Markets have largely taken Hurricane Harvey's devastation in stride, but the full scope of its impact may not be felt for weeks to come.
As the scope of Hurricane Harvey’s destruction becomes more apparent, our thoughts are first with all those now rebuilding their lives after the storm.
At the same time, we are working to serve our investors and shareholders by carefully assessing the potential effects on the U.S. economy, specific sectors and our investment portfolios – while keeping a close eye on the progress of Hurricane Irma and Tropical Storm Jose, bearing in mind that hurricane season runs through the end of November.
To date, none of our investment managers have indicated that they expect Harvey to have a significant long-term impact on the U.S. economy. Analysis conducted by Brandywine Global suggests that the rebuilding activity of the Houston metro area (the nation’s 4th largest city) should ultimately provide a positive catalyst for the region. Recovery efforts could resurrect previously stalled plans for a federal infrastructure spending package, though it may be too soon to tell. On a national level, U.S. unemployment claims should rise and construction activity may slow in the near term. As a result, after months of strong economic indicators, data may be more mixed going forward, making a cleaner picture of the U.S. economy harder to come by – complicating the Federal Reserve’s decision-making at its remaining meetings in 2017.
Harvey had little impact on the broad U.S. stock indexes in the week following landfall (i.e. Aug 26-Sept 1) with the S&P 500 closing higher each session during that period; returns for the NASDAQ and Russell 2000 were even higher. Even the S&P Energy sector, an early locus of concern, was up 0.85% for that week, while Financials ended flat. The S&P 500 Property & Casualty industry group was down 3.4%, however -- and off over 8% from its 2017 high on August 9 as the market anticipated Harvey’s arrival.
Fixed income markets
The bond market’s reaction has been generally muted. The benchmark 10-year UST yield moved lower in the immediate aftermath of Harvey, from 2.17% on August 25 to 2.12% by August 31, but was back to 2.17% at the close on September 1. Spread sectors have seen only limited impact, given that values are primarily driven by long-term credit fundamentals, according to Western Asset. Spreads on corporate debt for property and casualty insurers have only widened a little, as much of the flood-related damage to housing is not covered by private homeowner's policies; residential flood insurance is a separate and oftentimes optional Federally administered program. Energy and utility sector spreads have gone sideways as it appears the various industries were well prepared, taking precautions early, with the loss of revenue and cash flow is seen as temporary and manageable.
A muted reaction: Option-adjusted spreads for Property & Casualty, Energy Midstream and Utilities High Yield segments, July-September 2017
Source: Bloomberg, as of 9/4/17. Past performance is no guarantee of future results. Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.
Sector impact: Insurance
Estimates of the damage from Harvey are now hitting $180bn, but analysts at ClearBridge Investments point out that industry estimates for private sector insured losses should be a fraction of that, at $10-20 billion.
This is well below the totals from Hurricane Katrina in 2005, and potentially comparable to 2012’s Superstorm Sandy. Given that $65 billion of insured losses from 2005’s trio of hurricanes (Katrina, Rita, Wilma) were not enough to create sustained pricing power for property & casualty (P&C) insurers, the manager does not believe Harvey will create a “hard market” for P&C companies that would enable them to charge higher premiums. Clearbridge also views the potential impact on reinsurance markets as minor. Even the $65 billion of insured losses from Katrina, Rita, and Wilma had minimal impact on reinsurance pricing, as capital soon flooded the industry and drove pricing back down.
Sector impact: Energy
ClearBridge Investments believes the impact from Harvey is likely to be higher on energy companies, given that it was centered along the Texas Gulf coast that is a central hub for refineries, processing plants, storage facilities and export/import docks for crude oil, refined products, and natural gas: the Gulf accounts for a large percentage of US refining capacity.
To date, energy infrastructure companies have reported minimal-to-no damage to their assets along the Texas Gulf coast. Power outages have affected natural gas liquids (NGL) fractionating plants. Refineries have shut down due to flooding (with some closer to Corpus Christi already beginning restart operations). Yet, with many refineries remaining shut down, two privately-owned refined product pipelines have also shut down due to a lack of refined products to transport. Further, a portion of Eagle Ford Shale oil production was pre-emptively shut ahead of the storm’s arrival. Such disruptions could have an impact on third quarter through-put volumes for some MLP companies.
Brandywine Global notes that as Harvey made landfall, energy markets priced in the loss in demand—that drop in demand outstrips the loss in supply caused by the hurricane, as the trend in declining inventories was already in place prior to the storm. The regional demand for oil could be suppressed over the next couple of months. However, it is still too early to understand the impact Harvey will have on a range of industries, particularly energy-related businesses, such as railroads and shipping.
RARE notes that as there have not been any reports of major damage to any midstream pipeline assets or facilities, assuming a quick restart of these facilities as the flood waters recede, the overall impact to the midstream pipeline sector is expected to be minimal. From a midstream perspective, they note that most pipelines run underground and should therefore not have material damage. Some midstream operators preventatively shut-in gas, LNG and crude oil pipelines but most continued to run. Above-ground midstream infrastructure, such as fractionation, gas processing, or liquid storage could see more damage, although early assessments appear relatively benign.