How natural disasters affect the economy and the markets
March 21, 2023
5 minutes to read
The earthquakes that hit Turkey and Syria in early February took a heavy toll. The latest figures indicate they left more than 50,000 dead and more than 100,000 injured. A further 9 million people have been affected as their homes are now rubble or because their jobs no longer exist. The UN calculated that USD 1 billion will be needed to meet just the urgent needs. Although various countries have jointly committed more than USD 550 million in support, only USD 165 million has actually been made available so far (position as of 20 March 2023).
What is the total cost of rebuilding?
The damage to infrastructure is immense. According to a rough estimate, the earthquake brought down over 210,000 buildings in Turkey (representing at least 600,000 residential units). Across the border in Syria – in a region that has been the scene of conflict for more than 10 years - you are looking at more than 10,000 affected buildings. Many roads, water pipes and other types of public infrastructure were also damaged. The UN estimates the material damage in Turkey at over USD 100 billion. The World Bank estimates the damage in Syria at USD 5.1 billion.
What is the impact on the Turkish economy and its growth?
The earthquake caused the collapse of a significant percentage of the Turkish economy. Of the total number of Turks in the workforce, 16% work(ed) in the affected area. Agriculture and the textile industry in particular are crucial pillars of the local economy. The region accounted for 11% of the country’s industrial production and 14% of its agricultural production before the disaster. Although economic activity has restarted, it will take years for the situation to return to normal in the region.
Opinions differ on its impact on Turkey’s economic growth. According to the European Bank for Reconstruction and Development, the earthquake will result in the loss of up to one per cent of Turkey’s GDP this year. This is considered a "reasonable estimate" due to the expected stimulus of the reconstruction later in the year. Moody’s, the rating agency, sees things more positively. One month after the earthquake, it even revised its growth prospects for Turkey for 2023 upwards from 2 to 2.3%, and for 2024 from 3 to 4%. This leading rating agency also bases this on an economic boost from the reconstruction.
After the disaster: what about the longer-term economic picture?
Although it may appear very cynical, natural disasters generally do trigger additional economic activity. Primarily in the construction sector, but also in the wider economy. After all, they not only create a need for concrete and steel, but also for new equipment in hospitals, new furniture in living rooms, new machines in factories, etc. The real question is: is this (temporary) economic boost enough to offset the economic losses?
Recent research into the impact of natural disasters on economic growth shows that losses are not offset by above-average growth rates in the aftermath of a disaster. The study examined the economic impact of more than 12,000 "minor" and "major" natural disasters that took place between 1970 and 2019. The researchers calculated that the affected economies suffered an average loss of 2.1 to 3.7 percentage points of gross domestic product in the year of the disaster, but that these losses were not compensated afterwards. The average growth rates in the years before and after the disaster are not statistically different, indicating that natural disasters do not affect medium term economic growth. However, the negative effects of natural disasters on growth appear to be greater in poorer countries, which implies that the economic impact of natural disasters also depends on economic development.
Fact or fiction: natural disasters cause greater economic damage than they used to?
Various natural disasters in recent decades have caused enormous damage. These include the earthquakes in Northridge (US – 1994) and Kobe (Japan – 1995), the tsunami in Asia (2004), hurricanes such as Katrina (US – 2005) and Harvey (US – 2017), and the earthquake and tsunami in Japan (2011). If you add all of these up, you will be in the hundreds of billions of USD in losses, on top of the human toll. The natural disaster that hit Japan in 2011 – resulting in a nuclear incident – alone caused damage of USD 220 billion, making it the most expensive natural disaster ever.
Losses (adjusted for inflation) due to natural disasters have increased in recent decades. The number of natural disasters causing significant losses has increased by a factor of three since the nineteen eighties. Population growth (the more people there are in a disaster zone, the greater the losses) and economic growth (which increases prosperity and means we have more valuable goods and infrastructure that can be damaged) are still the main drivers for increases in losses from natural disasters. Moving forwards, climate change could increase the frequency and/or intensity of future natural disasters, which in turn can only exacerbate economic damage.
What impact do natural disasters have on the stock market?
The Turkish stock market (Borsa Istanbul 100 Index) plunged 16% over a few days after the earthquakes, with losses reaching USD 35 billion. In the end, the authorities intervened and the stock market was closed down for a few days. On the day it reopened, the markets bounced back completely. One reason for this was that the Turkish government required pension funds to increase their exposure to equities. In addition, a 15% tax on buybacks was cut to 0%. Furthermore, investors shifted their focus from panic to the opportunities that reconstruction brings with it. Just 10 days after the earthquakes, the stock market was back to its pre-disaster level.
The market scenario in Turkey – a sharp decline followed by an equally sharp recovery – is not a universal scenario. Hurricane Katrina, for example, caused more than USD 150 billion of material damage in 2005, but hardly caused any harm to the S&P500. On the contrary, the index even rose by 1.1% in the week of the disaster. It was a different story for the Japanese Nikkei 225, which was firmly in the red after the disaster in 2011, and took almost 20 months to fully recover. Historically, therefore, there is little point in talking about the magnitude of the impact of natural disasters on stock market performance. According to a study examining the impact of natural disasters in more than 100 countries on 27 different exchanges, the effect varies mainly by the type of disaster and the place where it occurs. For example, biological disasters (such as epidemics and pandemics) generally have a greater impact on markets than geological disasters (earthquakes, volcanic eruptions). Geological disasters, in turn, create more impact than flooding. The same study shows that European markets are the most sensitive to the impact of natural disasters, followed by the American and Asian markets. Finally, the impact of natural disasters on the stock market is often localised to the region; generally, there is little contagion of foreign stock exchanges, according to other research.
Historically, man-made disasters have been the biggest threat to market continuity. These include events such as the Wall Street crash in 1929, and the financial crisis in 2008.
As an investor, what is the best way to position yourself during and after a natural disaster?
Panic is rarely a good time to take decisions. Historically, financial markets have shown themselves to be very resilient. Despite the initial shock caused by natural disasters, markets recover with time. Sometimes very rapidly (like recently in Turkey), sometimes slowly (as with Japanese stocks after the 2011 disaster). After all, disasters – no matter how cynical it sounds – also open up investment opportunities. Governments and central banks may also intervene to stabilise the economy after a disaster. Financial, fiscal and monetary measures will then help to reduce the negative impact on financial markets. Just keeping a clear head can therefore be a good strategy for long-term investors.
If you have invested in a specific region that is then affected by a disaster, "staying put" is obviously not completely risk-free, especially in the short term. Natural disasters can lead to a (further) fall in equity prices. In addition, natural disasters can disrupt the economy and consumer confidence in a region or country, which can then lead to a decline in business activity and have a negative impact on your investment in the longer term. Investors with a long-term investment horizon and a diversified portfolio may therefore be better placed to focus on the potential returns associated with the recovery of a market following a disaster. In addition, investors can diversify their portfolios to limit the risk of exposure to disasters. Investors with a much shorter investment horizon and a strong focus on an affected region may consider reducing their positions, with the risk of missing out on the longer term rebound, but with the potential benefit of limiting any further losses.