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posted on 23 September 2017

The Winds Of Fortune: How Severe Storms Boost Stocks

by John Persinos,

Investing Daily Article of the Week

A week ago two new hurricanes, Jose and Maria, were heading for the United States. So far neither has made continental landfall; Jose is in the Atlantic and churning off the northeastern coast; Maria pounded the Caribbean and followed a trajectory similar to Irma’s before veering to the north after ravaging Puerto Rico. This activity comes in the wake of hurricanes Harvey and Irma, all of which begs the question: What’s next? Locusts?

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The markets nonetheless continue to break records, bringing to mind the Wall Street aphorism that “markets climb a wall of sorry." Investors this year have consistently shrugged off geopolitical worries, chaos in Washington, DC, and even an unprecedented succession of hurricanes.

Whether it has been Harvey, Irma, or North Korea, the improbable survival of each crisis du jour has whetted investor appetite for risk and spawned a relief rally. The familiar dynamic continues to play out this week.

Last Monday, The Dow Jones Industrial Average posted a closing record for the fifth day in a row while the S&P 500 closed at a record high for the second consecutive session. The outcome of the Federal Reserve’s latest meeting which started Tuesday contributed to ending the the market's continued upward movement in the face of mounting troubles, at least temporarily.

In the meantime, whenever you see spiral rainbands on the Weather Channel, do you get the urge to run for the financial exits? That would be a mistake. Below, I’ll show you how to generate capital appreciation and high income from natural disasters.

History shows that in almost every case, severe storms are actually good for the broad market. Take a look at our chart:

Storm-Tossed Profits

Discussing how to profit from natural disasters such as Harvey and Irma (and now Jose and Maria) that result in human suffering can be a sensitive topic. Disaster capitalism is akin to so-called sin stocks: we want to become wealthier, but get squeamish when it’s at the expense of others.

However, as an investor, you should remain coolly dispassionate and leverage investment opportunities as they are, not as you wish them to be. From time to time, I’ve recommended money-making opportunities in defense (a soothing word for “war"), tobacco, marijuana, handguns, alcohol, and casinos. On Wall Street, morality encompasses many shades of gray.

Disaster capitalism…

Natural disasters come in many varieties, from earthquakes to droughts, wildfires, and hurricanes. The latter are growing in ferocity and frequency, as the earth’s temperature gets warmer.

In the U.S., hurricanes account for the majority of natural storm damage. For the most part, hurricanes also are the only type of natural disaster that can be accurately predicted. Although their exact paths can be unpredictable, we know well ahead of time when a hurricane is about to hit. That gives investors a head start to plan their moves.

Hurricanes by definition occur along coastlines, which makes the oil and gas industry the most affected. The Gulf Coast produces one-fifth of total U.S. oil output. The Gulf’s waters are dotted with offshore oil and gas platforms and the area’s coastline is home to several refiners, shipping ports and storage terminals.

When hurricanes hit, the price of oil and gas tends to spike because production is disrupted; it’s a basic matter of supply and demand. The ramifications affect the upstream, midstream and downstream sectors - from exploration and production, to transportation, to refining.

As the chart above shows, storm damage over the long run usually provides economic stimulus. Scarcity of product increases prices; damaged equipment needs to be repaired or replaced; capital investment spurs new job creation and earnings growth.

When energy stocks tank immediately before or after a hurricane, a shrewd contrarian play would be to invest in the exchange-traded funds (ETFs) or actively managed mutual funds that are targeted to the energy industry operations most in harm’s way. That’s a safer move than taking bets on individual energy companies that confer singular risks.

Good news for income investors…

For income investors, the good news is that many of these energy investments confer outsized yields. Notably, shares of master limited partnerships (MLPs) typically get sold off after a storm but then recover. Income investors should consider high-yielding energy MLPs right now, the shares of which now trade at reasonable valuations because they took sustained punishment as energy prices fell earlier this year.

In the cases of Harvey and Irma, there hasn’t been lasting physical damage to MLP pipelines, transportation networks and storage facilities. After hyperbolic warnings from weather forecasters and investment analysts, the energy hub along the Gulf and southeastern coast has quickly gotten back on line.

A favorite of long-term investors who seek dividend-paying stocks, energy MLPs are classic income plays that become alluring for contrarians during hurricane season. The herd mentality punishes high-income energy investments in the midst of natural disasters, when in fact you should be looking for bargains that boast strong fundamentals.

Another source of high income are agriculture stocks and funds, most of which offer good yields. If you’re seeking long-term retirement income combined with capital appreciation potential, consider ETFs and actively traded funds that are pegged to agricultural commodities such as cotton and oranges. States that were the worst hit by Harvey and Irma, notably Texas, Florida and Georgia, are major agricultural producers. As with oil and gas, prices for these foods and materials initially go through the roof after a storm, as farmland is wiped out.

Also look at auto industry ETFs. After a hurricane, viewers are treated to lurid images on cable television news of cars and trucks strewn about the landscape like broken Matchbox toys. Automakers typically see a dramatic increase in sales after a hurricane.

Conversely, insurance company stocks usually take a prolonged beating in a hurricane’s aftermath, as they get hit with huge numbers of claims. Consider shorting insurance ETFs in advance of the storm but monitor the situation. When insurance companies start to announce big rate hikes to compensate for depleted coffers, their shares will start to bounce back.

Other sectors to consider piling into are home-building and construction stocks. Do-it-yourself chains that cater to homeowners and small businesses thrive in the immediate wake of a hurricane. For the same reasons, heavy construction stocks also embark on an upward trajectory, as new contracts are signed with corporate and government clients.

Raw materials companies accordingly get a boost, as homeowners, construction workers and government agencies buy more wood, concrete, metal, and stone to rebuild homes, facilities and infrastructure. Consider raw materials ETFs with top holdings of companies that feature major operations in affected areas.

The time for energy, auto, insurance, agricultural, and raw materials plays is immediately before or after a hurricane, depending on the ferocity of the storm and where it will hit. The 2017 Atlantic hurricane season has been exceptionally busy and provides many profitable scenarios at various entry points for fast-acting investors. Amid the creative destruction, there is investment opportunity.

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