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Ignore the Pundits -- Katrina Will Hurt

The spike in gas prices last week saw fuel consumption drop 4%. That provides some insight into both the consumer and the cost of gasoline. $3 seems to be the tipping point that significantly affects consumer behavior. It also reveals that there is less room in family budgets than many had previously believed.

About 70% of the U.S. economy is consumer-based. If the corporate sector were more actively hiring or spending, perhaps this would matter less. Until that mix changes, my economic outlook remains guarded.

Yet at the same time, the market's internals and technicals have been quite healthy. This explains in part why the markets have proven so resilient lately. In the weeks leading up to Katrina, both the Dow and Nasdaq were making higher lows. The Nasdaq held critical support recently and bounced off of it. Redwood Technimentals Chief Strategist Kevin Lane notes, "It is hard to envision a harsh sell-off while the NYSE Composite Index is making new highs. All this recent activity suggests to us that we may be able to challenge the upper end of the range again." This despite the long-term economic damage Katrina has wrought.

How do we reconcile these two apparently opposed factors? Consider them over differing timelines: There is an increasing danger of economic deterioration over the longer term (12-24 months). In the shorter term (one to three months), the markets have enough strength to power higher.

Historical Comparisons

Many commentators have noted the market's impressive resilience in the face of adversity. This is not historically unprecedented. When the great San Francisco earthquake hit in April 18, 1906, it took the markets a few weeks to register the costs and economic impact. By May, the markets had fallen 10%. But the full impact was not well understood until the following year, leading to the Panic of 1907, and the Dow took a nearly 50% hit during that period. History buffs will recall the Panic and its aftermath were the impetus for the creation of the Federal Reserve System. ( This paper details the economic impact of 1906 Earthquake.)
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