What Florence Could Mean for Stocks

hurricane

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    It’s a familiar story. A hurricane makes landfall and devastates a large area of land. There is a sad story from a human perspective. This year, the story is centered in North Carolina.

    Factset summarized the financial impact in a headline that read, “Insurance Industry and Financials Sector Earnings at Risk Again Due to Hurricane Florence.”

    The analyst noted, “Hurricane Florence is expected to cause significant property damage and business losses across the southeast coast of the U.S. over the next few days.”

    From a corporate earnings perspective, what sectors or industries in the S&P 500 are likely to see a negative impact from the hurricane?

    One industry that will likely see a negative impact from Hurricane Florence is the Insurance industry, as companies in this industry will record catastrophic losses for the property damage caused by the storm.

    Last year, the S&P 500 Insurance industry witnessed a substantial decline in earnings for the third quarter after Hurricanes Florence and Irma. From August 25 through November 10 in 2017, this industry saw a 68% decline in EPS (to $2.19 from $6.75). Over this same period, the S&P 500 Financials sector saw a 13% decline in EPS.

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  • The chart below summarizes that historic impact.

    S&P 500 insurance

    Source: Factset

    The Past Is Not a Guarantee

    Of course, the future is not guaranteed to be exactly like the past. But, the past often provides insights into what we can expect as investors. In many cases, the past is all we have to consider what the future is likely to hold.

    For example, we cannot understand what the impact of Hurricane Florence will be on the stock market. But, we can look at similar events to understand what happened in the past.

    By looking to the past, we can develop an expectation for the future. We can expect large losses but much of the damage might be uninsured.

    Florence’s Impact Will Be Severe

    Insured losses from winds and storm surge spurred by Hurricane Florence will range from $1.7 billion to $4.6 billion, catastrophe risk modeling firm AIR Worldwide noted in a report.

    The estimate does not include the impact of ongoing flooding caused by the storm’s “unprecedented precipitation,” said AIR Worldwide, a Verisk Analytics Inc (VRSK.O) unit.

    But, insured losses are just a part of the damage as The Wall Street Journal noted,

    Moody’s Analytics…estimated the economic cost of Florence to be between $38 billion and $50 billion including damage to property, vehicle losses, and lost output.

    At the upper end of that range, Florence would rank seventh among the biggest storms, just after Hurricane Andrew in 1992, according to Moody’s estimates.

    The widespread damage, however, is lower than last year’s Hurricane Harvey, which smashed into Texas and inundated the state with rain for days. Harvey’s bill for the insurance industry was $30 billion, according to Wells Fargo Securities, with its Category 4 winds causing more severe damage than the Category 1 winds of Florence.

    Based on Moody’s estimates, last year’s three hurricanes each caused more damage than Florence: Harvey’s tally reached $133.5 billion; Maria’s $120 billion; and Irma’s $84.2 billion.

    History Might Offer a Precedent

    Although tragedies often have little impact on the markets, traders do seem to expect the events to impact the market. This might be because of the market’s reaction to the San Francisco earthquake of 1906.

    The Dow at that time is shown in the chart below. This event does seem to be associated with a market reversal.

    DJIA weekly chart

    As the Journal of Economic History explains:

    “In April 1906, the San Francisco earthquake and fire caused damage equal to more than 1% of GNP. Although the real effect of this shock was localized, it had an international financial impact: large amounts of gold flowed into the country in autumn 1906 as foreign insurers paid claims on their San Francisco policies out of home funds. This outflow prompted the Bank of England to discriminate against American finance bills and, along with other European central banks, to raise interest rates. These policies pushed the United States into recession and set the stage for the Panic of 1907.

    San Francisco’s $200,000,000 “ash heap” involves complications which will be felt on all financial markets for many months to come [and] the payment of losses sustained … represents a financial undertaking of far-reaching magnitude.”

    Florence has had a large impact on agriculture and its full impact won’t be known for weeks.

    For now, investors need to know this story isn’t over. Often, the market is able to continue in the direction of the trend that was underway when disaster struck. But, sometimes, that disaster marks a top. If prices break down and move 5% below their all-time high, it could pay to expect a deeper decline.

    Factset concluded, “It is interesting to note that last year there was about a two to three-week lag between the time the Hurricanes Harvey and Irma hit the U.S. and the substantial downward revisions to earnings estimates for companies in the Insurance industry by analysts.

    Given the timing of Hurricane Florence, any potential downward revisions to earnings estimates for companies in the Insurance industry may not occur until late September or early October.”

    But, the impact on the stocks could be seen in stocks before analysts act.

    Since 1990, there have been 5 other category 2 Atlantic storms that made landfall in the Carolinas.

    Two weeks later, the S&P 500 Insurance Industry Group drops by an average 4.7 percent, trading negatively 80 percent of the time.

    Further, the S&P 500 Property & Casualty Insurance Sub Industry Group also loses about 4.7 percent, also a negative trade 80 percent of the time.

    It could be best to act now as an investor to get ahead of the possible downgrades.

    Florence again demonstrates the importance of digging deep for investment ideas right now. It could be best to focus on companies that aren’t in the spotlight, but that will require research that can take an extended amount of time.

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