Shares Lurch as Energy Climbs

Hopes for a Fed pause bolster major averages, but Katrina's economic aftermath remains murky.
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Chaos in the streets of New Orleans with damages that could top $25 billion, gasoline prices above $3 a gallon, and other nightmarish scenarios resulting from Hurricane Katrina's devastating passage are leaving investors wondering which way is up.

Indices went nowhere fast and finished mixed Thursday amid pressure from continued gains in energy prices. Crude rose another 53 cents to $69.47 a barrel while gasoline advanced 15 cents to $2.40 per gallon. The downside was limited, however, amid increasing hopes that Katrina's impact will compel the

Federal Reserve

to halt its yearlong campaign of rate hikes.

Those hopes were bolstered Thursday by a midday meeting between Fed Chairman Alan Greenspan and President Bush. After meeting with Greenspan, Bush told reporters that Katrina represents "a temporary disruption that is being addressed by the government and by the private sector."

The

Dow Jones Industrial Average

finished down 21.97 points, or 0.21%, at 10,459.63, after gyrating between a low of 10,425 in the morning and a high of 10,513 in the afternoon. The market placed its hopes (and its money) on shares of aluminum producer

Alcoa

(AA) - Get Report

, heavy-equipment maker

Caterpillar

(CAT) - Get Report

and, of course, oil giant

Exxon Mobil

(XOM) - Get Report

.

The

S&P 500

finished up 1.26 points, or 0.1%, at 1221.59, while the

Nasdaq Composite

dipped 4.19 points, or 0.2%, to 2147.90.

Economic reports showing strength in retail spending in August were outweighed by news of decelerating manufacturing activity in the ISM report. The data left investors confused amid rising expectations that the Fed may stop raising rates if the economic outlook seems too fragile.

"What's really driving the market is that economists are saying economic growth is now tilted to the downside for the reminder of 2005," says Michael Sheldon, chief market strategist at Spencer Clark. "It's going to take some time to figure when oil prices get back on track, how weak the economy will get and whether

or not the Fed will ease."

Friday's release of August employment figures may not help the case for the end-of-rate-hikes scenario. Economists on average expect the economy to have added 200,000 to the payrolls in August, bringing the unemployment rate to 4.9%. That's fairly close to what most economists consider full employment, a level where tight labor markets are expected to start producing wage-inflation pressures.

Without Katrina's impact, the Fed would view this number together with evidence of strong consumer confidence earlier this week and have no reason to sway from its current course of lifting short-term rates back to a neutral level, says Moody's economist Elizabeth Casinelli.

"The events this week are probably going to dictate what happens in the near term" for Fed policy, she says. "With the yield curve about to invert, it would make sense for the Fed to hesitate

about tightening further, but everything will depend on how things play out in the next few weeks."

The market, meanwhile, already has started discounting an increased likelihood that the Fed will soon halt its rate hikes.

According to Miller Tabak, the odds that the Fed will again hike rates at its Sept. 20 meeting have now fallen to 48% from 90% on Wednesday and those of a Nov. 1 hike (assuming the Fed hikes in September) have dipped to 8% from 100% on Monday. The market is now expecting that the Fed will stop raising rates after one more rate hike this year, and expects one more hike next year.

The benchmark 10-year Treasury bond finished down 3/32 and its yield rose to 4.03%. The yield dipped below 4% intraday but hit resistance levels at 3.99%. The two-year note, the yield of which most closely tracks the fed funds rate, gained ground, adding 5/32 and its yield falling to 3.72%.

Although the majority of the money in the market has been going into energy and sectors that may benefit from reconstruction efforts, banks and brokerage stocks also have been gaining as the yield curve steepened.

A narrowing yield curve over the past year -- as long-term yields stayed low while short-term ones rose - has hurt banks which typically borrow at cheap short rates and lend money at more expensive long-term rates.

On Thursday, the Philadelphia banking index gained 0.4% behind strength in

J.P. Morgan

(JPM) - Get Report

,

Banc of America

(BAC) - Get Report

and others.

"Bank stocks have really underperformed over the past couple of months and they tend to perform better when the Fed stops raising rates," says Spencer Clark's Sheldon. "But it takes a little bit of time for the impact to really be felt on their earnings because if the economy slows, that means loan growth will also drop."

Likewise, housing stocks, which have taken a beating throughout August, have been making a comeback this week, as the yield of the 10-year bond, used to benchmark most mortgage rates, dropped sharply. The Philadelphia Stock Exchange Housing Sector Index gained 0.2% Thursday and is up 4.4% since last Friday's close. Homebuilders

Hovnanian

(HOV) - Get Report

and

Toll Brothers

(TOL) - Get Report

were among the big winners this week.

To view Gregg Greenberg's video take on today's market, click here

.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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