The impact of natural disasters and wars on trading

Hurricanes, earthquakes, floods, wildfires and typhoons are catastrophic events that often lead to significant damage to infrastructure and property and can also cause tragic loss of life. Wars, which entail prolonged and significant hostilities, can have equally devastating consequences. Natural disasters and wars can happen practically anytime and anywhere in the world.

Since they can disrupt businesses, damage operational facilities, hold up supply chains and more, natural disasters and wars can have dramatic impacts on asset prices, in both directions.

How can natural disasters affect markets?

In the wake of a natural disaster, assets like stocks and bonds can experience long-term losses that can take months or even years to recover from. Conversely, commodities can often increase in value due to supply and demand if the natural disaster has increased their scarcity.

Here are some ways natural disasters can affect the markets:

Let’s look at some relatively recent historical examples.

Hurricane Katrina led to unprecedented petrol prices

The pause in refining activities caused a serious gas shortage across the US, which led to crude oil futures skyrocketing to $70 a barrel for a short time. And believe it or not, gas prices also shot up like crazy, hitting nearly $4 a gallon in some parts of the US. After Hurricane Katrina hit the US mainland on August 30, 2005, oil production in the Gulf Coast states took a major hit, dropping by 95%. And 10 months later, the region was still struggling, producing 30% less oil than it used to before the hurricane.

Japan’s 2011 tsunami caused the Nikkei to drop 7.5%

On March 11, 2011, a 9.1 magnitude earthquake jolted the seafloor about 70 kilometres offshore of Japan's Tohoku region, causing a massively destructive tsunami. In the days following, Japan's Nikkei stock market index fell by a huge 7.5%.

California’s wildfires sent PG&E’s share price plummeting

The Californian wildfires in 2017 and 2018 had a significant impact on the stock price of Pacific Gas and Electric (PG&E). Prior to the wildfires, PG&E was valued at an impressive $36 billion, with its stock trading at nearly $70. However, when it became public that one of the largest fires was started due to a tree coming into contact with power lines owned by PG&E – and rumours of a potential lawsuit began – its stock price fell precipitously.

Economic implications of the US Invasion of Iraq

The US invasion of Iraq in 2003 caused significant turmoil in financial markets. In the months leading up to the invasion, stock markets became volatile and oil prices surged on concerns over potential supply disruptions from the Middle East.

When the invasion began in March, stocks plunged as investors dumped equities in favour of safe haven assets like gold and bonds. The Dow Jones fell over 300 points on the first day of the war. Oil prices spiked to nearly $40 per barrel. The uncertainty surrounding the length and outcome of the war prompted many investors to sell stocks and wait on the side lines.

As the invasion progressed, oil prices continued to climb due to supply constraints. This fuelled inflation concerns and weighed on consumer confidence. While stocks rebounded from their March lows, the major indexes remained volatile for several months after the invasion started.

How can natural disasters be traded?

Here are some general principles traders can consider regarding natural disasters.

• Diversification

Traders may choose to diversify their portfolio by investing in a variety of sectors and industries rather than a single instrument. This can help to reduce risk and protect against losses during a natural disaster.

• Hedging

Traders may choose to hedge their risk by buying put options or by shorting markets that are likely to be negatively affected by the natural disaster. Hedging involves strategically opening new positions to protect your existing positions from unexpected market changes.

• Go short on relevant stocks

When a natural disaster strikes, relevant stocks can experience a momentary decline due to sentiment, but they tend to stabilise fairly quickly. By taking a short position in a stock you believe could be negatively affected, you have the potential to gain profits from a natural disaster.

• Go long on relevant commodities

Commodity prices are guided by specific supply-and-demand conditions. By impacting production and thus increasing scarcity, natural disasters tend to drive commodity prices up. For this reason, traders tend to go long on commodities they believe will be impacted by an impending natural disaster, like a hurricane.

Natural disasters and wars can lead to increased volatility and dislocations in financial markets. For active traders willing to accept higher risks, these turbulent times may present opportunistic short-term trading possibilities. When traditional relationships between assets break down, there is potential for traders to capitalize on price anomalies and market overreactions.

However, it is crucial even for traders to exercise caution, as the unfolding impacts of major events can be unpredictable. Jumping into trades without thoroughly analysing the shifting market dynamics and being aware of downside risks could lead to significant losses. Experienced traders understand it is better to wait patiently for high-probability setups than to recklessly bet on market turmoil.

While some adept traders may have the skillset to extract profits during periods of upheaval, restraint and risk management are still required. Traders should aim to trade ethically within their means and focus more on sound execution than profiting from difficult situations.