While I’m writing this article, Hurricane Irma is bearing down on Florida, bringing its 175 MPH winds and huge storm surge to the low-lying state. Thankfully, forecasters foresaw its path and there have been massive evacuations. We can only hope that the loss of life will be kept to a minimum.
There will, however, be incredible destruction. Houses will be blown away, coastal flooding will occur and many billions of dollars will be lost. The immediate negative effect on the economy of Florida will be tremendous. And, with Harvey having just inundated Houston, the combined effects of the two hurricanes on the economy of the US will be quite noticeable.
But, will the overall effect be bad? Or, are there gains to be had in the aftermath of these disasters? The answers to these questions are not as straightforward as one might think and this week’s newsletter will try to shed some light through the storm clouds on their economic impact.
Houston We’ve Got a Problem
In the areas impacted by the storms, the economic impact is actually quite debatable. It’s called the “Broken Window Effect”, which means that, when something needs to be replaced, there is money spent on fixing it, which is good for the economy. However, this money could have been spent more productively elsewhere, or maybe saved, so the effect is rather unclear.
The above figures demonstrate how the immediate (1st Q) effect of a disaster has a generally positive economic impact. Money comes into an area in terms of insurance policies and aid from both government organizations and relief groups like the Red Cross.
Longer term, the situation becomes quite different. In areas where the storm caused losses but not complete destruction, repair takes place, then things return more or less to normal. However, look at what happened in New Orleans after Katrina. A mass exodus caused tremendous long term disruptions to the economy and it has never fully recovered.
Could this happen with our current hurricanes? I believe it might. Florida and the Houston area are both low lying zones that are subject to frequent flooding. As Global Warming causes mega-hurricanes to become the norm not a once-in-a-lifetime event, people are going to have to seriously consider why they would live there. Add in increased insurance premiums, which could dramatically increase the cost of living, and these areas might suffer an exodus of citizens.
If this is the case, companies with major operations in these areas could be impacted and, certainly, localized real estate plays will take a major hit.
Nationally, Things are Rather Uncertain
When disaster hits a small portion of the US, how does it impact the country as a whole? Forecasters are at complete odds over the long term effects of a natural disaster on the economy.
Looking at Harvey, as an example, a more neutral view comes from The Wall Street Journal’s survey of economists which estimate the storm will affect the most important economic reports at the national level in the months ahead. They expect the storm to reduce the pace of job gains by about 27,000 jobs a month in the third quarter on average, followed by little change in the fourth quarter and then a boost of 13,000 in the first quarter 2018, as many people find work in the rebuilding process.
The growth rate of gross domestic product will fall by about 0.3 percentage points in the third quarter, they expect, followed by no effect on the fourth quarter, and an 0.2 percentage point boost in the first quarter of 2018.
“The devastation in the surrounding Houston area, America’s fourth-largest city, will be significant enough to negatively impact activity and employment nationally, especially in the third quarter, but some of those effects will be transitory,” said Chad Moutray, chief economist for the National Association of Manufacturers. ”
On the other hand, research out of Columbia University professors Hsiang and Jina showed a negative effect from natural disasters. These two looked at 6,712 cyclones, typhoons, and hurricanes observed from 1950 to 2008 and the economic fortunes of the countries they struck in the years that followed. With their data, Jina and Hsiang can decisively say: These storms are bad—very bad—for economic growth.
“There is no creative destruction,” Jina said. “These disasters hit us and [their effects] sit around for a couple of decades.”
How will these two recent storms impact the US over the next several quarters? I guess only time will tell.
Areas to Invest, Areas to Avoid
Home Depot is the first name that comes to mind when one thinks about disasters. They are actually very good at bringing needed items to an area and NOT price gouging as they outfit people in advance of, or post, a hurricane.
Chains like Home Depot that provide the needed goods and services to fix or rebuild hard hit areas should benefit greatly from disasters. As another example, Houston is the refinery capital of the world, so suppliers to these refineries are well positioned.
Another beneficiary would be the automotive industry. The number of cars trashed by the flooding is huge. They will need to be either repaired or replaced. Auto parts suppliers and used car dealers should see greatly increased traffic and the automotive industry as a whole should see modest gains.
The list of sectors and companies to avoid around a disaster is fairly large; the most obvious being insurers. Check out the chart of KBWP, a property and casualty insurer ETF; it took a little hit recently.
Longer term, however, insurers tend to adjust rates to reflect risks. If global warming is going to increase the rate of large scale disasters, they might suffer a lag in raising rates, but insurers are pretty good at making money, so no pity parties needed.
Besides insurers, there are going to be many other companies hit hard by disasters. These tend to be more locally focused (think Florida-centric dining chains).
Keep Your Eye On The Hurricane’s Effect
The bottom line in all this is that disasters are not good for economies. Money that could be put to use in more meaningful ways is spent rebuilding what was already there.
However, in the wake of this destruction is an incredible amount of rebuilding. The overall economy might have been better without a hurricane, but there’s no denying that the aftermath of one is not negative across the board. There are plenty of beneficiaries that profit post these events.
When investing it’s always important to understand the effects of what’s going on outside of your universe. While you might think you’re insulated in one stock, the ripple effect of a large-scale disaster could be huge. But, if you’re not directly in the eye of the storm, the impact of the disaster might not be meaningful or could even be positive.