The Trader’s U E-Letter: Issue #151
Thursday, September 8, 2005
How Is the Stock Market Affected by Natural Disasters? Three Reasons Katrina Shouldn’t Change Your Investment Style
D.R. Barton, Jr., Chairman, Trader’s U
“Why is the stock market going up… during one of the worst national disasters in history?”
I’ve heard this, and many other questions, over the last week and a half. Hurricane Katrina and its aftermath have showed us suffering on a wide scale. And when we see the effects of this suffering, we wonder how anything else moves forward.
Curiously, the stock market is doing just that… and confusing us in light of the economic and emotional devastation.
So, I’ve done some research and found very interesting trends that happen after large-scale storms strike. And the results are consistent and surprising.
Let me explain.
What’s Driving U.S. Stocks Higher?
First, I’m not suggesting that there is a way to profit from the effects of Katrina or other natural disasters, either on the long or short side of the stock market. This analysis is provided to shed some light on the confusing market action where the market is going up in spite of a huge economic loss.
I’ve read many accounts of the recent rise in stock market prices, including:
- The U.S. economy was already robust with low inflation, rising output, and falling unemployment.
- The government’s release of strategic petroleum stockpiles mitigated the effects of reduced production, refining and distribution from the Gulf region.
- Advanced logistics automation immediately and effectively re-routed distribution of goods that could have been bottlenecked in the region affected by the hurricane.
- The overt hinting that the Federal Reserve would use this event as a reason to stop raising interest rates.
- Temporary reduction in environmental requirements for gasoline so that the U.S. could import over-stocked European supplies.
- The reduced general goods and services output from affected areas were quickly compensated (at least in part) by other regions in the U.S.
I’m sure all of these items had positive effects on the economy and markets. And perhaps similar reactions have been mitigating factors in the past. But the fact is that the market has shown a repeating behavior of upward price movement after major natural disasters.
Katrina’s Three Older Siblings… and How They Moved the Stock Market
The last day before Katrina struck the Gulf Coast, the Dow Jones Industrial Average closed at 10,450. Eleven days later, it closed at 10,589, up 139 points, or 1.3%.
What happened? Let’s ask history…
Below you’ll find the daily charts of the Dow Jones Industrial Average following hurricanes Andrew (1992), Hugo (1989) and Camille (1969). All three storms had monstrous effects, both economically and emotionally. For the weather hounds out there, these were classified as category five, four and five hurricanes, respectively. For the non-weather hounds, category five is the highest rating given to a hurricane and has sustained winds of 156 miles per hour or higher.
Take a look in the charts below:
In all three cases in the charts above, we see the stock market move up immediately after the storm, just like it has after Hurricane Katrina. To be fair, four data points are not “statistically significant.” But we can safely say what’s NOT happening: The markets don’t retreat after a big storm hits.
Historically, big hurricanes and other natural disasters reduce near-term output while boosting economic growth over the long-term through reconstruction. This balance of positives and negatives tends to reduce the overall economic impact of hurricanes.
Increasing your activities in helping those who are suffering from Katrina is a wonderful thing to do. But significantly changing your investment plans based on the hurricane seems to be unnecessary.
The Chart of the Week
Don’t be too zealous about the upward thrust by the market - at least until it gets thorough the multi-year high established in late July and early August. Also, be wary of a test that moves just a few points above this level and then retreats.
Great trading,
D.R.
D. R. Barton, Jr., editor and founder of Trader’s U. Barton is chief operating officer and risk manager for the Directional Research and Trading hedge fund group. He is also one of the top-rated national speakers, lecturing on stock and futures trading, along with other key strategies for investors.
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