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Were Harvey and Irma a TKO for US equities?

By: Mary Fjelstad, senior research analyst 

We would like to extend our deepest sympathies and best wishes to all those whose lives have been affected by the recent storms.

We are in the eye of the hurricane season right now after the recent one-two punch of Harvey and Irma, with possibly more to come. These two massive storms wreaked havoc on people and property in two separate coastal regions of the southern US – Harvey in Texas and Irma in Florida. One might, therefore, expect the devastation to negatively impact the stock market and particularly some specific sectors most vulnerable to severe storm damage.

Let’s look at the behavior of the broad US equity market using the Russell 3000 Index as it navigated through these two major storms. Harvey reached hurricane status on August 24 and Irma became a category 5 on September 5. As the chart below illustrates, the largest market dips occurred prior to Harvey’s ascent to hurricane status, so it is possible that other major news stories from early August could also have caused these market dips.

For example, just around the time of the first big market drop came the news that North Korea had the capability to arm missiles with nuclear war heads. This led to heightened tension between the US and North Korea. The well diversified broader market is more likely to be affected by an international nuclear crisis than by a largely localized and short-term natural disaster. And indeed, the graph shows that despite reacting to North Korea, the market seemed not to react to Hurricane Harvey.

Russell 3000 Index cumulative return July 17–September 2017

 

Source: FTSE Russell. Data as of September 11, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

The next, albeit smaller, dip occured right around the time of the upgrade of Hurricane Irma on September 5. But on September 9 the forecast changed, indicating that Irma might spare the higher property value areas on the east coast of Florida of its full impact. At this point the broader market turned upward again.

Where we might notice the market effect of natural disasters most clearly is at the sector level. Since Harvey inflicted a huge amount of damage on Houston, TX – a major hub of oil and energy production – we might expect an impact on the various industries within the Energy sector. However, as we can see in the chart below, the Energy sector as a whole, as well as many of the related industries, were underperforming well before Harvey arrived. Because energy sectors and industries are so diversified regionally, if one region shuts down because of a local disaster, the companies in the unaffected regions take over. Oil, moreover, is a commodity whose pricing is highly elastic. That means companies can easily pass their losses and expenses on to the end consumer – leaving the company’s finances intact.

Energy sector and industries cumulative excess return over Russell 3000 Index

Source: FTSE Russell. Data as of September 11, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

Insurance, particularly property and casualty, is another sector you might expect to be affected by massive hurricanes. Much like oil and energy companies, insurers have the ability to pass on their losses to their clients via increased premiums. However, their ability to do so is much less immediate. The chart below shows a downturn in performance in most of the Insurance industries as Harvey’s arrival became imminent. An even deeper dip occurred as Irma became a category 5 storm. Then, with the exception of multi-line insurance, we can see a rebound around September 8, when Irma changed course away from the more expensive areas along Florida’s east coast.

Financial Services sector, Insurance subsector and Insurance industries cumulative excess return over Russell 3000 Index

 

Source: FTSE Russell. Data as of September 11, 2017. Past performance is no guarantee of future results. Please see the end for important legal disclosures.

A closer look at the Insurance subsector and industries can be quite telling. As we have seen, the dip was less severe for all Insurance industries around the onset of Harvey than of Irma. One possible explanation for this is that the damage inflicted by Harvey was primarily due to flooding rather than storm destruction, and homeowner insurance policies normally do not cover flood damage. It has been reported that 80% of those affected by flooding by Harvey did not carry flood insurance.[1]

Natural disasters such as hurricanes can tragically affect the lives of many people. Purely from a stock market perspective, the impact of such storms tends to be local and short-term. The one-two punch of Harvey and Irma, while a tragic event, did not have a major impact on the US equity market as a whole or for any specific industry or sector. More important, however, is their impact on people whose lives have been changed by these disasters and to whom we offer our sympathy and best wishes.

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 [1] See for example, Long, H., “Where Harvey is hitting, 80% lack flood insurance,” 2017, Washington Post, August 29.

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