IB Weekly Thoughts < >

It’s evident that Hurricane Sandy will be one of the costliest storms in U.S. history, both on a societal and economic scale. The death toll is already 92, and currently 4.5 million people are without of power. This is terrible. However, the effects on the U.S. economy is what I’m trying to think through, as some folks are arguing that this is disastrous for our economy, while others are actually saying Sandy will provide a net boost to GDP due to the re-build process that is already underway. Each sector will feel its own specific effects, some positive some negative, but I am not in the camp claiming that the net effect will be positive to the economy. It’s too early to accurately put numbers around the cost of the Sandy clean-up, but there are some benchmark numbers we can go by (e.g., Hurricane Irene). Let’s delve into the inner workings of various industries leading up to the storm, in the midst of the storm, and look out to the weeks and months ahead. From an investment perspective, it’s important to think through industry dynamics that will come into play in the near and medium term as a result of Sandy, and where consumer, private sector, and government dollars are shifting.

Discretionary Retail: Because the storm wreaked havoc on so many homes, most families will not be focused on buying a new necklace or a new pair of jeans in the near future. Blue collar and white collar companies (big and small) were shut down for the most part this week due to loss of power and dangerous commuting conditions. Many people are still not at work. These are lost wages that will not return to workers and consumption, hence the economy. The first place this gets cut out of is traditional discretionary spending including clothing, restaurants, jewelry, etc. Some prelim estimates are out projecting this will detract 3% from November same-store-sales numbers for retailers.

Travel/Leisure: A total of approx. 20,000 flights were canceled due Sandy from Monday through Wednesday. That’s about 10% of total U.S. flights during that period, according to the National Air Traffic Controllers Association. Airlines have sat 20,000 planes on the runway for 3 days, earning zero revenue off of the seats. In addition, hotels have empty rooms, rental car firms have underutilized fleets, and buses and trains are not running. The entire travel industry will feel the effects in October, and most likely in the weeks ahead as we slowly get back to our travel schedules.

Insurance: Clearly when disaster hits, this is bad for insurance companies’ profits as they have to pay for damages. By reading articles and observing video/photos, it appears that most of the residential damage was done by (a) trees/debris damaging cars, homes, etc., or (b) flooding damage. The former damage is covered my any basic insurance package that private sector insurers issue. However, it is very rare for insurance companies to offer flood insurance. In fact, if a homeowner wants flood insurance in the first place, he/she most likely will have to reach out to the federal government which historically has been the only entity to actually issue flood insurance. This issue will cause a lot of controversy, and potentially add to the bill that consumers will have to pay out-of-pocket. It is important to note that the federal government is exploring the possibility of forcing insurance companies to cover all damages (including flooding) Sandy inflicted on homes by changing insurance laws…There are many implications here, so keep an eye out.

Industrial/Infrastructure: This is a broad category, so let’s try to think about infrastructure-type of products in this category…Things like concrete, pipes, tubing, etc. This is mostly funded both the public and private sector. Needless to say, both are somewhat in the same boat here. The federal gov’t and municipalities need to spend to repair damaged roads, bridges, water utilities, power lines, etc. This means more tax-payer money going to companies that supply anywhere from cement mixes to metal pipes. The private sector needs to do the same. Think about the various factories and facilities in the northeast that have been damaged or flooded. Serious repair work needs to go into this infrastructure as well. This means similar type of brick-and-mortar materials need to be purchased to repair the manufacturing base of our northeast economy.

Shipping: Seaports all the way from Virginia up to Boston were closed over the past few days, and many were seriously damaged. Best case is that most ports were not seriously damaged; however that still means that there were 2-3 days where domestic and international trade in the northeast simply did not happen. This affects not only the shipping industry obviously, but has broader consequences to overall trade and economic activity. This also comes into play with railroads, another major shipping industry. CSX closed down routes at the beginning of this week in the northeast. This is another blow to ground-based industrial transports in the U.S. (think coal, chemical, agriculture products, and forest products). These products simply could not be sold to customers during this time.

Nondiscretionary Retail: Most everybody in the tri-state area ran to buy nondiscretionary items like food, water and other consumer durables before Sandy hit in attempt to “stock up” on supplies. This occurred in October, so various nondiscretionary retailers should have good Octobers (e.g., think Rite-Aid, Costco, Wal-Mart). Now, this industry is a bit tricky as it will get the benefit of a high demand towards the end of October, and then a “back to normal” trend (or maybe even a dip) in November most likely. There will inevitably be a couple days where doors are shut, but once re-opened business should return to normal. However, from an investing point of view, one must ensure that certain store locations were not harshly damaged this week. The October business pickup may very well be the last business some stores will see until a few months if the damage is that severe.

Home Refurb / Construction: Citizens of the northeast will also be concentrating much of their efforts on spending to fix and repair whatever destruction the storm caused to their homes, automobiles and other possessions. Even if individuals won’t pay for this, then insurance companies will. Either way, over the coming months, various construction companies (roofing, tiling, home builders, etc.) will get the benefit of this additional consumer spend.

Power: Millions are still without power. Gov’t officials and power utilities are without a doubt working to get power back to homes and cities, however it’s difficult to do so with such outdated power infrastructure (specifically in New York City). The consequence to this outcry by citizens is most likely long-term. I would not be surprised if there was (a) further power infrastructure spending implemented to update our grid, and/or (b) de-regulation to some extent to encourage better transmission of power and more up-to-date utility infrastructure. This is a ways out, but I’m sure it will continue to be news worthy.

 

Measuring Sandy’s Impact:

The most recent and similar comp out there to Sandy is Hurricane Irene in 2011, which caused $15bn worth of damage. Sandy, however, was much strong and wider of a storm – a good side-by-side comparison shot located here. During Irene, 15,000 U.S. flights were canceled, and Irene also hit the east coast over a weekend, so not as much business activity was affected as it wasn’t a weekday and folks were not scheduled to be at work in the first place. I first saw a $20bn number thrown out there in terms of total economic impact of Sandy, and just recently I heard $60bn was a possibility, which is a ~0.3% GDP impact. We don’t know yet. What we do know is using Irene as a benchmark, it’s clear that it’s going to cost up well over $15bn after all is said and done.

 

Structural Shift in Capital:

Although there isn’t a unanimous economic positive or negative as a result of Sandy (hence the reason for arguments in the media about a net positive or negative GDP affect over the long-term), I think there is one major theme at play here: a structural shift in consumer dollars in the northeast. Instead of buying a few extra presents for Christmas, consumers might be repairing their roofs. Instead of going to Disney World in the spring, families might be paying deductibles. Instead of municipalities using budget dollars to increase the number of teachers in a city, government officials might deploy billions to repair local roads, water treatment plants, and bridges. And instead of manufacturing facilities paring back on spending over the next few months in the wake of the fiscal cliff, they might actually be spending additional capex to repair facilities before year-end. 

 

- SRM2012