the city, more than enough to evacuate all those who did not have transportation. The residents of New Orleans were warned in advance to leave the city, and most did.  But it was well known that thousands of inner-city residents would have to be transported out via public means (ie – buses).

When New Orleans Mayor Nagin ordered the mandatory evacuation, emergency workers told residents to go to the Superdome and other specific points where they would be evacuated by buses to other locations around the area and in the state.

But the buses never came.  The question is why?

Why did Mayor Nagin never order the buses?  We still do not know the answer, but a thinking (ie – nonpartisan) person would have to assume that there was a valid reason why the buses were never ordered in to evacuate those people.  

There are several possibilities; in no particular order: 1) Mayor Nagin panicked and forgot (not likely); 2) the bus drivers had already evacuated; 3) the people with access to the bus keys had already evacuated, even if the mayor could have commandeered volunteer drivers; or 4) they had no pre-planned destinations or shelters to send such a large number of people. 

To date, we still do not know why there were no buses.  What we do know is that there was plenty of warning and time to evacuate all the people that needed transportation.  This should be the first priority of the ongoing investigation. 

Commoditiy Prices To Be Volatile

Dr. Friedman’s analysis of the Gulf ports and restricted traffic along the Mississippi River should translate into a lot of volatility in many different commodities markets in the months ahead.  Grain prices have fallen sharply since mid-summer, both because of big crops this year and more recently due to concerns that exports will be significantly affected by the damage to the ports.  The bulk of our grain exports go by barge down the Mississippi River.   

Copper, aluminum and other base metals have risen in price recently, not only due to the still strong economy, but more recently due to the hurricanes.  Many of our industrial metals are imported via the Gulf ports and the Mississippi.

So, not only are the hurricanes affecting the economy and the stock and bond markets, we could be looking at a lot of volatility across the board in the futures markets over the next 3-6 months or longer.  Hopefully, this will translate into some good trends for our Trading Advisors to catch.

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How Time Flies

My 15 year old son is learning to drive, and doing well I might add, but I have figured out I am not a good passenger.  He also just had his first date, and Dad did the driving - that was interesting.  Seems like only yesterday I was teaching him how to ride a bike and coaching his baseball and football teams.  Meanwhile, my 13 yearold tomboy is turning into a young lady, but at least I still coach her softball team.  It doesn’t seem like I have been married to, and working with, Debi for 20 years, but I have.

I was in a local health food store last week, picking up some vitamins.  After scanning purchases, the checkout clerk asked me if I “qualified for the discount.”  I’ve shopped at this store for years, and no one ever asked me that.  Looking confused, I asked her, “what discount”?   She replied, “the 55 or older discount.”  I quickly replied that I do not qualify (I’m 53).  I must admit, I was shocked, especially given that my hair isn’t even gray.

As my late Mother always said, getting old is bad, but the alternative is a whole lot worse!