Katrina Makes Waves for Markets, Mutual Funds

Long-term effects remain to be seen

As Hurricane Katrina smashed into the coast of the Gulf of Mexico on Monday, its effects could be felt as far away as Wall Street -- crude oil futures briefly surged over $70, energy stocks rose and insurance issues sank. But after the damage is assessed and debris cleared, what will Katrina's long-term impact on the markets amount to? And how can mutual fund investors respond to Mother Nature's fury?

While it's far too early to accurately evaluate Katrina's full scope, it appears the storm was devastating to the Gulf region, even as it received a downgrade from Category 5 (the highest level, representing wind speeds of greater than 155 miles per hour) to Category 4 (representing wind speeds between 131 and 155 mph) on Monday when it hit the Gulf; and its path moved eastward of heavily-populated New Orleans. Still, virtually all sectors of the U.S. economy will likely feel the effects of Katrina. We believe that three industries in particular -- energy, insurance and airlines -- will come under specific focus from investors.

About 95% of Gulf oil production and 88% of Gulf gas production was shut down as a result of Hurricane Katrina, and it may take weeks to evaluate the extent of the damage. As a result, U.S. Energy Secretary Samuel Bodman has approved a loan of oil from the Strategic Petroleum Reserve. However, the biggest concerns may lie on the refined products side, with about 13% of U.S. refining capacity still shut down as a result of the storm, as well as locally produced natural gas, according to Tina Vital, an energy equity analyst at Standard & Poor's.

The sentiment was felt in the market as well. Nymex WTI oil prices have risen 5.6% to $69.81 since last Friday, but Nymex gasoline has climbed 28% to 247.45 cents and natural gas is up 19% to $11.66.

Some Gulf producers, such as ConocoPhillips (COP), and some Gulf refiners, such as Valero Energy (VLO), were lucky and may have escaped the path of the storm, but Vital believes lack of power, flooding, and damage to nearby state infrastructure will be the biggest hurdles to restoring operations. With the Colonial refined products pipeline down at least until the weekend, and U.S. gasoline inventories already low going into the Labor Day weekend, Vital believes we may soon see $3 gasoline prices at the pump, and expects the upward price impact of Katrina will be felt for months. Vital maintains her "positive outlook" on integrated oil and refinery stocks.

Some oil service and disaster relief companies may also benefit from Katrina. For example, Standard & Poor's Equity Research Services upgraded Cal Dive International (CDIS), a company that provides marine contracting services around the world, including wells in the Gulf of Mexico, to a "buy" from "hold."

Much of the investment community will likely focus on insurance, particularly the property & casualty and reinsurance sectors. According to early projections (which vary greatly), Katrina could cost the insurance industry as much as $26-billion in claims, making it the most expensive storm in history -- Hurricane Andrew in 1992 wracked up a bill of about $16-billion (unadjusted for inflation). In 2004, four hurricanes that slammed into Florida and the East Coast resulted in a combined $23-billion payout by insurance companies.

Disasters of this type sometimes benefit insurance stocks in the long term, since investors expect these companies to significantly boost their premium rates. But Tom Davis, financial services analyst at Loomis Sayles, doesn't think that will happen. "The insurance industry had nearly a decade of pricing declines, but now we are in a better pricing environment, having witnessed a four-year period of significant rate increases," he said. "As such, it's probably unlikely that we'll see insurance stock prices shoot sharply higher going forward."

Davis noted that the four hurricanes that hit the Southeast last year "didn't trigger an industry-wide upward movement in pricing." Insurance equities, he said, have performed "pretty well over the past six to nine months largely because their earnings are now coming through from the pricing and rate increases enacted over the past few years, not as a result of last year's big hurricanes."

On Monday morning, after Katrina made landfall, Standard & Poor's insurance industry equity analyst Cathy Seifert reiterated her neutral outlook on the property & casualty sector. "Insurance stocks typically strengthen in hurricane season amid the belief that storm losses will drive up premium rates," she said. "But if Katrina causes serious damage to oil rigs in the Gulf, oil prices could spike. We believe that would offset any potential upside to insurance stocks from the belief that premium rates would strengthen."

Seifert added that Allstate Corp (ALL) and Hartford Financial Services Group (HIG), each ranked 5 stars, or "strong buy" by Standard & Poor's, remain her top picks in the sector.

For Allstate, said Seifert, "we don't believe the damage will be as bad as originally feared. Based on our analysis of market share, we think Allstate is highly exposed to the area, in terms of home insurance. However, because this storm hit low-lying areas, flooding may account for a greater percentage of total losses than in other catastrophes. The typical homeowner's policy excludes damage caused by flooding."

"Allstate will probably take a pretty good hit from Katrina, but given their national presence, they'll be able to absorb these claims fairly readily across the country," agreed Davis. "On the other hand, the small regional carriers which write policies in just the Gulf of Mexico states could be in big trouble, depending upon their reinsurance programs."

Reinsurers, which provide insurance to the insurance companies themselves, may pose a bigger risk, as they bear most of the costs associated with catastrophic claims. In essence, the primary insurance companies spread their risk among the reinsurers. "The reinsurers could face considerable losses in the event of a large enough catastrophe," Davis said. "However, while reinsurers face larger potential losses than primary insurers, they do so with less frequency than the primary insurance firms."

Seifert remains "cautious" on reinsurance, "amid concerns over pricing and reserve adequacy."

Among the plethora of financial services mutual funds, one in particular, the $191-million Fidelity Select Insurance (FSPCX), represents an almost `pure play' on the industry.

Perhaps no industry has been more hurt by persistently high crude oil prices than the struggling airlines, which witnessed a spate of airport closures and cancelled flights as a result of Katrina. Higher fuel prices may further damage the profitability and fragile financial health of airline carriers. Already on the verge of bankruptcy, Atlanta-based Delta Air Lines (DAL) sank 2.3% the day Katrina hit land, and plunged another 5.8% on Tuesday. Northwest Airlines (NWAC), also attempting to stave off bankruptcy, dropped 1.5% yesterday, and another 5.1% on Tuesday. U.S. Airways Group Inc., which is already in bankruptcy, plunged 13.3% on Monday alone.

John Derrick, co-portfolio manager of the Holmes Growth Fund (ACBGX), expects Katrina to exert a short-term negative impact on the retail sector across the board, due to likely higher gasoline prices. "Consumer spending power would probably diminish," he said. "In fact, even before the hurricane, we have already seen some weak sales numbers from Wal-Mart Stores (WMT) and Gap Inc (GPS), among others, over the past month. Now, higher gasoline prices would intensify this situation."

Other industries with a significant presence in Mississippi, Alabama and Louisiana -- like casinos, tourism and riverboat gambling -- will probably also suffer disruptions and loss of local revenues. To illustrate, Thomas Graves, lodging & gaming analyst at Standard & Poor's, maintained a "neutral opinion" on casino stocks. "We expect Hurricane Katrina to hurt gaming results from the Gulf Coast and New Orleans areas," he said. Companies he believes will be affected include Harrah`s Entertainment (HET), which operates a casino in New Orleans, plus two casino/hotels on the southern Mississippi coast; and MGM Mirage (MGM), which runs a casino/hotel in Biloxi, Miss. However, Graves added, most of these companies' operations are located outside of the southeastern U.S.

The following table shows a sampling of mutual funds/ETFs which have significant exposure to certain major oil stocks that are likely to be impacted by Hurricane Katrina:

iShares DJ U.S. Energy Sector Index Tr (IYE)

Exxon Mobil (XOM)


S&P Select Energy SPDR Fund (XLE)

Exxon Mobil (XOM)


iShares S&P Global Energy Sector Index Tr (IXC)

Exxon Mobil (XOM)


iShares DJ U.S. Energy Sector Index Tr (IYE)

Chevron Corp (CVX)


S&P Select Energy SPDR Fund (XLE)

Chevron Corp (CVX)


iShares Morningstar Large Val Fund (JKF)

Exxon Mobil (XOM)


Dreyfus Premier Tax Managed Growth Fund/A (DTMGX)

Exxon Mobil (XOM)


Dreyfus Premier Structured Large Cap Val A (DLVAX)

Exxon Mobil (XOM)


Dreyfus Premier Core Equity Fund/A (DLTSX)

Exxon Mobil (XOM)


The following table shows a sampling of mutual funds/ETFs which have significant exposure to certain major insurance stocks that are likely to be impacted by Hurricane Katrina:




Scudder Dreman Financial Services Fund/A (KDFAX)

American International Group (AIG)


Kelmoore Strategy Liberty Fund/C (KSLCX)

American International Group (AIG)


S&P Select Financial SPDR Fund (XLF)

American International Group (AIG)


GJMB Growth Fund (GJMBX)

American International Group (AIG)


Constellation HLAM Large Cap Quality Growth (HLGRX)

American International Group (AIG)


North Track Funds Dow Jones U.S. Fin 100/A (NDUAX)

American International Group (AIG)


MassMutual Select Large Cap Value/A (MMLAX)

American International Group (AIG)


Diamond Hill Bank & Financial/A (BANCX)

Allstate Corp (ALL)


Smith Barney Financial Services Fund/A (SBFAX)

Aon Corp (AOC)


PBHG Large Cap Fund (PLCVX)

Hartford Financial Services Group (HIG)


Edgar Lomax Value Fund (LOMAX)

Allstate Corp (ALL)


Dean Large Cap Value Fund/A (DALCX)

Hartford Financial Services Group (HIG)


*Source: Standard & Poor's. Data as of June 30, 2005.

InvestmentAdvisor.com has more mutual fund news from Standard & Poor's available here.
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