Jubak's Journal Recent articles: • Will Katrina tip the U.S. into recession?, 9/2/2005 • Play the lottery with airline, tech stocks, 8/30/2005 • 3 picks for the dog days of summer, 8/26/2005 More... | Jubak's Journal Save your portfolio from Katrina and the Fed The hurricane's huge economic impact will mean both price spikes and a new strategy from the Fed. Here's how to prepare your portfolio for both -- and find some profits. By Jim Jubak The bond market has decided that Hurricane Katrina will soon put an end to the Federal Reserve's interest-rate hikes. Treasury bonds moved sharply higher in price on Wednesday, Sept. 1, tacking another 0.06% onto recent increases. The yield curve has inverted, with two-year Treasury notes yielding more than three-year notes, a sure sign that bond traders think that interest rates are headed down. The yield on a 10-year Treasury note is now 4%, just 0.3 percentage points higher than the yield on a two-year note. And, finally, the fed funds futures market, where traders place their bets on the direction of interest rates, is now pricing in a 76% chance that the Federal Reserve will raise interest rates again when it meets on Sept. 20. But that's down from a 90% chance on Aug. 31 and the 100% odds reflected in prices during most of August. The odds for another rate increase in November have tumbled to 21% from 52%.
But hold on. The argument for a quick end to interest-rate hikes isn't nearly as overwhelming as it seems at the moment, while everyone is reeling from the daily reports of destruction coming in from the Gulf Coast. A new sort of conundrum I think the Federal Reserve is facing a huge dilemma right now. It's uncertain which way the interest-rate decisions will go at the September, November and December meetings of the Fed's Open Market Committee. That uncertainty certainly makes the stock markets tough to read. But I think investors can put together a strategy, not just for coping with that uncertainty, but also for profiting from the Fed's Katrina dilemma. In this column I'll offer you 10 stock picks particularly well-suited to this uncertainty. Related news and commentary on MSN Money Here's the problem facing Alan Greenspan and Co. at the Federal Reserve. Even before Katrina, economists were worried that rising energy prices were finally starting to take a bite out of consumer spending, the engine for the economic growth in the recovery that started in 2001. Even if $40-a-barrel oil or $50-a-barrel oil wasn't enough to slow the economy, surely $60 or $70 oil would be, economists argued. The devastation caused by Katrina has resulted in not just $70 oil, but $3- to $4-a-gallon gasoline. There's also the prospect of heating oil selling for $2.50 a gallon, and of natural gas at $14 per 1,000 cubic feet, up from $1.86 and $11.11 last winter, respectively. The argument for slower economic growth seems just about irrefutable. The bond market has concluded that, if the economy is slowing, the Federal Reserve will stop raising short-term interest rates. Higher interest rates produce slower economic growth, economic theory says. Thats why interest rates are used as a weapon against inflation. But with the economy already slowing, the Fed can take its foot off the brakes. A dangerously rapid slowdown, of course, would require a 180-degree change in policy. Then, we could expect the Federal Reserve to start cutting short-term interest rates again, to stimulate the economy. Greenspan's hobgoblin: inflation That reasoning would be absolutely convincing -- if the Federal Reserve just worried about economic growth. But economic growth isn't the Fed's only concern, or even its dominant one. Greenspan's Fed is obsessed with keeping inflation under control and with preventing any return of inflationary expectations. Which makes Katrina a huge policy problem, since the devastation caused by the hurricane is wildly inflationary. Higher energy prices are a huge part of this, of course. They ripple out across the economy, raising the prices for everything from air travel (the cost of jet fuel has soared) to anything shipped by truck (higher diesel prices). But the effects aren't limited to energy. Katrina has disrupted the transportation and storage infrastructure of the Gulf Coast ports that handle a great proportion of U.S. imports and exports. So, for example, coffee prices have climbed better than 7% this week, with more than 25% of all U.S. coffee bean inventories stored in New Orleans. No one knows how U.S. crops of corn, soybeans and wheat will get to market or where they'll be milled or stored, if the port of New Orleans stays out of commission for an extended period. The disruption so far is driving down the price of grains, since middlemen aren't buying; they've got nowhere to store or ship these commodities. But it's likely that the long-term effect of the transportation shutdown in the region will be to drive up grain prices. Prices of other agricultural commodities already are rising: refined sugar, for example, costs 30% more than normal, reports the U.S. Department of Agriculture. Even the rebuilding of New Orleans and the rest of the battered Gulf Coast will be inflationary. Many needed materials -- copper, cement and timber, for example -- were in short supply globally before Katrina. Reconstruction demand will push many commodity prices higher. The correct conventional response to this kind of price inflation is, of course, to hike interest rates in order to bring down economic growth and dampen demand. A pause in the Fed's rate-hike plan? How will the Federal Reserve balance these two dangers, slowing economic growth and rising price inflation? Will Greenspan and company stick to their targets for a neutral interest rate and keep going until they get short-term rates to 4%? Will they decide that the benefit of higher rates in the battle against inflation is worth the risk of an economic slowdown? Will they decide to postpone further rate increases until they can see how the economy responds to the bottlenecks created by Katrina? My personal vote? I think the Federal Reserve will put off at least one of the two interest rate hikes that investors had been expecting in the remainder of 2005. Greenspan's Federal Reserve always likes to rely on data, data and more data in making decisions. Right now, almost everything they know about the economy comes from before Katrina. I think the decision to put off an interest rate hike or two will be easier to make, too, because the kind of price inflation that we're likely to see post-Katrina is a response to an event; it doesn't create the inflationary expectations that the Federal Reserve fears the most. The Federal Reserve might well decide to save its rate increase ammunition until it can tell if the post-Katrina price increases in energy and other commodities have started to fuel expectations for future price increases. That said, I'm certainly not 100% certain how the Federal Reserve will come down, and that leads to my three-part stock strategy designed to avoid relatively predictable post-Katrina losses and to increase exposure to potentially profitable stocks and sectors. Skip commodity-reliant companies
I'm not talking rocket science here: In the next couple of quarters, companies in the airline, automobile and trucking industries will get slammed by higher fuel costs. If there was an 80% chance that Delta Air Lines Other sectors, such as retail and financial, don't require wholesale avoidance. But investors need to cut back on exposure to the shares of companies with higher-than-average vulnerability exposure to slower economic growth and slower consumer spending. In retail that means thinking twice (or more) about shares of companies with higher-than-average exposure to lower-income consumers. In finance, the same caveats apply to companies with substantial exposure to consumers with less-than-sterling credit. With railroads, I'd avoid companies where the potential damage to their system outweighs the company's ability to increase revenue by grabbing more traffic at higher prices. So I'd avoid CSX The economy shifts, and they win Second, look for companies positioned to profit from the way that Katrina has shifted costs in the economy. The rapid rise in the price of oil and natural gas makes me look at shares of coal companies. Coal had a substantial cost advantage before Katrina. It looks even more attractive as an alternative fuel after Katrina. Peabody Energy Another place to look for companies like this in is the utility sector. Here, a utility such as FPL Group In the oil service sector I'd look for shares of companies whose assets have escaped major damage from Katrina and that are positioned to gain major new work as the oil industry rebuilds. Cal Dive International Free of the energy drag Third, and finally, I'd look to increase my exposure to sectors of the economy widely known for their lack of exposure to the price of energy. New developments on past columns When will oil run out of gas? Good news from Marathon Oil's On a less positive note, the company's Kentucky and Illinois refineries are currently running at reduced rates due to the shutdown of the main crude-oil pipeline from the Gulf Coast to the Midwest. Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. E-mail Jim Jubak at jjmail@microsoft.com. At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Marathon Oil and PepsiCo. He does not own short positions in any stock mentioned in this column. | |||||||||||||||||||
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