North America has been hit with a series of devastating natural disasters. Mexico had two powerful earthquakes over 7.0 in magnitude that devastated the country. Hurricane Harvey decimated parts of Texas and Louisiana, Hurricane Irma wreaked havoc on Florida, Hurricane Maria ravaged Puerto Rico and the Caribbean, and most recently the North Bay fires destroyed thousands of homes and businesses. The human tragedy is immense and the road to recovery for those impacted will be a long and arduous one.
As difficult and challenging as it will be for those directly impacted, as fiduciary advisors we have to ask ourselves: what kind of economic impact do natural disasters have and how do financial markets react?
Damages from Hurricane Harvey and Irma are estimated to exceed $100 billion. When all is said and done, this could be one of the most costly natural disasters ever recorded in the United States. There is no doubt the economy will be impacted – people have lost their cars, possessions, and homes. Economic activity in these damaged communities will temporarily halt as people focus on re-building their lives.
Looking back at recent events such as Hurricane Katrina and Sandy can shed some light on what we can expect. History shows the impacts resulting from natural disasters are usually temporary and limited to the affected region. These events should not impact the longer term trends of the broader economy because the United States is a diversified economy at nearly $20 trillion in size with more than 150 million people in the labor force. We expect the likely outcome from recent events is a short-term spike in unemployment claims and a small boost to inflation, given Hurricane Harvey’s impact on Texas refineries.
We recognize it will take a lot of time and effort for every affected region to rebuild and recover, but these efforts should lead to a boost to Gross Domestic Production (GDP). Private and public spending will increase and people will again buy cars, build homes, and repair infrastructure. The short-term will be painful, but the longer term economic trends should be unaffected.
This may come as a surprise to many, but the stock market has historically been largely unaffected by hurricanes. Ned Davis Research, an institutional investment research firm, did a study that looked at the six costliest hurricanes in the U.S. and the S&P 500 price change during each of these periods. The study shows that the average return of the S&P 500 a year after the hurricane hit was 8.4%. Hurricane Ike, which occurred in September 2008, was the only period with a negative result, which can be attributed to the Global Financial Crisis rather than the hurricane.
This time was no exception – the U.S markets have continued to reach record highs as hurricanes and earthquakes hit. Natural disasters create short term noise and disruption, but as long as companies continue to exhibit strong fundamentals, markets tend to look past the temporary headwinds and focus on the future.
While hurricanes have little effect on the broader markets, they do impact specific industries and companies differently. In the short run, there are clear winners and losers after a hurricane. Historically, construction, infrastructure, and materials companies have benefited while insurance, service, and auto parts companies have suffered.
Natural disasters have the biggest impact on human lives – the devastation caused to families and communities cannot be understated. From an investment standpoint, experience teaches us that natural disasters have had little to no long term effects on the broader economy and capital markets. Investors often focus on shorter term events, but in the long run, markets are mainly driven by earnings and economic outlook. Events like this highlight the importance of investing with discipline versus emotion and owning a portfolio that is well diversified.