Consumers keep piling on debt, and many face higher house payments as adjustable mortgages are reset. Yet US stocks and bonds have proved surprisingly resilient, at least so far, in the face of these multiplying headwinds.
We think there are several reasons for the market’s underreaction to the hurricanes and their after effects. The overarching reason is that those effects are more subtle and longer term than is currently grasped by investors.
The storms’ impact on the US economy is regarded by many analysts as a timing issue. In this view, the hurricanes’ shorter-term impact on jobs, personal income, and corporate earnings in 2005 will be offset – perhaps more than offset – by reconstruction spending peaking in the first half of 2006.
But securities analysts, whose views greatly influence market valuations, tend to focus on cash flows and income statements. What they appear to be overlooking is the effect of the storms on balance sheets: the tremendous destruction of asset values. The assumption is that all the costs of restoring this lost value will be borne by some combination of private and (borrowed) government funds. That is an optimistic assumption.
The most enduring impact of the storms may stem from their effect on US consumer psychology. Witnessing the losses inflicted by these unexpected shocks may restore people’s ingrained instinct – attenuated in recent years by steady economic expansion and rising home-equity wealth, and in recent months by remarkably steady financial markets – to put money aside for the proverbial rainy day. Greater household savings would slow the American economy.
The next six months are likely to see both the end of Fed tightening and a reversal of recent improvements in the federal fiscal picture. The dollar will likely be hurt by both these trends.
Jeff Knight, chief investment officer, global asset allocation, Putnam Investments.
