Natural Disasters exacerbate risks across markets

Dear Friends,

We trust you and yours had a warm holiday season and a good start to the New Year.

Sadly, we know some of our friends are dealing with the impact of the massive fires in Los Angeles over the past month. We know of several families in our extended network who have been displaced and some who have suffered devastating losses. Our thoughts are with them and their loved ones.

The immediate human impact of the fires has been apparent for weeks. In our view, there are three long term impacts which will take longer to manifest themselves over the coming years.

Firstly, the role of climate change in the extent of these fires cannot be denied. Seasonal rains have failed to materialize in Southern California. This coupled with the hottest year on record globally and high winds, created the conditions for a devastating group of wildfires. The impact of climate change has been evident for decades, yet efforts to limit it have barely made a dent in the growth of greenhouse gas emissions. The largest advances in moving towards renewable fuels have been made outside of the various diplomatic efforts to reduce emissions, driven by certain countries (primarily China and India) seeking to address the fact that they do not have significant fossil fuel reserves. The move to electric vehicles has now gained enough momentum to bend the emissions curve in the medium term, but we will still have to contend with the impact of the warming that has already occurred.

Second, the failure at national and global levels to limit greenhouse gas emissions is coupled with the unwillingness or inability of local governments to prepare for the impacts of climate change. Los Angeles’ building codes and local services were unprepared for such a disaster, despite many premonitions. Local officials are unwilling to institute the tough budgetary and zoning measures that would harden their environments. This is not unique to Los Angeles. Various cities with waterfront property are unprepared for storm surges and the rise in sea levels implied by our current 1.5 degrees of global warming. Los Angeles is one of the wealthiest places in the world, as is California. Poorer regions and cities will have to contend with far fewer resources to deal with the coming impacts of climate change. It is also unreasonable for us to expect that we might be insulated from the impacts by wealth or individual preparedness. A widespread series of natural disasters will impact us all. As Los Angeles vividly demonstrates, the wealthiest regions of the world shall not be immune to the deleterious effects of climate change. Even in wealthy areas, retro-fitting housing and other structures to harden them against climate change will face funding obstacles and opposition from naysayers. The eventual result is likely to be a series of entirely predictable disasters, with pliant local authorities absolving their inaction by references to acts of god. This pattern is likely to enhance the appeal of strongmen for a citizenry that is frustrated by the inaction and lack of vision exhibited by the status quo.

Third, the losses are going to change the behavior of the insurance industry. On one day in January, we saw estimated insurance claims from the LA fires rise from $10Bn to $50Bn, with total losses estimated at over $150Bn. These losses can easily be covered by US property & casualty insurers and global re-insurers. However, close on the heels of the $25Bn losses from Hurricane Helene, mostly inland, insurers have begun to change their risk assessments. We expect many insurers to exit markets they deem uninsurable, especially in areas prone to flooding during storms and those vulnerable to wildfires.

Risk assets continued their rise in 2024, with the S&P 500 ending the year close to all time highs. This was coupled with an election that unified control of the executive, legislative and judicial branches in the hands of Republican officials. We suspect internal divisions among Republican factions may limit action on certain controversial proposals, but tax and regulatory policy can be expected to be less strict under this administration. This would normally argue for a risk-on strategy, but two factors should limit such exuberance. Firstly, internal divisions and the unpredictable nature of the Trump administration is likely to cause concern among investors, though in contrast to the first Trump administration, large American businesses are lining up to ally themselves with the current administration. Secondly, market valuations remain at cyclical highs, advocating for more moderate positioning.

We continue to recommend a balanced allocation that includes exposure to commodities and fixed income, especially given the more attractive rates that are on offer.  While growth stocks have substantially outperformed value over the past two years, we expect investors will start to rotate back into value stocks if inflation continues to moderate and economic growth cools.  Since Trump’s election win, investors have been concerned with the inflationary risk inherent with two of his major policy goals – immigrant deportation and tariffs.  While these concerns are certainly warranted, it’s very possible they have already been fully baked into market expectations and there could be a disinflationary surprise if the Trump administration is unable to fully deliver on these campaign promises.  Either way, we expect 2025 will likely see heightened volatility compared to the past two years as the market adjusts to this new political reality.

Regards,

Subir and Louis

The foregoing contents reflect the opinions of Washington Square Capital Management and are subject to change at any time without notice. Content provided herein is for informational purposes only and should not be used or constructed as investment advice or a recommendation regarding the purchase or sale of any security. There is no guarantee that the statements, opinions or forecasts provided herein will prove to be correct. 

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