24, 2002.O’Brien, Robert. “US Stocks Mixed at Close; Dow Transports Off2%.” Dow Jones Newswires, November 12, 2001.Plummer, Robert. “Recovering from Disaster: Exchanges ReopenAgainst Incredible Conditions.” Futures Industry Association, October/November 2001 (http://www.futuresindustry.org/fimagazi-1929.asp?a=727).Prime-Tass Economic News Agency. “Kudrin Says KhodorkovskyArrest Won’t Have Major Market Impact.” October 27, 2003.Reuters. “Global Markets—Stocks, Dollar Soar—Bonds, Gold Sink.”March 13, 2003.Reuters. “Spanish Stocks—Factors to Watch on March 12.” 2:03 A.M.March 12, 2004.Reuters. “U.S. Stocks Plummet, Dow Posts Largest Point Loss.” 4:30P.M. EDT, September 17, 2001.Schneider, Susan. “Emerging Debt-Brazil Climbs after CurrencyBounces Higher.” Reuters, September 30, 2002.Simms, G. Thomas and Justin Lahart. “Currency Investors’ Vote onthe Euro: Down 2.4% in Two Days.” The Wall Street Journal, June 1,2005, p. C1.Torday, Peter. “Maastricht Move Hits Bond Markets.” The Independent, June 4, 1992.USA Today. “U.S.S.R. Crises and the Dow.” August 21, 1991.The Wall Street Journal. “Danes’ Rejection of EC Treaty DepressesStocks in London and Other Big Bourses Across Europe—A WallStreet Journal News Roundup.” June 4, 1995.
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The Wall Street Journal Europe. “What’s News, Business andFinance.” August 20, 1991.Wells, Rob. “Stocks Stage Dramatic Rally on Failure of Soviet Coup.”Associated Press, August 21, 1991.White House (http://:www.whitehouse.gov/news/releases/2003/03/2003).Whitney, Glenn, and Douglas R. Sease. “Dollar Jumps as Danes VoteAgainst Treaty.” The Wall Street Journal Europe, June 3, 1992.Yonhap News Agency, Yonhap English News. “Presidential Impeachment Jolts Financial Markets.” March 12, 2004.Zuckerman, Gregory. “Stocks Record Biggest Rally in Five Months—Industrials Rise 269.68 Points, As Nasdaq Climbs Into the Black;Technology, Insurers Lead Surge.” The Wall Street Journal, Friday,March 14, 2003.
Endnotes1
The original name, Operation Infinite Justice, was changed to Operation IraqiFreedom in deference to Muslim sensibilities that only Allah can dispense infinite justice. Other key members of the Coalition, such as Australia and theUnited Kingdom, assigned different names to their invasion operations.
2
President Bush addressed the nation from 8:01 P.M. to 8:15 P.M. EST on Monday,March 17, 2003. Relevant passages of his address follow (http://:www.whitehouse.gov/news/releases/2003/03/2003):Today, no nation can possibly claim that Iraq has disarmed. And it willnot disarm so long as Saddam Hussein holds power. For the last fourand-a-half months, the United States and our allies have worked withinthe Security Council to enforce that Council’s long-standing demands.Yet, some permanent members of the Security Council have publiclyannounced they will veto any resolution that compels the disarmamentof Iraq. These governments share our assessment of the danger, but notour resolve to meet it. Many nations, however, do have the resolve andfortitude to act against this threat to peace, and a broad coalition is nowgathering to enforce the just demands of the world. The United NationsSecurity Council has not lived up to its responsibilities, so we will riseto ours.
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In recent days, some governments in the Middle East have been doingtheir part. They have delivered public and private messages urging thedictator to leave Iraq, so that disarmament can proceed peacefully. Hehas thus far refused. All the decades of deceit and cruelty have nowreached an end. Saddam Hussein and his sons must leave Iraq within 48hours. Their refusal to do so will result in military conflict, commencedat a time of our choosing. For their own safety, all foreign nationals—including journalists and inspectors—should leave Iraq immediately.3
Winning the peace, however, proved to be more problematic as strategic errorsby coalition military policymakers and a series of missteps by the Coalition Provisional Authority and its predecessor organization, the Office for Reconstruction and Humanitarian Assistance, allowed a nascent insurgency to develop andgrow.
4
Reuters. “Global Markets—Stocks, Dollar Soar—Bonds, Gold Sink.” March 13,2003.
5
David Brancaccio. Marketplace. Thursday, March 13, 2003.
6
Gregory Zuckerman. “Stocks Record Biggest Rally in Five Months—IndustrialsRise 269.68 Points, As Nasdaq Climbs Into the Black; Technology, Insurers LeadSurge.” The Wall Street Journal, Friday, March 14, 2003.
7
Ibid.
8
Reuters. “Global Markets—Stocks, Dollar Soar—Bonds, Gold Sink.” March 13,2003.
9
The Wall Street Journal Europe. “What’s News, Business and Finance.” January18, 1991.
10
John Dennis Brown states: “At the reopening Tuesday, it was quickly apparentthat Wall Street’s Camelot would continue under Lyndon Baines Johnson’s banner; a buyers’ panic swept prices steeply higher in the third largest gain in history…” Brown, John Dennis. 101 Years on Wall Street. Englewood Cliffs, NewJersey: Prentice Hall 1991, p. 86.
11
The Prime-Tass Economic News Agency reported on Monday, October 27,2003:Russian markets are unlikely to tumble following the arrest of MikhailKhodorkovsky, CEO of Russia’s largest oil company Yukos, DeputyPrime Minister and Finance Minister Alexei Kudrin told reporters Monday…“I hope that the court system will guarantee a transparent andobjective examination of this case,” Kudrin said. “So I don’t think themarket will react in any significant way.”Prime-Tass Economic News Agency. “Kudrin Says Khodorkovsky Arrest Won’tHave Major Market Impact.” October 27, 2003.
12
Agence France Press. “Russian Stock Market Plummets After Oil Tycoon’sArrest.” October 27, 2003.
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13
Agence France Press. “Russian Stock Market Plummets After Oil Tycoon’sArrest.” October 27, 2003.
14
The Congress Party won a plurality of parliamentary seats but needed the support of minor parties to form a new government and elect a prime minister.
15
Agence France Press. “Indian Stocks Plunge on Investor Fears About New Government.” May 17, 2004.
16
Business Standard. “Huge Margin Calls Triggered Free Fall; Do Not Blame ItAll on the Left.” May 18, 2004.
17
Business Standard. “FIIs Making Market Jumpy: Left ; Absolving Themselves ofAny Blame for Monday’s Bloodbath.” May 18, 2004.
18
The May 28, 2005 issue of The Economist reports that although UBS Securitieswas punished by the Securities and Exchange Board of India for “obstructing theinvestigation,” no evidence was found of market manipulation by it, or any otherforeign firms, during the May 17, 2004 selloff in Indian stock prices.
19
Dow Jones Newswires. “India Sensex Ends Up Provisional 8.6% At 4893.64.”May 18, 2004.
20
Jonathan Karp. “Candidate’s Gains Pummel Brazilian Currency.” The WallStreet Journal, September 24, 2002.
21
Susan Schneider. “Emerging Debt – Brazil Climbs After Currency BouncesHigher.” September 30, 2002.
22
John Dizard. “Global Investing – The Long and Short of Brazilian Betting.”Financial Times, September 6, 2002.
23
For example, John Dizard of the Financial Times reported on September 6, 2002that the then approximately 1750 basis point spread of the dollar denominatedBrazilian C bond over comparable U.S. Treasury securities “… is a significantspread over Colombia (8.13 per cent over Treasuries), for example, or Peru (9.13per cent over Treasuries).” John Dizard. “Global Investing – The Long and Shortof Brazilian Betting.” Financial Times, September 6, 2002.
24
The ultimate adoption of the Treaty of Maastricht resulted in the EuropeanCommunity becoming the European Union on November 1, 1993.
25
The Wall Street Journal. “Danes’ Rejection of EC Treaty Depresses Stocks inLondon and Other Big Bourses Across Europe—A Wall Street Journal NewsRoundup.” June 4, 1995.
26
Glenn Whitney and Douglas R. Sease. “Dollar Jumps as Danes Vote AgainstTreaty,” The Wall Street Journal Europe, June 3, 1992.
27
Peter Torday. “Maastricht Move Hits Bond Markets.” The Independent, June 4,1992.
28
Jeffrey Heller. “European Stock Markets Recover from EC Shock.” June 4,1992.
29
Neil Dennis. “Spectre of French No Casts Pall over Euro.” Financial Times, May28/29, 2005, p. 11.
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30
G. Thomas Simms and Justin Lahart. “Currency Investors’ Vote on the Euro:Down 2.4% in Two Days.” The Wall Street Journal, June 1, 2005, p. C1.
31
Dan Bilefsky. “Dutch Rejection of Charter Sparks Larger EU Fears.” The WallStreet Journal, June 2, 2005, p. A3.
32
John Dizard. “Global Investing—Playing Spread Poker with Europe’s Bonds.”Financial Times, May 2, 2005.
33
Dow Jones International News. “Europe, US Investigate Suspicious Pre-AttackTrades-Report.” 10:46 A.M. September 16, 2001.
34
Robert O’Brien. “US Stocks Mixed At Close; Dow Transports Off 2%.” DowJones Newswires, November 12, 2001.
35
CNN.com. “September 11: Chronology of Terror.” Posted 12:27 P.M. EDT, September 12, 2001 (www.cnn.com).
36
In an article describing how U.S. futures exchanges were affected by September11 terrorist attacks, Robert Plummer reports: “Traders said there were some‘wild’ moves in Eurodollars and bond trading on Tuesday before those marketswere shut down shortly after the disaster.” Robert Plummer. “Recovering fromDisaster: Exchanges Reopen Against Incredible Conditions,” Futures IndustryAssociation, October/November 2001 (http://www.futuresindustry.org/fimagazi1929.asp?a=727).
37
Agence France Press. “Shares Crash, Oil Rises as World Reels in Horror at USAttacks.” September 11, 2001.
38
Reuters. “U.S. Stocks Plummet, Dow Posts Largest Point Loss.” 4:30 P.M. EDT,September 17, 2001.
39
Reuters. “Spanish Stocks—Factors to Watch on March 12,” 2:03 A.M. March 12,2004.
40
Brian Blackstone. “Global Yield: Spain Bombings Another Blow to Euro Zone.”Dow Jones Newswire, March 11, 2004.
41
Denise Duclaux. “U.S. Stocks Drop, Security Fears Plague Wall Street.”Reuters. 12:51 P.M., March 15, 2004.
42
Baldwin Hesse. “Markets Nosedive, Rebound on News of Blasts.” USA TodayJuly 8, 2005, p. 7A.
43
Associated Press Newswires. “South Korean Stocks Plunge, Dollar Rallies AfterUnprecedented Presidential Impeachment.” March 12, 2004.
44
Yonhap News Agency, Yonhap English News. “Presidential Impeachment JoltsFinancial Markets.” March 12, 2004.
45
The Wall Street Journal. “What’s News, Business and Finance.” August 20, 1991.
46
Rob Wells. Associated Press. “Stocks Stage Dramatic Rally on Failure of SovietCoup.” August 21, 1991.
47
USA Today on August 21, 1991 noted that the stock market reaction to news ofthe Gorbachev ouster was over three times the percentage reaction that the DowJones Industrial Average had news of the ouster of former Soviet Premier NikitaKhrushchev in 1964.
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5WEATHER ANDNATURAL DISASTERS
“A merchant’s happiness hangs upon chance, winds,and waves.”—Japanese proverb
A Tale of Two Natural DisastersShortly before 8:00 A.M. (local time) on Sunday, December 26, 2004,a magnitude 9.0 earthquake occurred off the west coast of the islandof Sumatra in the Indian Ocean.1 The powerful earthquake induced atsunami that quickly spread across the Indian Ocean. The Boxing Daytsunami killed tens of thousands of people from Aceh, Indonesia toPhuket, Thailand; to Tamil Nadu, India to Sri Lanka; to the coasts ofSomali and Kenya in Africa; and caused billions of dollars in propertydamages.133
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Financial markets were closed when the earthquake and subsequent tsunami occurred. This gave market participants time to assessthe impact of the tsunami’s damage and consider the implications forfinancial market prices. Although the tsunami caused tremendousdamage and suffering, the tsunami did not wreak similar havoc onfinancial markets. Indeed, although equity markets in Thailand,Indonesia, and India fell somewhat in the wake of the disaster, theimpact on world financial markets was minimal. This was the caseeven though the death toll continued to escalate rapidly in the daysthat followed and the full extent of the disaster was substantiallyworse than initial accounts indicated.The financial market reaction to the Boxing Day tsunami of 2004stands in sharp contrast to the reaction that occurred when a magnitude 6.9 earthquake struck 20 kilometers southwest of Kobe, Japan at5:46 A.M. on Tuesday, January 17, 1995.2 Despite rigid building codesdesigned to minimize structural damage and deaths from earthquakes, thousands of buildings were destroyed by the quake and subsequent fires and more than 5,500 people were killed.3 Tens ofbillions of dollars in property damages resulted.4 In this case, as withother potential trading catalysts, market participants must assesswhich markets would be impacted, the direction of the impact, aswell as the magnitude and duration of the anticipated price move.Again, these assessments come in the form of trading theses, whichrationalize and motivate prospective trades. Sometimes, the thesesare simple. Sometimes, the theses are complex. The trading thesesare invariably partial economic equilibrium arguments. Even if thetrading theses are correct, traders must assess the appropriate magnitude, duration, and timing of the expected reaction.Perhaps surprisingly, there was not an immediate response to theKobe earthquake in world financial markets. Judging from contemporaneous news reports and the market reaction, it appears that an obvious and very simple trading thesis motivated market participants
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immediately after the earthquake and likely went along the followinglines.Japanese firms with assets in Kobe and Japanese property andcasualty insurance companies with significant Kobe exposure will suffer substantial losses, so the stock prices of those firms should fall.Similarly, the stock prices of companies likely to be engaged in thereconstruction efforts should rise.Another trading thesis probably went along the following lines:Japan will rebuild Kobe. The Japanese government will pay forrebuilding infrastructure in Kobe. Private individuals and firms willpay (via insurance payouts) for reconstructing damaged private property. In either case, the cost will be immense. The cost of reconstruction will be financed by selling Japanese holdings of foreign assetsand reneging on an earlier pledge by the government to cut taxes.This will cause the yen to rise against other currencies.The prospect of rebuilding Kobe acted as a trading catalyst forbase metals, as detailed in this report from the Inter Press Service onFriday, January 20, 1995:Base metal prices earlier this week rallied as realization thatthe…Kobe earthquake in Japan would mean more construction for rebuilding and hence increased demand for steel, copper, nickel and aluminum. Adding to the reconstruction wasthe disruption to metals production in Japan and the possibility of shortages. The main beneficiary was nickel—used in theproduction of stainless steel—where three-months traded tofour-and-a-half year highs…Copper and aluminum…alsoadvanced, trading to their highest levels for over five and fouryears respectively. Private estimates suggest, however, thatadditional requirements from Japan will not be greatly significant, except perhaps for lead and zinc, which will be affectedby the damage to Sumitomo’s plant in Harima.5Notice that the presumed trading thesis is simple—the reconstruction of Kobe will require base metals which will drive up their
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prices holding supply constant. The excerpt notes that the metals allrallied on the news of Kobe’s earthquake. Notice also that the excerptsuggests that the rally is not fully justified in that “additional requirements [for base metals] will not be greatly significant.” This illustrateshow financial and commodity markets may respond to a trading catalyst using a widely shared trading thesis even when a significant market reaction is not justified.Although the share prices of selected individual firms rose or felldepending upon their perceived exposure to the Kobe earthquake,the initial reaction of the overall stock market to news of the Kobeearthquake was fairly limited. However, as days passed, the Kobeearthquake became a powerful trading catalyst that affected not onlythe Japanese stock market but also European stock markets—withLondon’s Financial Times-Stock Exchange (FTSE) 100 stock indexfalling 1.3%, Frankfurt’s Deutscher Aktienindex (DAX) index falling1.4%, and Paris’ Cotation Assisteé en Continu (CAC) stock indexfalling 2.2%.6 The overall Japanese stock market reacted to news ofthe Kobe earthquake with a significant delay, as shown in Figure 5.1and as described in this excerpt from an article that appeared in theGuardian newswire on Tuesday, January 24, 1995.Share prices in Tokyo crashed by more than 5 per cent yesterday in delayed reaction to the Hanshin [Kobe] earthquakeand immediately sent European stock markets into a spin.But the slide was eventually halted after Wall Street showedonly limited losses in response to the jitters elsewhere.Tokyo stocks plummeted by more than 1,000 points, 5.6 percent, yesterday…as worries spread about the damage fromlast week’s earthquake and the failure of the government toproduce a reconstruction plan.…[T]he Nikkei index…[closed] at 17,785.49…In the weeksince the earthquake, the market has lost more than 1500points, although the fall was slow at first because Tokyo wasunaffected and brokers and economists in the capital failed torealize the extent of the damage.7
1/23/95date.open 18807.00date.high 18817.91date.low 17778.79date.close 17785.49
1/23/95
12/1/94
1/1/95
2/1/95
CHAPTER 5 • WEATHER AND NATURAL DISASTERS
20000.0019800.0019600.0019400.0019200.0019000.0018800.0018600.0018400.0018200.0018000.0017800.0017600.0017400.0017200.0017000.0016800.0016600.0016400.0016200.0016000.0015800.0015600.0015400.0015200.0011/1/94
3/1/95
Reaction of the Nikkei 225 stock index to the January 17, 1995 Kobe earthquake. Daily trading range of the Nikkei 225 stock index from November 1, 1994 to March 31, 1995.
FIGURE 5.1
The Nikkei finally reacts to the Kobe earthquake.137
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The preceding excerpt details the significant impact that theearthquake-induced decline in Japanese stock prices had on foreignequity markets. The reason foreign equity markets should be significantly affected by the Kobe earthquake, however, is not clear. Noticethat the excerpt provides a seemingly plausible but unlikely explanation for the delayed reaction, namely that “worries spread about thedamage from last week’s earthquake and the failure of the government to produce a reconstruction plan.”Earthquakes are measured on a logarithmic scale such that thepower of an earthquake increases by a factor of 10 for every one-pointincrease in magnitude. The destructive power of the earthquakeinduced Boxing Day tsunami was immense and eventually claimed283,106 lives.8 Only three earthquakes in the world in the preceding100 years had a greater magnitude.9 The destructive power of theKobe earthquake was considerably less than that of the Boxing Day2004 earthquake and tsunami, yet the market reaction was considerably different. There was a substantial, albeit delayed, reaction to theKobe earthquake but virtually no reaction to the Boxing Day tsunami.Why the differential reaction?Clearly, where an earthquake occurs matters. Equally clearly,news of the Kobe earthquake was well-known to market participants.Yet, there was a delayed reaction in the financial markets to the newsof the earthquake. Two questions naturally arise. First, why didn’tmarket participants react earlier to the news? Second, was themarket’s reaction to the news appropriate given the magnitude of theprice changes?Other observers have also commented on the delayed reaction ofthe Japanese stock market and the reaction of other financial marketsto the Kobe earthquake. Yale University Professor Robert Shiller,author of the book Irrational Exuberance argues:The best interpretation of the effects of the Kobe earthquakeon the stock markets of the world is that news coverage of theearthquake, and of the accompanying stock market declines,
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engaged the attention of investors, prompting a cascade ofchanges that brought to the fore some more pessimisticfactors…As the main source of public information about the stockmarket’s performance, the media will continue to have a tangible impact on the playing out of significant market events.On a day-to-day basis, a large part of the media’s coverage issnake oil. Then, the price level is firmly in the hands ofinvestors with better sources of information. But in mediadefined watershed periods, many people look to the media astheir advisor of last resort. Market analysts should not underestimate the media’s power to shape public attention.10Essentially, Professor Shiller argues that saturation media coverage is principally responsible for the market’s large and delayed reaction to news of the Kobe earthquake. Although this is an interestingconjecture, it does not explain why other media-saturated events likethe coverage of the Boxing Day tsunami did not have a similar effecton market prices. There is a natural human desire to impose order onseeming chaos. However, market reactions do not have to makesense. Perhaps a more convincing explanation of both the delayedresponse to the news and the appropriateness of the market’s reactionis that trading is a game where the “rules” change but the objective(i.e., to make money) remains constant.What are the lessons for traders from the market reaction (or lackthereof) to these two natural disasters? One lesson is that the size ofthe humanitarian disaster is not a good measure of the likely reactionof financial markets. Rightly or wrongly, it matters greatly where thedisaster occurs. Large death tolls associated with earthquakes inChina on July 7, 1976 where more than 255,000 people perished;western Iran on June 20, 1990 where more than 40,000 people died;southeastern Iran on December 26, 2003 where 26,200 people died;India on January 26, 2001 where 20,023 people died; or Turkey onAugust 17, 1999 where 17,118 lives were lost were not associated
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with significant reactions in world financial markets.11 From a financial market perspective, these natural disasters were essentially nonevents despite the tremendous human suffering and loss of life thedisasters inflicted. To be sure, part of the explanation for the seemingdearth of response of global financial markets to these events liesin the comparatively low money value of what was destroyed. Yetanother lesson and important part of the explanation lies in the tenuous reasoning that underlies the assumption that global marketsshould be affected by local disasters. There is little reason to believethat global markets should be affected by many of these eventsdespite the reaction to the Kobe earthquake. The differential reaction of financial markets to these two humanitarian disasters illustrates the fickle response of financial markets to news of naturaldisasters and serves as yet another lesson. A third lesson is that themarket’s response can be delayed and can increase rather than diminish as time passes.A final lesson is that there may be numerous opportunities totrade off of events that are well-known to market participants. Aminute is a lifetime in the world of trading—that is, it is more thanenough time to enter or exit a position in many markets. Indeed, oftenonly a few seconds are needed to enter or exit a trading position.
Natural Disasters as Trading CatalystsNatural disasters can take many forms including earthquakes,tsunamis, hurricanes, tornadoes, fires, pandemics, epidemics, volcanic eruptions, landslides, droughts, and floods, among others. Thelocalized nature of many natural disasters means that the marketimpact is often, but not always, localized as well. Sometimes, the market’s reaction to a natural disaster is limited to impacting the stockprice of specific companies whose fortunes are adversely or favorablyimpacted. For instance, in the run-up to and aftermath of a hurricane, building supply and home repair firms like Lowe’s or Home
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Depot often experience a discernible increase in their stock price,presumably based on the trading thesis that such firms will experience greater sales as consumers attempt to repair damaged homes.Some natural disasters, like earthquakes, are inherently difficult,if not impossible, to predict. Other natural disasters may be morereadily predictable, but the extent of the likely destruction is not.From a trading perspective, it is far more important to be able to predict the likely market response and its timing to a natural disasterthan to be able to predict the occurrence of the natural disaster itself.As shown earlier, the market reaction to natural disasters can varysubstantially.Natural disaster trading catalysts that affect a number of marketsmay do so sequentially rather than simultaneously. Moreover, as isthe case for other trading catalysts, the market reaction sometimesincreases as time passes. Once again, this gives rise to potential trading opportunities after the news is out. It should be emphasized, however, that such impacts may be relatively short-lived. This risk meansthat traders should adjust their trading position size and trading horizon accordingly.The questions about the role of natural disaster trading catalystsare similar to those of other trading catalysts—namely, which marketswill be affected and when? How long will the reaction last? Will thereaction increase or decrease in intensity and magnitude as timepasses? If the reaction increases in intensity and magnitude as timepasses, will that be due to an increase in estimated damages from thedisaster or something else?
Contamination of the Food Supply: Mad Cow DiseaseDiseases that affect plants and animals raised for human consumptiondirectly or indirectly can also act as trading catalysts. For instance, onTuesday, May 20, 2003, Canadian authorities announced that aCanadian cow had been diagnosed with bovine spongiform
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encephalopathy (BSE), or mad cow disease.12 This led the UnitedStates Department of Agriculture to impose a ban on the importationof Canadian cattle and certain meat products. Canada is a largeexporter of beef and the United States is one of its largest customers.Once again, traders must assess which markets will be affected, as wellas the direction, magnitude, and duration of the impact. The market’sresponse to the announcement provides a fascinating illustration ofhow the discovery of a dreaded disease in beef cattle can serve as atrading catalyst and impact a number of markets. It also provides aninsight into the relationships traders perceive. Figure 5.2 depicts thereaction of Chicago Mercantile Exchange (CME) live cattle futures