Do you think Katrina will hurt the markets? If so, this will surprise you…
Despite the catastrophic
damage and unimaginable loss incurred by residents of the Gulf Coast, history
shows that natural disasters have little effect on broad financial markets over
the long term. While certain industries such as insurance,
transportation and other regional businesses are impacted significantly by major
natural disasters, the broad financial markets recover swiftly after an initial
shock. The economic environment, monetary policy and technical trends are
much more important to the long-term direction of stock prices.
I have highlighted four of the most devastating
natural disasters of the past century and the financial market’s reaction.Â
Two of the four markets bounced back swiftly from impulsive declines and the
other two never declined significantly. However, each market saw a
different long-term outcome, indicating that the market’s ultimate trend was
probably based on a multitude of factors not related to the natural disaster.
2004 Indian Ocean Earthquake and Tsunami
On December 26, 2004, the fourth largest earthquake in the 20th century
caused a tsunami that stretched from South Asia to East Africa. The tidal
wave killed over 200,000 people and displacing 1.1 million others. The
estimated $2 billion in damage caused by the tsunami does not convey the
significant human loss.
Financial markets in the Asia Pacific region were
brazen in their reaction to the natural disaster.  From Indonesia to
India, stock prices closed higher in the days and weeks after the tsunami.Â
In fact, the Jakarta market hardly reacted at all, despite Indonesia being one
of the hardest hit nations with an estimated 120,000 people killed. The
Jakarta market, which was in a powerful bull trend as shown by the rising 50 and
200 day moving averages, rose 15% over the next several months following the
disaster.
1992 Hurricane Andrew
On August 22nd, 1992, Hurricane Andrew made
landfall in southern Florida, causing 15 deaths, $30-billion in property damage
and leaving more than 250,000 homeless. Until Hurricane Katrina, it was
billed as the most expensive natural disaster in US history.
While numerous insurance companies declared
bankruptcy following Hurricane Andrew, the Dow Jones Industrial Average fell
only 2.2% during the two days following the hurricane’s landfall. The Dow
made a second bottom in October 1992 and continued its steady climb throughout
1993. The Index rose 14% in 1993 until the Federal Reserve began a
tightening cycle in 1994.
1969 Hurricane Camille
On August 17, 1969, Hurricane Camille struck the Gulf Coast, causing over 250
deaths and an estimated $4.2 billion in damage (1969 dollars). The parallels
between Hurricane Camille and Katrina are eerie – both were category five
hurricanes before landfall, both caused hundreds of deaths in Mississippi and Louisianan,
and both ravaged the Gulf Coast economic infrastructure.  Â
“For survivors, chaos reigned along the coast. There was no gas,
electricity or drinking water. Roads were impassable, railroads washed out,
telephone lines down,” wrote Time magazine in August 1969.
Despite the destruction, the Dow Jones Industrial
Average actually closed higher the day and week of the hurricane.Â
The market had been falling for the previous three months because investors
feared President Nixon would institute price controls to alleviate rising
inflation. While the Dow Jones Industrial Average began a brief recovery
several months after Camille, it fell again towards the end of 1969 as inflation
and interest rates continued to rise.
1906 San Francisco Earthquake and Fire
An earthquake registering 7.9 on the Richter scale struck California on April
18th, 1906. The earthquake and resultant fire, which engulfed much of San Francisco,
caused over 600 deaths and an estimated $400 million in property damage (1906
dollars). The combined disasters essentially destroyed a city of 400,000
inhabitants (versus a total US population of 85 million at the
time).
The Dow Jones Industrial Average reacted rather slowly to the news because
the most significant damage was caused by fire after the earthquake.Â
Still, the Dow Jones only fell 5% during the next two weeks and recovered
rapidly after the decline. The index made a second bottom in July and
essentially traded sideways for the remainder of 1906.
Not until March 1907, did the market make a dramatic move, when the Dow Jones
plunged in the “Panic of 1907.” However, the crash was caused by
the deflating of copper stocks and the resultant financial panic, not the
devastating earthquake a year before.
Markets Rebound In The Short Term
Despite swift downdrafts, financial markets often rebound quickly from major
natural disasters. Several reasons account for such rapid bounces.Â
First, large corporations, whose stocks make up the major indexes, are usually
insured against business interruption and have the wherewithal to resume
operations quickly. While the companies might miss a quarterly profit
estimate, the long-term financial impact to large companies is miniscule.Â
Second, governments and central banks often inject liquidity into the financial
system to provide money for the rebuilding effort. Third, the short term
economic disruption caused by a natural disaster is often offset by the long
term economic activity generated from reconstruction. And finally and
unfortunately, the majority of the damage is often incurred in poor areas,
which have little economic influence to begin with, as was the case in the 2004
Indian Ocean tsunami.
Historically, damage resulting from major
earthquakes, hurricanes or tsunamis has had little effect on broader financial
markets over the long-term. While today’s market might be slightly
different because of the nationwide spike in gasoline prices, the lesson from
history is fairly clear. No matter how severe the destruction, investors
are better off understanding economic fundamentals, monetary policy and
technical trends than reacting to the negative short-term fallout from natural
disasters.
Thomas Neuhaus
Thomas Neuhaus is a principle of Investment
Management of Virginia, a registered investment advisory firm for which he
co-manages. Mr. Neuhaus’ career has encompassed all aspects of the investment
business from investment banking to sell-side research to buy-side portfolio
manager. Prior to working on the buy-side, Neuhaus worked as the head of
technology equity research for BB&T Capital Markets, where he covered the
business services and business intelligence software sectors. From 1994 to 1997,
Neuhaus was an Investment Banker for a regional investment bank, completing
initial public offerings, mergers & acquisitions, and private financing for
Business services, Telecom, Internet and Software companies.
Tom graduated from the University of Virginia with a degree in Finance.