What Harvey Could Mean for Stocks

We are forced to look at history once again. That is a natural response when we are faced with uncertainty. We tend to do this in many parts of our lives. For example, before we go to a family gathering we may recall what happened at previous events and prepare accordingly.

On a larger scale, we turn to history when trying to make sense of politics. As a new president is being inaugurated we often look for precedents and compare the modern day with something from the past that we believe to be similar. This gives us at least a sense of security and a baseline for expectations.

Although we look to history in many ways, in the stock market we are told that we shouldn’t do that. In fact, the Securities and Exchange Commission (SEC) insists that investors be told the past should not be considered as particularly useful information.

SEC Rule 156 requires mutual funds to tell investors not to base their expectations of future results on past performance before they invest. That’s why we commonly see a warning that “past performance may not be indicative of future results. “

Yet, the past is often the only guide we have to the future.

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 Harvey 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. This is reasonable because human nature is largely unchanged over time. Movie makers understand this. That’s why you can go to the theatre now to see a movie about a tulip bubble that unfolded in the 1630s. Or, you can stream it later.

The events of that day will evoke similar emotional responses today. That’s one reason investors have to repeatedly learn the lessons of bubbles whether the irrational exuberance develops in tulip bulbs, internet stocks or perhaps cryptocurrencies like bitcoin.

Harvey’s Impact Will Be Severe

Hurricane Harvey is inflicting a devastating personal toll on its victims. It’s impact on the US economy seems to be unavoidable. Houston’s economy is the fourth largest in the US. While some are looking at Hurricane Katrina for comparisons, New Orleans had, and still has, a much smaller economy.

Given the economic reach of Houston, the damage will almost certainly create a short term headwind for national GDP.  This is likely to reduce economic activity in the current quarter. Longer term, many analysts expect a bounce in GDP as recovery efforts kick in.

It’s likely that the money spent rebuilding Houston will increase economic activity in that region. But, that spending is likely to come at the expense of other areas. For the private sector, resources are limited. Dollars spent in Houston will not be spent expanding factories elsewhere.

Netted out, at the national level, there is unlikely to much of be an effect on overall GDP. However, the risks are most likely to the downside because the federal government is struggling a rising deficit and the Federal Reserve intends to tighten monetary policies. This indicates spending in Houston will be constrained to some degree.

Stock Markets Tend to Shrug Off News

In the stock market, based on history, we are unlikely to see Hurricane Harvey have a direct impact. For one example, we can look at Hurricane Katrina.

Katrina came at the same time as two other large storms. That was the largest of several storms that year. Insurance losses totaled $117 billion after Hurricanes Katrina, Wilma and Rita struck America. Hurricane Katrina alone claimed 1,836 lives and resulted in insured losses of some $71 billion.

However, the stock market seemed to ignore this news. The chart of the Dow Jones Industrial Average is shown above. It shows the Dow was in a trading range and remained in that range throughout the storms. The next big move was to the upside.

The next chart shows how news can affect markets when they are in a down trend. Below is the Dow around 2001. The tragedy of 9/111 affected the nation but the stock market continued trading in the general direction that preceded the attack.

 

The same pattern is seen outside of the United States.

In March 2015, an earthquake measuring 9.0 on the 10 point scale struck near the largest island of Japan. The earthquake triggered 50-foot tsunami wave that disabled the power supply and cooling of three nuclear reactors at the Fukushima power plant, causing a major nuclear accident. All three cores largely melted in the first three days of the incident, an unprecedented occurrence.

The chart of the Nikkei index, a benchmark for Japanese stocks is shown below. The chart shows there was a high degree of volatility in the aftermath of the news. But, stocks were already in a downtrend and the downtrend continued after the news.

The usual impact of news on the stock market seems to be increased volatility for a time and then a continuation of the major trend that was underway when the event occurred.

1906 May Be the Best Precedent for 2017

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.

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.”

The size of Houston’s economy is estimated to be more than $500 billion. This represents 2.96% of the $17 trillion US economy.

Houston is not wiped out, but it is a leading economic center and the damage to key industries appears to be severe. Houston has long been home to many oil and gas companies. Obviously, the energy sector is adversely affected by this event and we are seeing supply disruptions.

The most immediate national economic impact of Harvey seems to be in gas prices. According to news reports, 10 refineries were shut down in the Gulf Coast region, accounting for about 17% of the total US refining capacity, according to the Department of Energy.

With many of its supplying refineries closed because of flooding from the hurricane, the Colonial Pipeline suspended shipments on its gasoline, diesel and jet fuel pipelines. The 1,500-mile Colonial Pipeline from Texas to New York is among the largest suppliers of fuel to states along the East Coast.

Delays in restarting production could trigger a slowdown in the national economy.

For now, investors need to know this story isn’t over. Usually, 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, expect a deeper decline.