Dear Club Members:
Now that my day job has simmered down, I am returning to the blog.
I have been thinking about the connection between earthquakes and stock market declines for some time now.
When the earthquake struck Japan on March 11, 2011, the S&P 500 Index had already been declining since February 18, 2011. Within days of the quake, the market seized up as if in acknowledgement of the economic consequences ahead. You see, Japan is the world's third largest economy. The triple hit of an earthquake/tsunami/nuclear meltdown shrank the first quarter Gross Domestic Product (GDP) in Japan by 3.5%. Industrial output saw its biggest ever fall. Spending plunged as consumers and business confidence took a heavy hit. Private consumption, which accounts for nearly 2/3 of the Japanese economy, was down 0.6 percent in the 1st quarter. Yesterday, the International Monetary Fund (IMF) cut its growth forecast for Japan in 2011 to minus 0.7 percent from the positive 1.4 percent it had predicted in April.
My heart goes out to the Japanese people as they battle these effects at the local level.
The more I thought about the problem, I more I became interested in the impact of the earthquake on outside sources of support to Japan. I am thinking about the insurance industry. Did you know that Berkshire Hathaway, Warren Buffet's company, has exposure for the payout of insurance claims? And that these claims imposed at least a $1.1 billion loss for the company?
According to the Los Angeles Times (March 13, 2011 article), the insurance costs for the quake alone are $35 billion (upper range), according to an analysis released by Boston-based AIR Worldwide. The Times declared the disaster as one of the most expensive catastrophes in history. And note that the $35 billion figure does not include insurance losses related to the tsunami or nuclear damage.
Global insurance companies will bear the costs of these insured losses. The key insurance companies on the hook for the payment of claims would include Chaucer, AIG and reinsurers like Munich Re and Swiss Re. Chaucer is a Lloyd's of London insurer, one of its main activities being the insurance of nuclear power plants. Chaucer operates Lloyd's Syndicate 1176, one of the largest biggest insurers of nuclear risk. As for Munich Re, Warren Buffet is the largest single shareholder with a stake in 10.2% of the company. Then, there are the American Nuclear Insurers, an association of 21 companies that underwrites insurance for U.S. Reactors. This association has a reinsurance relationship with the Japanese nuclear industry. Another major U.S.-based player with international operations is Overseas NEIL Ltd.
At least one catastrophe bond, a $300 million security sponsored by Munich Re, was wiped out as a result of the Japan disaster.
What might be the parallels, if any, to the San Francisco Earthquake of 1906?
A preliminary answer is provided by a wonderful economic paper by Kerry Odell and Mark Weidenmier. Their paper, "Real Shock, Monetary Aftershock: The 1906 San Francisco Earthquake and the Panic of 1907," squarely frames the issue: "Can localized disasters have international economic effects?" Source: 64 The Journal of Economic History 1002 (December 2004)
Here are a listing of a few parallels between the San Francisco Earthquake of April 1906 and the Japan Earthquake of March 2011:
1. Both earthquakes involved extensive secondary damage beyond the initial quake. The secondary destruction in San Francisco was fire. The secondary destruction in Japan was water and nuclear devastation.
2. Both earthquakes caused big economic damage. The San Francisco damage was equal to more than 1 percent of the national GNP. The total economic damage from the earthquake and secondary effects will easily surpass 1 percent of the Japanese GNP which was $4.85 trillion in 2000.
3. The real effect of the shock in both San Francisco and Japan was localized.
4. Both quakes produced an international financial impact.
5. Authorities in both San Francisco and Japan discounted the damage in initial reports so as to not scare or trouble the investment community.
Now, these parallels are interesting but they are backward looking.
If the pattern bears out in the coming 15 months, then what might happen between now and October 2012? We could see the following developments if the parallels continue on course:
1. Large amounts of money flowing into Japan in the autumn of 2011 as foreign investors pay claims on their Japanese policies out of home funds.
2. This outflow prompts the European Central Bank, along with the Federal Reserve Bank, to raise interest rates.
3. These policies push the U.S. into a double dip recession and set the stage for the Panic of 2012.
Now, these are just speculations. I do not have hard empirical data to show that global companies are now paying out on claims or that they are selling securities to raise money to pay out claims within 60 days of the presentment of insurance claims. But the timing tends to match up, doesn't it? The earthquake happened on March 11, 2011. The market makes a top within 60 days of the quake and then begins to fall.
Anyway, I have the idea here for an essay. I just need the time to research available facts and suggest a pattern might be repeating itself.
Later,
Wink
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