The New Yorker recently came out with an excellent, excellent article on the looming, lurking, silent terror that is the Cascadian Subduction Zone and how the Pacific Northwest is exposed to, put it lightly, wipeout risk. After terrifying my spouse by gleefully reading out loud all the potential cataclysms and destruction that would occur all along the Pacific Northwest – from Vancouver, Canada all the way down to California – I slept on the article. Then I woke up this morning, and over a cup of strong, dark roast coffee, contemplated how this new bit of information shifted our thinking on our investments.
To be honest, I had all but completely forgotten about that New Yorker article this morning. What pushed the idea of a mega-earthquake back to the forefront of my mind occurred as I sat here, sipping my coffee and reading the C.H. Robinson Wordwide Annual Report.
C.H. Robinson is a 3rd party transportation and logistics company. For the sake of not turning this into an article outlining the minute details of C.H. Robinson, let’s just say the company is intriguing because it consistently, year in year out, compounds invested capital at an eyebrow-raising rate.
Anyways, as I was reading about the trucking and transportation industry, I started to imagine the affects of a major earthquake in the Pacific Northwest on the North American transportation industry. How would a major 9 magnitude earthquake affect transportation in the region? What would be the damage? What would be the damage if investments were locally concentrated within the region?
The Pacific Northwest Seismic Network has an informative map of the plate tectonics at work in the Pacific Northwest region:
The Oregon Department of Geology and Mineral Industries has a graph that illustrates a 10,000 year history of major earthquakes originating from the Cascadian Subduction Zone:
It is from this data set that the New Yorker article puts the chance of a big (~8 magnitude) one happening in the region in the next 50 years at 1-in-3 and the chance of a really big one (~9 magnitude) at 1-in-10.
Now, based on the 41 events that have occurred roughly over 10,000 years, the average intervals between the 41 major earthquakes is 243 years. Of course, averages can be deceiving and a quick glance at the data suggests that major earthquakes don’t occur in this region like a Swiss time piece every 243 years. Nevertheless, it is worrisome that the last major event occurred in 1700.
This is what we know. This is the best evidence we have on hand. And it suggests that you should expect a major earthquake in the Pacific Northwest region every 243 years. It is plain, dumb luck that a prospering civilization has been able to grow and flourish – astonishingly, in that specific point in time (since 1700), in those specific circumstances of the industrial revolution, advent of modern technology, and a free and prosperous society – in what is a statistical anomaly. Quite incredible when you think about it.
The Unknown Unknown
While our best science on hand suggests that we should be experiencing a major earthquake to rock the region every 243 years or so on average, it hasn’t occurred in over 300 years. Our knowledge of the Earth’s crust and plate tectonics is still in its infant stages. Therefore, we have no idea when the next big earthquake is going to strike this region. And therein lies the problem.
Let’s say you have your investments concentrated in the Pacific Northwest region. You have a few rental homes along the coasts of Seaside, Oregon, and a business in a building in the older, downtown district of Portland that is not retrofitted for current building codes for seismic activity. When that magnitude 9.0 hits, you face wipe out risk with that concentration of your assets in such a vulnerable space. You want to mitigate away wipe out risk as much as humanely possible.
Of course, you – nor the experts – have the faintest idea when exactly the Cascadian Subduction Zone will decide to go for a spin. So you need to take into account and prepare for, in Rumsfeld’s immortal words, the unknown unknown; or in Taleb’s words, the black swan event. And the best way I can imagine handling this is through diversification.
Insurance obviously plays a big role in protecting yourself against various forms of risk. But since this whole earthquake business got me thinking of investment diversification, let’s take a glance at how you would tackle it.
We have friends who are doctors who are about to open up a clinic in Richmond, BC. Richmond is the proverbial earthquake whipping boy in Vancouver as it lies at sea-level on soft sediment. The popular opinion is that the ground will liquify in the event of a major earthquake and Richmond would literally be screwed the worst.
Taking this into account, if I were opening a medical clinic in Richmond, not only would I have ample insurance, I would want to take the profits generated out of the business and diversify the capital across many different investments: some Coca-Cola here, a little Nestle there, and sprinkling of Johnson & Johnson. What do these companies have in common? They operate worldwide. They provide refreshment, convenience, and medicine and with unassailable brands and trademarks. They generate immense profits and are very likely to generate immense profits into the future. They all offer current earnings yields between ~4-6%, with all offering ~3% dividend yields.
It would be incredibly prudent to take the excess profits from the superior returns of capital employed in the clinic and to diversify the income stream so that you not only generate torrents of cash from the operating business, you also have passive sources of income being generated from ownership in some of the best companies in the world. That way, if the next big one were to hit the region, even if you faced the destruction of your clinic and a humanitarian crisis situation on the ground for months, even years, to come, you would have Coca-Cola, Nestle, and Johnson & Johnson generating cash income for you, unaffected by the destruction of the Pacific Northwest as they all operate globally. That’s how I would go about things. But that’s just me.
Warren Buffett talks about the ovarian lottery and the luck involved in success in life in The Snowball. It may be important to be conscientious of another form of luck that rules our lives: the geological lottery. For the people and businesses living and operating in the Pacific Northwest, the relative geological tranquility of the past few centuries in a major seismic region of this planet has been like mana from heaven, allowing for the growth and development – economically, culturally, and socially – of a great civilization in extremely advantageous conditions.
Imagine: can you realistically picture the success of San Francisco and Silicon Valley or the rise of Bill Gates and Microsoft in Seattle if the Pacific Northwest region had experienced multiple 8 to 9 magnitude earthquakes in the past few centuries? The disruption caused my such awesome ecological devastation would have cracked and disjointed the steady rise of the economy of the region. It’s not hard to imagine that the Pacific Northwest would be less than fertile grounds to nurture and raise the imagination and genius of the region.
When counting the advantages and privileges we all experience in life, it is probably important to be mindful of the role of luck and the geological lottery.
May the tranquility of the region continue for many generations to come. But I will be prudent and make sure a significant percentage of our assets are diversified across different sectors and industries worldwide.
- The Joshua Kennon philosophy on diversifying your income stream away from your primary business.
- Reddit had an AMA with 3 earthquake experts on the New Yorker Piece. They all agreed that the article was accurate. go read it for yourself if you are interested.
- A review of the 2011 9.0 magnitude earthquake that hit Japan (the one that took out Fukushima) and the parallels we can draw to a potential 9.0 off the Cascadian Subduction Zone. Read it here.
- A review in Slate on the New Yorker article and the Reddit AMA. Read it here.
- If you want to be terrified (and learn) about tsunamis from the National Oceanic and Atmospheric Administration.
- A snapshot of the projected destruction of the Lower Mainland in the event of a 9.0 off the Cascadian via the Insurance Bureau of Canada.