In the Wake of Katrina

Calvert's investment officers discuss Hurricane Katrina's impact on the economy, the markets, and their portfolios.

Hurricane Katrina ranks as one of the worst natural disasters in the history of the US, and New Orleans and the Gulf Coast were decimated by its winds and flooding. Is the worst of the disaster over, or is it just beginning for the economy and the markets? In the following interview, Steve Falci, Chief Investment Officer, Equities, and Cathy Roy, Chief Investment Officer, Fixed Income, explain why they believe that the long-term effects of Katrina will be limited and how a disciplined investment process can benefit investors.

Cathy Roy	Steve Falci

Q. What impact will the destruction in the Gulf Coast have on the US economy?

Cathy Roy: Certainly the human costs of Katrina are high and are likely to be lasting. From an economic perspective, however, the Gulf Coast represents only one slice of the overall US economy. We expect Katrina to have three effects on the economy: the price of oil could rise modestly, inflation could rise to a degree, and GDP growth could weaken slightly. These trends were already in place before Katrina hit, however, so we haven't changed our long-term outlook.

Steve Falci: It's reasonable to expect that earnings growth will slow somewhat post Katrina. But earnings were stronger than anticipated in the second quarter, which led to expectations that earnings growth could be in the 10% to 12% range for the full year. Even if a setback materializes, earnings growth in general, while slowing relative to last year, could still be fairly healthy.

Q. Oil prices rose dramatically in Katrina's aftermath, then fell back. Are oil prices headed higher long term?

Steve Falci: It's useful to take a longer-term perspective. The price of oil doubled in the two years before Katrina. While the hurricane has caused some short-term disruptions, those impacts are fairly small compared with the larger issues - supply and demand imbalances, declining capacity - that are pushing oil higher.

Cathy Roy: Katrina's disruptions only enhance our longer-term concerns about the oil industry. Higher prices put a spotlight on the need for conservation policies and investment in alternative energies.

Q. What long-term impact will prices at the pump have on consumer spending?

Steve Falci: Higher oil prices act as a tax on the consumer, and will take up more disposable income. From our standpoint as socially responsible investors, we are also interested in longer-term implications, like monitoring the degree to which higher gas prices change consumer behavior. Will people be motivated to purchase more fuel-efficient vehicles? Or choose to use mass transit more often?

Q. Will the Federal Reserve put their program of raising interest rates on pause to help the economy manage Katrina's impact?

Cathy Roy: We're not expecting the Fed to change course. There is adequate evidence of inflationary pressures in our economy, even outside of rising oil prices, to encourage the Fed to stay on course. Investors respond to their expectations of inflation. As investors continue to be pinched by higher oil prices, the Fed will need to demonstrate that it is determined to keep inflation under control.

Q. What effects have you seen in your markets?

Steve Falci: Immediately after Katrina, the transportation, leisure, and consumer sectors gave up ground, while energy, construction, and some basic materials stocks surged. However, we feel that some of the moves may have been overdone and have created some opportunities for a long-term investor.

Cathy Roy: The municipal bonds of Louisiana, Alabama, and Mississippi have been placed on credit watch, meaning that credit agencies are concerned about those state's ability to meet their bond obligations. A number of commercial mortgage-backed bonds are exposed to real estate in the affected regions, so they could see some price softening. The majority of mortgage-backed bonds are guaranteed, so the impact on that sector is expected to be minimal. Surprisingly few areas of the taxable bond market have yet been hurt by Katrina.

Q. How, if at all, are you repositioning your portfolios?

Steve Falci: From an equity standpoint, we are viewing the current market in the context of our long-term, disciplined, socially-conscious investment process. In this or any other market, our managers must make long-term assessments of where earnings power will come from. There may be opportunities in those companies that declined in the aftermath of Katrina - some of which are well positioned for the long run and are now attractively priced.

Cathy Roy: In our fixed-income portfolios, we generally have a lower interest-rate exposure compared with our benchmarks and peers because we anticipate higher interest rates, both short- and long-term. As far as individual issue selection, I would echo Steve's comments. We see a lot of opportunity in the municipal bonds of the affected states. They have been beaten down on credit fears, but we are confident that they will stay whole. In the taxable market, we are looking at the bonds of insurers that have slipped in the wake of the disaster. Most of these issuers have good long-term prospects.

Q. What are your recommendations for investors as they review their own portfolios?

Steve Falci: Maintain a long-term view and a diversified portfolio. Many of the short-term impacts on stocks that we saw in the immediate aftermath of Katrina were excessive and have the potential to correct themselves over a longer time horizon.

Cathy Roy: I agree. The market and the economy will face modest headwinds for the remainder of the year - lower growth, higher interest rates, higher inflation. But we still expect GDP growth to stay in the 3.5% range, which is relatively good. A diversified portfolio can help you manage risks while still being positioned to benefit from the ongoing strength of the US economy.