The Fog of Katrina

The task of calculating the enormous damage from Katrina – in Human lives, in property damage, and in
economic terms – continues. As insurance claims and Federal aid flow into the
region, it is worthwhile considering a more difficult to measure effect of the
hurricane: Its ability to obscure economic and earnings data. Katrina is
looking a lot like a catchall excuse for all the shortfalls of Q3 & Q4.
Apologists have begun using the storm to avoid responsibility for every
disappointment. I anticipate economists, corporate officers, even politicians
will take full advantage of the opportunity to scapegoat the storm for their
own failures. (e.g., even spice seller McCormick blamed the storm on their
shortfall).

To those of us who attempt to read the entrails of the market, even more troublesome is the obscuring of the true underlying economic conditions. How the fog of Katrina impacts investor psychology and behavior has yet to be seen. Human Nature being what it is, I expect we will see an unholy litany of Candide-like
rationales – some justified, most not – for everything from consumer spending to energy costs to inflation data.

Let the excuse making begin!

Indeed, early signs of this were apparent last week in response to the University of Michigan Preliminary
Consumer Confidence data. The survey saw a 14% decrease in measured sentiment,
and a two month decline of 20%. The WSJ noted this was “the largest decline in points over a two-month period since comparable records began in 1978."

The Dismal set reacted as you would imagine, with one
wag even opining that “The index was likely weighed down heavily by the
emotional response to the devastating images that resulted from Hurricane
Katrina.”

Go figure: a sentiment survey being impact by negative emotions. Is it any wonder these guys don’t have a clue?

Ultimately, investors may be getting set up for a nasty surprise. This may play out 60–90 days from now: As we’ve noted, with massive government stimulus fading prior to the disaster, growth was already decelerating, as Real Estate began to cool, and consumer spending slowed. Oil prices had nearly reached a tipping point. But now the disaster gives cover to the cheerleaders and perma-Bulls, allowing them to maintain their sunny outlook. Meanwhile economic decay gets
obscured and rationalized.

Thus, the markets can continue to grind higher over that same 2 – 3 month time period. We have no idea what finally removes the scales from investor’s eyes, but eventually, something gets revealed that cannot be papered over as Katrina’s fault. The risk to those who buy into this excuse making is that once this occurs, an unseen trapdoor may get sprung.

We would expect to adapt a much more defensive posture 60 days hence.