Hurricanes And The Stock Market

 |  Includes: SPY
by: Clif Droke

How does the stock market typically perform following a major hurricane? This is a question that traders are asking right now in the wake of Hurricane Irene, which was one of the most significant storms in years. In this article we’ll see how the stock market tends to perform following hurricanes in general, particularly when the market is a similar technical position to the one that currently exists.

Although it may seem strange to some, the simple fact is that weather, or more specifically, fear-inducing news headlines about the weather, has a definite impact on investor psychology. This impact can provide a proverbial “Wall of Worry” for stock prices during an upward trend in the equities market. It can also serve as a catalyst for a counter-trend rally during a downtrend. Such was the case following the horrendous hurricane season of 2005 and other vicious storm seasons of recent years.

Let’s start by taking a look at the infamous 2005 hurricane season. This was the season that brought us hurricane Katrina, which very nearly wiped out New Orleans and other parts of the Gulf Coast. In 2005 the S&P 500 Index (SPX) ran into a stumbling block beginning in August, a period which coincided with one of the nastiest hurricane seasons in the U.S. in years. The SPX was in decline for most of the month of August but bottomed almost to the day that Hurricane Katrina dissipated. Following this the stock market staged a worthwhile technical rally which took the SPX back up to its previous high in late July before the August decline began (see chart below).

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In the previous year of 2004, the U.S. experienced another major storm in the early-to-mid August time frame. Hurricane Charley caused approximately $14 billion (2004 USD, $16.3 billion 2011 USD) in damage to the United States, making it the fourth costliest hurricane in U.S. history, and the second costliest at the time. No sooner did Hurricane Charley dissipate that the S&P 500, which had been in a major decline, hit bottom and reversed this decline. The SPX went on to experience a major rally which once again took it back up to its previous high from late June of that year (see chart below).

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Now let’s look at another notable hurricane season in the U.S. and its impact on the stock market. The 1996 Atlantic hurricane season saw nine hurricanes develop, six of which became major storms. By far the biggest hurricane of the ’96 season was Hurricane Fran, which caused $3.2 billion in damage to North Carolina and caused 26 deaths. It developed on August 23 and dissipated on September 8. If you look at a chart of the SPX during this period you’ll see that the market peaked our around the time of Fran’s formation, corrected slightly, then took off again to the upside just as soon as Fran’s strength dissipated.

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Of course 1996 was a major bull market year for stocks and can’t be used as a strong corollary to 2011, but the positive effect on stocks brought on by the lifting of the hurricane is still there.

Going back even further to 1989 the U.S. experienced a devastating storm in September from Hurricane Hugo. The storm did $10 billion in damage, making it the most damaging hurricane ever recorded at that particular time. Hugo did most of its physical damage between September 17 and 24. Hugo’s psychological impact on the stock market was seen in the corrective decline the S&P 500 Index experienced during the hurricane. The SPX peaked at a high of 354 at the beginning of September ’89 and then dipped to the 343-345 area in mid-September, where it fluctuated until the hurricane dissipated. After the force of Hugo had been spent, the SPX roared back to life and rallied to a new high for the year before peaking in October.

What most of these historical examples have in common is that the market was in a declining phase during or prior to the destructive storms. Once the hurricanes dissipated, the stock market bottomed out and in every case was able to launch a meaningful rally of varying magnitude. The magnitude of the rally depends on the overall technical and fundamental condition of the broad market at the time of the hurricane’s appearance, of course.

Even in a declining market environment the SPX will typically react to the lifting of the negative psychology and fear-inducing headlines following a storm with a tradable rally, one that usually lasts at least a week or two. The dissipation of negative psychology surrounding Hurricane Irene should result in a similar outcome.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.