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Katrina Recovery Stories Prompt Strong Bounce

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Positive reports from the hurricane zone encouraged investors with hopes that the recovery time would be shorter than previously expected. News clips of rescues and dead bodies are becoming scarce and clips of the recovery progress are taking their place. Oil is flowing in our direction from over 20 countries and gulf production has grown from over 90% shut in to only 54%. Oil prices fell to close under $65 and back at pre Katrina levels. While it appeared the markets celebrated the pattern was once again that of a strong short squeeze on historical post holiday buying.

Dow Chart - Daily

Nasdaq Chart - Daily

SPX Chart - Daily

The economic junkies got a pleasant surprise today with a much higher than expected ISM Services number at 65.0. This is the first time since April-2004 that the headline number has reached 65. The consensus estimate was for 60.0 and the July number was only 60.5. After last week's sharp drop in the ISM Manufacturing number to 53.6 from 56.6 there were some ugly whisper numbers making the rounds for the ISM Services. The majority of gains came from a strong surge in New Orders to 65.8 and Employment to 59.6 from 56.2.

While the ISM Services was the only economic report there were plenty of market moving news. Wal-Mart affirmed its September estimates despite 18 stores still closed from a total of 120 originally closed. WMT said Katrina could hurt the final number but that sales of food had been much stronger than general merchandise and sales in the South were stronger than other regions. They were expecting a +2% to +4% increase in sales for September before Katrina struck. WMT reported an increase of +3.3% in sales for August to $23.33 billion, which was only 1/10th of a point under the +3.4% consensus estimate. The slight miss was impacted by five days of missed post Katrina sales with 120 stores initially offline.

Halliburton announced this morning that is was raising prices in October for all of its energy services business lines. The CEO said demand was so strong in all areas that they felt the move was justified. With HAL running as fast as it can go and more work than they can handle it makes sense to everyone to raise prices. Halliburton said they were hit by Katrina and lost some buildings and tools but it was not really material to the overall company. HAL jumped +2.50 on the news and did not sell off at the close.

Motorola rose nearly +50 cents after Morgan Stanley raised estimates and targets based on improving global demand, strong market share and gross margin improvements. Motorola has been quietly moving higher and just moved to a new 52-week high. This may be the stealth story of the chip sector and investors are coming back to the fold.

Also jumping +2.58 for the day was Apple Computer. AAPL is expected to announce a new product on Wednesday and rumors are hoping for an iPod cell phone. This would be another break through product and it could capture the market for the younger set very quickly. The hypothetical iPhone would be manufactured and marketed by Apple. The cell phone market is 13 times the size of the MP3 player market and would offer Apple an entirely new niche.

The real news apparently moving the market was a drop in oil prices to close just under $65. Half the refiners knocked out by the storm have been restarted with another 25% expected to start this week. Still there are four refineries accounting for 880,000 barrels per day of capacity (5% of U.S. capacity) that may not restart for up to a month or more. Still the good news outweighed the bad at least for Tuesday. Rigs and platforms are coming back online in the gulf with oil capacity still shut in dropping to 70% and gas capacity shut in falling to 54%. While that may be good news for those worrying about oil and gas supplies it is still a catastrophe for the sector in general.

Remember for the last several months every time there was a refinery outage for even a small breakdown or fire that prices shot through the roof. Every time a protest in Ecuador or riot in Nigeria caused temporary blip in oil supply the price of oil would rocket higher. Oil production may be coming back online but according to every company CEO and sector expert interviewed it will take months before full production is restored with many saying it will be Q1 or even Q2 2006 before things are back to normal. We have 90 million bbls of oil and refined products coming out of strategic reserves over the next 30 days and many people on the street think this will solve the problem. This is far from reality. It is simply irrational euphoria based on a false hope generated by media coverage.

The Corp of Engineers said they could have New Orleans pumped out in as few as 23 days but maybe as much as 80 days depending on the weather. They are plugging in additional pumps everywhere they can but it is thunderstorm season as well as peak hurricane season. Any rain from any source will add to the water levels with the major drainage systems still down. More than 60% of New Orleans is still underwater. Nevertheless, optimism is present everywhere and officials hope rebuilding efforts could begin 90 days from now if everything goes ok. The other major problem is the Mississippi river. It is still not open to general traffic due to the loss of 60 barges that are sunk somewhere along the river. Deep draft vessels are being held outside the port until all channels can be cleared of debris. They hope to have the port open in a week. This is the biggest agriculture port in the world and harvest season is just ahead. Only one half of the ports 400 employees have been in contact with the port. Just getting open will only be half the battle. Bottlenecks due to lack of workers will slow everything to a crawl.

Once rebuilding does start there will be a huge demand on wood, sheetrock, steel, copper, paint, concrete, carpet, insulation, etc. The initial thought is that this will produce a massive infusion to GDP as what is now being called $100 billion in damage is rebuilt. Others claim that the manufacturing and supply lines cannot cope with that much demand and continue to supply building projects in the rest of the U.S. at the same time. Even if they could the jump in prices would likely put many projects on hold until demand slowed. Graniterock, a 100 year old materials supply company said on Tuesday that prices are rising faster than at any time in their history. Prices for concrete and asphalt components have soared over +30% in just over a week. Stock in Cement maker Cemex, (CX), has risen more nearly $10 in just the last four days in anticipation of massive cement demand. Companies PD, WY, TXI, FRK, HD and LOW to name just a few are also seeing their stocks prices jump in anticipation of increased demand.

This demand will last for a long time since they can't even get into some areas of New Orleans for weeks to come. The demand today is for demolition crews, dump trucks and body bags. The governor of Louisiana is estimating the potential for 10,000 bodies to be still in the wreckage. We are far from watching a city rise from the mud, oil production flow from the Gulf and gasoline prices fall back to $2.50. The shock to our economy and to corporate earnings is still very under estimated in my opinion.

Current "official" estimates are for a -0.5% to -1.0% drop in GDP for Q3 and Q4. Increases to GDP are not predicted until late Q1 and Q2 2006 as a result of the rebuilding effort. There is a growing consensus that Q3 and Q4 earnings are now very overstated and will have to be corrected soon. Lehman and Goldman both lowered their recommendations of equity allocations and boosted their recommendations of cash.

Just getting power to businesses and the mud swept out does not mean they will be open for business. Employees are already becoming a major problem. Based on current reports less than 50% of employees have been in contact with their employers. Chevron is erecting a tent city for their employees after more than 75% lost their homes. Valero had 50 mobile homes brought in for workers sharing the same fate. Still less than 50% of employees have been contacted. Homes don't exist, phones, power and water do not exist. Every motel room within 750 miles has been rented as families wait out the high water. Others have relocated to stay with relatives even farther away or are sitting out the wait at one of the refugee centers in neighboring states. Over 100,000 residents are now lodged in refugee centers. Carnival Cruise Lines was tapped by FEMA today to supply three cruise ships to house a continuing flood of homeless. Harrah's said one of their casinos could open in four weeks but there are no estimates on the other two. They are paying their employees full pay for up to 90 days in order to keep in contact with them and in hopes of a return to work on any future reopening. Make no mistake, the economy is in for a massive shock and it will be made worse by the continuing energy crisis.

According to the Coast Guard 192 platforms and 27 rigs are still evacuated and 19 platforms are still missing. Rowan said today that one of its biggest and oldest rigs was lost but had been found lying on the bottom about a mile from its original location. This story is being repeated daily as the damage discovery process continues. Consider how long it will take to either refloat and rebuild a sunken rig or put a new one in place to recover that lost production. You can't just go out and tie a cable on it and wench it up. The recovery/rebuild/replace process is going to be very lengthy and I believe it is being underestimated by the public. For a country that consumes 26 million bbls of oil per day the donation of 90 million bbls from strategic reserves is only a drop in the bucket. The normal Wednesday oil inventory report has been moved to Thursday and it is not expected to be pretty. Sharp drops in all inventory levels are expected.

Crude Oil Chart - Daily

Analysts said the markets rallied on falling oil prices and positive sentiment from overseas markets. There was also the historical post Labor Day rally as traders got back to work. Unfortunately this post Labor Day bounce is typically the last hurrah before plunging to the September lows. The last five years has seen the Labor Day rally produce the highs for the month with the end of the month producing the lows. The following table shows the date of the Dow high for the month and the low for the month. In 2001 the markets were already heading south from the Labor Day rally when the 9/11 attack occurred. If history repeats itself the Tuesday gains will be short lived.

The Dow rebounded on Tuesday to come very close to 10600 once again and post a +141 point gain. Unfortunately +107 points of that gain came at the open on a monster short squeeze. Futures were up strongly overnight after being closed on Monday. Falling oil prices and the Wal-Mart affirmation helped juice those futures and the rest as they say was history. If you look at some of the stocks with good gains today you will probably notice that most had been in a long decline. The sudden rebound sent the shorts running for cover and the end result was a sharp gain out of character for the recent moves. Check out AMZN, AZO, WFMI, WMT and CCL. News on the later two did not help the shorts either. Of the Dow 30, HD gained +3.42% with AXP, WMT, MCD and PFE gaining around 2.5% each. Also out of character to their recent trends.

The Nasdaq surged over its 2150 resistance on the opening burst of buying and short covering stops being hit. It traded between 2160-2165 the rest of the day with the last group of diehards pushing it a couple points higher at the close. 2170 and 2180 would be the next resistance levels should the buying continue. The SOX also surged to a four-week high at 475. There is a definite bid under the chips despite no real improvement in outlook.

The SPX shot over resistance at 1225 in the opening tick and then held in the 1230 range most of the day. Again, a final bout of short covering at the close pushed it a couple points higher but still under next resistance at 1235. The SPX is still benefiting from a strong energy sector that refuses to give back its gains and continues to power higher. Most energy stocks are off last week's highs but are poised for another push higher. HAL, SUN, TSO, SLB, KMI and VLO finished the day strongly in the green. Refiners and service companies should continue to outperform.

My outlook remains negative. I believe the economic benefit from Katrina is at least 4-6 months away and it could last for two years. However, before that benefit appears there will be a period of earnings adjustment where corporations will have to adjust guidance for hurricane impact. Earnings warning season will be in full bloom over the next four weeks and once they start it could turn into a flood. Oil prices may not be setting new records any time soon but I doubt they will retreat back below $60. This will keep gasoline, heating oil, diesel and jet fuel prices high and continue the damaging impact on the economy and earnings. There should be less driving now that the summer is over but we also have a serious hit to our crude supply and refining capacity that will more than erase any gains from slowing gasoline demand. The only benefit I see in our immediate future is the potential for the Fed to pass on hiking rates again at the September meeting. While this would be positive for market sentiment it will have little impact on the economy. In fact, much of the buying momentum this morning was from commentary over the weekend suggesting the Fed will take a pass. In effect this potential outcome has now been priced into the market. As a trader I am long oil stocks and short the broader market using the Russell futures. If I am wrong on my market short then I will reenter once the rally bloom fades. I suggest everyone do the same. History is on our side but there is never any guarantee of a repeat performance. We just calculate the odds from all the factors available and place our bets accordingly. As always, enter any position passively and only when the price comes to you and be ready to exit aggressively if the trend you expected changes suddenly. September is known for its volatility.

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