Imagination is more important than knowledge.

Albert Einstein (14/03/1879 – 04/18/1955), German-born physicist

In our post about the various factors that may affect our investments, we have seen that it requires a lot of information and knowledge and sometimes a lot of imagination to make wise decisions in financial matters.

Now let’s put our imagination to the test and try to identify the impact that a natural phenomenon can have on various investments.

Let us imagine the following situation (which we hope will never happen):

A hurricane destroys a substantial number of oil platforms in the Gulf of Mexico where more than a quarter of the entire US production of oil and natural gas is located. What will the impact of this disaster be on which type of investment?

First of all, the corporate owners of the devastated platforms will not be able to produce and sell oil for a long time, their profits will decrease, and with them the value of these companies, so that the share prices of these companies will fall.

Insurance and reinsurance companies that will have to compensate oil companies for the damage they suffered, will see their profits shrink as well, so the value of these companies as well as their share prices will also decline.

The share prices of producers of oil platforms however will probably go up because investors expect that these companies will benefit from lucrative contracts to rebuild the devastated facilities, increasing their profits and the value of their shares.

If the failure of production capacities cannot be compensated by other facilities, the result will be a drastic reduction in oil supply. Faced with a constant demand, reduced supply will drive up prices for gasoline and heating oil.

Those oil producers that have not been affected by the hurricane will take advantage of the rising prices. They can sell their products at higher prices and increase profits. Their share prices are therefore likely to rise.

On the other hand, companies which need to purchase large quantities of fuel at higher prices – such as airlines for example – will see their operating costs increase sharply and their profits decline accordingly.

A sharp rise in oil prices also has a negative impact on the purchasing power of consumers. If these have to spend a higher proportion of their disposable income on gasoline and heating oil, they have less money to buy consumer goods, so that the turnover, profits, value and share prices of consumer goods manufacturers will probably also fall.

If oil prices remain high for a long time, this can lead to a real energy crisis. Manufacturing companies may run into difficulties and have to lay off part of their workforce. A rise in the unemployment rate tends to undermine consumer confidence and to slow economic growth. This will cause investors to anticipate a general decline in profits – and values ​​- of companies. They will sell their shares and look for alternative investments, which will further increase the pressure on stock prices.

This is certainly not an exhaustive list of all the effects one single event – a hurricane in our example – might have.

But this example shows how complex the relationships between different economic sectors are and how difficult it is to draw the appropriate conclusions from specific events.