After The Storm, Recession Fears Rise

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It may be the perfect storm: Katrina, oil, a bursting housing bubble and busted consumer confidence could send the nation into recession.

The economy will pay the price for surging energy costs and storm-related disruptions to the flow of goods and oil. That's reality, but there also is a psychological impact-of shock, sadness, shaken confidence in the government's ability to deal with crisis in the homeland.

Economic loss from Katrina and the New Orleans flood likely will exceed $100 billion, and the cost of interrupted economic activity is above $100 million a day, according to Risk Management Solutions, an insurance risk-management service. RMS estimated the insured property loss from Katrina at $20 billion to $35 billion, likely the most costly natural disaster in U.S. history (though below 9/11's cost to insurers of some $40 billion).

America stopped for days of mourning post-9/11, but the nation quickly rallied and both consumer confidence and a weak 2001 economy rebounded. Two months after 9/11, economists ruled a recession had begun in March '01; they later determined it ended in Nov. '01.

This story is playing out differently. The economy was far stronger going into this disaster, commerce and advertising continued last week, yet confidence in government's response crumbled. The unity of 9/11-us vs. them-gave way to the division of us vs. us.

The tragedy hit at a time when rising gas prices and falling housing sales were already raising questions about this expansion. It is conceivable that economists months from now will say a new recession began in August 2005; recessions begin when the economy is at its peak.

Poor Americans will have to cut spending to pay for gasoline and heat. Other Americans may feel poorer and less secure even if they can afford $3 gas, and a rational response would be to cut back and hold off on big purchases. Just in time for the holidays, that could spell trouble for consumer spending, which last quarter accounted for 70% of GDP.

"Consumers will have less discretionary income to spend," said Morningstar analyst Kimberly Picciola.


Costly fuel is a direct hit to beleaguered airlines, while oil and weakening consumer demand could depress corporate profits in sectors such as retail and restaurants that rely on discretionary spending.

"We're in for a rough stretch," said Bob Goldin, exec VP at restaurant industry consultancy Technomic. The oil shock raises the specter of inflation, though it's not clear marketers would easily be able to raise prices.

All of this could put pressure on ad spending. In the last downturn, advertisers cut spending 6.2% in January 2001, two months before the recession, and didn't turn up spending till May 2002, six months after economic expansion resumed.

Print media could pay the price. If fuel costs remain high, it is conceivable postage rates could rise to cover the Postal Service's fuel costs. Newspapers, too, are dependent on gas for delivery, and their retail advertising could suffer if gas prices prompt consumers to do less driving to the mall. "Anything that makes the price of gas go up affects newspapers," said John Maxwell, newspaper analyst with Maxwell Research.

High gas prices could steer more business online-though, which made free shipping central to its marketing, could face higher parcel fees if rates rise.

Larry Fischer, president-media sales for Time Warner Cable, is bracing for a ripple effect from oil: He believes higher gas prices, exacerbated by Katrina, will cause consumers to buy fewer SUVs, which will lead to a decline in advertising as automakers adjust to selling fewer of those highly profitable vehicles. Automotive is the largest ad category, accounting for 10.8% of 2004 U.S. measured ad spending, according to TNS Media Intelligence data.

For now, the economy looks pretty good-in the rear-view mirror. Second-quarter gross domestic product rose 3.3%; economists expect 4.1% and 3.5% in the final two quarters, according to an early August survey by Bloomberg. July car sales and median home prices both set records. U.S. first-half ad spending rose a healthy 5.7%, according to Nielsen Monitor-Plus. The August unemployment rate (4.9%) hit a four-year low. Most retailers reported decent results in August.

AdMarket 50 stocks are largely holding their own, down 3.4% year to date, were flat last week amid tragedy and uncertainty.

But objects-or objections-may be closer than they appear. The National Association of Realtors reported small declines in July home sales and in its index of pending sales and a rise in inventory, creating a cacophonous debate on whether the bubble had burst. Wal-Mart Stores, with heavy reliance on lower-income America, reported weak sales growth in August. Detroit's sales faltered last month after a sizzling summer.

The housing boom helped drive economic expansion, making homeowners feel wealthier and giving them equity to pay for remodeling, cars and other purchases. The boom may be busted-raising more questions about how overextended owners will pay off their interest-only loans if the economy falters, prices decline and interest rates rise.

Katrina hit a region comparatively limited in population and money. Louisiana and Mississippi together account for just 1.9% of GDP; New Orleans is-or was-the No. 43 TV market, with 672,150 TV households, according to Nielsen Media Research. But the Gulf Coast is pivotal to the economy: It accounts for 47% of U.S. refining; 60% of oil imports go through the region; and 28.5% of U.S. offshore oil comes from the Gulf of Mexico, according to the Energy Information Administration. Katrina knocked out refineries that were supplying about 10% of the nation's oil, though some pipelines were already restored last week.

Shipping of other goods also was disrupted. Factories took a hit; Procter & Gamble Co. had its primary processing plant for Folgers and Millstone coffee in New Orleans. The plant is currently shut down, with P&G "assessing the situation."

Hard to cope

The gas crisis bodes badly for consumer confidence. The University of Michigan's Index of Consumer Sentiment fell sharply in August in one of the biggest one-month declines in 27 years. Survey director Richard Curtin attributed the decline to consumers' concerns about gas prices. "Consumers have found it increasingly difficult to cope with the recent surge in gasoline prices," he said. The Conference Board's rival Consumer Confidence Index showed an unexpected gain in August. "Consumers appear to be weathering the steady rise in gas prices quite well," survey overseer Lynn Franco said. It's hard to see confidence going up in September.

Gas prices are affecting vehicle sales. Sales of Ford Motor Co.'s traditional sport utilities crashed 33% last month; General Motors Corp.'s Hummer H2 fell 37%. An Aug. 26-29 survey by Kelley Blue Book and Harris Interactive found 59% of consumers who plan to buy a new vehicle in the next 12 months said gas prices had changed their minds or strongly influenced purchase decisions, while 70% said they'd consider a gas/electric hybrid. That bodes well for hybrid sellers, including Toyota Motor Sales USA, American Honda Motor Co. and Ford.

John Bulcroft, president of consultancy Advisory Group, said automakers face tremendous losses on car loans in flood areas and on inventory they financed or insured at dealers that were flooded. Erkut Uludag, partner of Roland Berger Strategy Consultants, predicted interest rates will continue to climb, adding to automakers' cost of selling products without the ability to pass along hikes to buyers. That's bad for Ford and GM, already at junk-bond status.

Gas prices late last week soared past $3 a gallon in much of the country, breaking March 1981's inflation-adjusted record of $3.03. At $3, the average U.S. household will spend 4.6% of pretax income on gas. It's devastating for the poorest 20% of households, which typically own one vehicle and will see gas consume 13.6% of income this year, nearly double 2003's 7.5%. The rich can afford $3 gas: It will cost the top 20% of households 2.8% of income this year vs. 1.6% in `03. But there's a psychological issue: It now costs $111 to fill up a Chevrolet Suburban.

Winter heating bills are expected to soar, creating more stress. Natural gas and heating oil in '03 consumed 1% of the average household's income, 0.6% for the top 20%-but 3.8% for the poorest 20%. If prices stay high, the poor could spend upwards of 20ยข of every dollar on gasoline and heat.

GM bets $3 gas is temporary. Paul Ballew, executive director of global market and industry analysis, last week told analysts and investors that GM expects oil prices to decline from current levels but remain above $50 a barrel for several years.

History suggests high gas prices will lead to less driving. In 1974, as consumers faced gas station lines and a 36% spike in gas prices, miles driven per car fell 6.7% to the lowest point since 1951, according to government data. Driving also fell in 1979 and '80 as pump prices broke a buck. Americans over time adjusted to higher prices, and miles driven per car broke a record in 2003.

written with contributions from bureau reports and Business Insurance senior editor Roberto Ceniceros.

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