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A Hurricane of Losses

So, in the midst of all the flamboyant weathermen "forecasting" the reach and intensity of Hurricane Matthew, you decided that you could not only predict the storm, but also its effect on the market. Really? "It's all the same," you said. "A storm is a storm is a storm, it'll rip through the coast and I'll be laughing all the way to the bank," you boasted.

And you were wrong.

Sure, it was the longest lived Category 4-5 Hurricane in the Eastern Caribbean. Storm surges of up to 4 feet, millions without power, and more than 1000 people dead, Hurricane Matthew was the most destructive storm to tear through the region in years. However, the expectations for the storm's economic destruction were initially much higher than they stand currently. Citi Research, a subsidiary of Citigroup, estimated the economic losses as a result of Hurricane Matthew to be $41 billion, but have dialed it back to $7 billion, likely due to the hurricane unexpectedly not making landfall until South Carolina. This $7 billion loss accounts for only 0.037% of the projected U.S. GDP for 2016: a tiny drop in the bucket.

That being said, individuals and families are the hardest hit by these disasters. Obviously enough, most individuals and families do not have the financial capability to withstand such a devastating storm as it flooded homes, swept cars away, and displaced--and will continue to displace--them for many weeks. This is especially true for individuals who own property that is not properly insured for natural disasters. Now all of the stock speculation comes in.

A quick Google search for "natural disaster investing" yields 1.44 million results, and a front page that looks like a con artist just had a field day; you have articles titled: "Stocks That Could Help You Profit From Disasters" and "Betting on Natural Disasters Has Become One Of The Best Investments Since The Financial Crisis." Nearly every article claims to have the "miracle stock(s)" to invest in before the storm hits. General practice when there is a hurricane (or most any natural disaster) on the horizon is to bet against insurers and Real Estate Investment Trusts (REITs), while building up long positions in home improvement and energy companies, and here's why:

  1. Insurers- This may seem obvious, and it is: insurers who have exposure to the area that is presumed to be affected by the storm are expected to be paying out large sums of money to those who are filing claims. However, insurers are more intelligent than some investors take them to be. Insurers are in the business of mitigating risk, so there is no reason why they would have too large a proportion of their portfolio of policies in one area (aka- geographic diversity) in order to avoid having to pay out on all of their policies at once. Furthermore, insurers are insured by reinsurers who, if insurance companies are in the business of mitigating risk, then reinsurers are risk magicians: able to make it all disappear, as if by magic.
  2. REITs- Again, a cursory assumption would lead an investor to believe that REITs with high exposure to the affected area would would sink like the Titanic (well, if it were on land...) since they'd be subject to all of the winds and rain, thus damaging the buildings and facing repair costs.  Now, if you think about it, there's not a single REIT building that isn't insured--so we return to point 1.
  3. Home Improvement Companies- A storm comes in and wrecks your house,  the first thing you'll likely do when you get back in is fix all the stuff that went wrong, right? So, with the huge influx of people with damaged homes, one would expect Home Depot and Lowe's to be the most popular place in town, which is true, but it comes at a cost. With the additional traffic, you need additional workers (who will probably need overtime) and additional shipments of goods (which will likely be delayed and cost extra to be dragged through the post-storm area)...oh, not to mention that these stores will likely have damage as well, so they need to repair their own stores.
  4. Energy/Petroleum Companies- Think of the gas station near you pre- and post-storm: pure chaos. Lines around the block, prices through the roof, and an extremely tight supply. Unfortunately, amid a booming business, the stations are also stuck with the impending horror of running out of gas, which means their wonderful day of sales has just been offset by a day of absolutely none. In addition, the suppliers may have damaged refineries, the oil trucks will be faced with rough and dangerous roads, and the general public won't need as much gas because they'll be petrified of driving until the "dust settles."

So, what is an investor to do? Well, the top-choice is to invest in catastrophe bonds, which have a provision that allows the issuer to pay the investor less than the promised coupon and/or their initial investment. Usually, these bonds pay a higher coupon than their 'plain vanilla'counterparts, since there is an added risk of the investor not getting the full amount of what is owed. Recently, New York City's MTA issued catastrophe bonds tied to the subway system after Hurricane Sandy caused widespread flooding. In the event of another flood, they can pay investors less than what is owed if the costs to repair the damages due to the flood are too high. So, for many investors seeking to capitalize on natural disasters, they look more to the likelihood of disasters not happening, so they can purchase these higher-yield catastrophe bonds.

As you decide on your own strategy for natural disasters, a word of advice: think of all the times you brought an umbrella you didn't need, or forgot an umbrella before a downpour; is that really what you want to go up against?

(Writer's note: this piece is in no way intended to downplay the tragic loss of hundreds of lives in the wake of Hurricane Matthew. Although my family was not immediately affected, my thoughts and prayers go out to those whose families were.)

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