How natural disasters can be economic mixed Blessings for investors
While the immediate effects following such disasters can include declines in the prices of stocks in certain sectors, they can also create investing opportunities. For investors, such disasters offer opportunities that are twofold in nature. You can contribute to the rebuilding effort, and position your portfolio for more, or larger, returns.
We’re referring to municipal bonds, which are the go-to means for municipalities, or government entities, to fund public projects. In natural disasters of the magnitude of Harvey (think 2005’s Hurricane Katrina) special bond programs can be created that offer incentives to investors that go beyond traditional debt issuances, such as general obligation bonds.
In a previous post about How natural disasters affect the stock market, we told you about how disasters like Hurricane Harvey affect the stock market. There we focused on how investors should play the equity markets in the wake of the historic storm. Here, we’ll discuss the capital markets, and how they will see an onslaught of debt issuances as officials in the affected areas look for the best ways to fund their rebuilding efforts.
The bond market
You can probably tell that far more attention is placed on the equity markets than the capital or debt markets. It is understandable due to the potential to reap far heftier returns from stocks than you would from bonds.
It is true that the interest gained on bonds is miniscule, however, for long-term, fixed-income investors, bonds should still be a part of the investment portfolio. The stable returns bonds provide over the long-term make up one of the reasons they make for good investments. Their stability typically stems from the fiscally sound issuers selling them.
Purchasing bonds is not cheap. Buying one bond could easily cost $5,000, putting them out of reach for many investors. However, you can structure your investment portfolio to include these debt instruments. This includes investing in bond funds and exchange-traded funds. Some of the most popular are HYLD for high yield bonds, MUB for general municipal bonds, and JNK for low-rated bonds.
Opportunities presented by Harvey
We expect to see a rise in the number of bond offerings from the state of Texas, Houston, Corpus Christi, and other issuing authorities in areas that were hit by Hurricane Harvey. This debt is likely to take the form of general obligation bonds, which is a type of debt that is backed by the full faith and credit of the issuer. This means that the issuing body will do whatever it takes, including raising taxes, to make sure bondholders are paid and prevent the bonds from going into default.
As noted above about Hurricane Katrina, specially-crafted bond programs can be put in place to help fund rebuilding efforts, especially given the circumstances created by natural disasters. If the federal government goes this route, bond buyers could have additional investment opportunities beyond the debt issued by the affected municipalities.
Choosing the best bond
Immediately following Hurricane Katrina, whose monetary damage has now been surpassed by Harvey, the bond rating agencies put affected governments on notice that there bond ratings could be lowered. Many of these credits were already on shaky ground, with ratings that were just above investment grade. The storm was expected to further strain their finances, and make them higher credit risks.
This is not the case with the Harvey-affected municipalities in Texas. These issuers already enjoy relatively strong ratings. Already, the three major rating agencies have weighed in on the matter. These are Fitch Ratings, Moody’s Investors Service, and Standard & Poor’s.
Fitch released a statement last week, noting the following:
“We believe the financial flexibility of local governments and, utilities, along with the resumption of normal business operations, will mitigate the risk posed by lost revenue. In most cases, following the initial interruption, economic activity and related tax revenue is likely to increase, as residents and business purchase items related to repair and rebuilding and workers are hired to assist in this effort.” Fitch
Standard & Poor’s nearly echoed Fitch in stating:
“Texas is well positioned to handle the demands of the disaster,” S&P noted.
The best thing to do to gauge the shape of these issuers is to obtain these ratings reports. They often include extensive research about issuers, and give guidance about the issuer’s creditworthiness.
While debt issuances will play a major role in the rebuilding of Texas and the communities slammed by Hurricane Harvey, you should be extremely diligent in turning to their offerings. Indeed, these credits will off stability as not being high risk, but that means the interest rates offered to investors will be the bare minimum.
If you hold any debt of an issuer hit by such an event, remember the same investment strategies apply to bonds as they do stocks. Don’t sell on the news. Instead, look for any ratings actions from the top three raters. These people don’t always get it right when it comes to predicting the likelihood of default, but they are solid sources for background and analysis.
Another thing to keep in mind is insurance. Poorly rated issuers tend to have insurance on their debt, which typically automatically gives them a triple-A rating – the gold standard in the bond industry. Be sure to find out what the issuer’s underlying rating is, too. This is the rating they were assigned as if they had no insurance.
As devastating as natural disasters are, there is a renewed sense of optimism from those of all walks of life who are able to contribute to the recovery and rebuilding process. For investors, there is the chance to help rebuild a school, library roads and other public projects. Although the returns from buying a bond pale in comparison to investing in a stock, the use of the proceeds can have a more impactful meaning, for the affected community, and your portfolio.