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El Niño – Is it Blowing Our Way?

BLOG, MARKETS & ECONOMICS  |  6 Jun 2014

After the record breaking severe winter the Midwest experienced, most people probably are not ready for more wild weather anytime soon.  However, there are growing probabilities that an El Niño is forming in the Pacific Ocean. Recent readings of water temperature just below the surface have been picking up a significant increase in water temperature. In the chart below, the red shows the growing extent of this warming in the water. That red splotch is large enough to cover the United States to give you an idea of the size of pool of warming water. That mass of warming water will continue to move towards the surface and when it does will likely affect weather around the world. So what kind of havoc will this wreak on the weather and the markets?

Pacific Ocean Temps

Source: Australian Bureau of Meteorology

What is El Niño?

El Niño is a Spanish name for a weather pattern in the Pacific Ocean where the waters in that region warm to abnormally high levels. This causes disruptions in the atmosphere and can trigger significant changes in climate and weather patterns around the globe.  El Niño means the Christ child, Jesus in Spanish because throughout history the warming in the ocean was often first noticed around Christmas time. The last really strong one occurred in 1997 and 1998 and was associated with wild weather around the world. There have also been a couple of more mild occurrences in the last few years, but the changes in weather were not too drastic. However, experts are saying that this new one that is possibly forming could be as severe as the 1997-1998 version. El Niño’s can occur erratically but one does tend to appear every 3 to 6 years or so. The opposite phenomenon, called La Niña, happens when the Pacific cools dramatically, leading to opposite weather effects from an El Niño in affected areas.

How Do They Form?

Scientists are not entirely sure what causes El Niño’s to form. Recent studies funded by NASA have found some suspicious ties to the severe winter in the Midwest and the extreme drought/heat in California this winter as a possible catalyst.  This pattern is known as a “dipole” pattern and has been shown to precede El Niño’s.  The NASA funded study also suggests that this pattern is an effect of “global warming”.

How does El Niño affect the weather and commodity markets?

In the Midwest, strong El Niño’s have been associated with warmer than average temps and wetter than average precipitation from December through March. (That doesn’t sound so bad after the recent winter). The Gulf coast experiences below normal temperatures in the winter season, so those of you heading to Florida next year, be prepared.

El Nino

Source: U.S. Climate Prediction Center

In Asia and the Philippines, droughts often accompany an El Niño and in the past have led to widespread food shortages and political unrest. However, governments in these countries have done a good job lately of stockpiling food to prepare for this.

Drought linked to a 2007 El Niño sparked a surge in food prices, including a trebling in the cost of rice to a record over $1,000 a metric ton in 2008 that sparked riots in countries as far afield as Egypt, Cameroon and Haiti. The last El Niño in 2009 brought the worst drought in nearly four decades to India, cutting rice output in the world’s number two producer by 10 million tons and boosting global sugar prices to the highest in nearly 30 years.    Source: www.gmanetwork.com

Places such as Peru, Ecuador and Chili often experience severe flooding from an El Niño, which can wreak havoc on copper mines and thus drive the price of that commodity sky high. The fishing industry off the western South America coast can also be greatly affected as the schools of fish are impacted by the warming water and move to other areas.

In Indonesia, where nickel is mined, droughts cause problems for the miners because mining equipment relies heavily on hydropower and less rain means less nickel production. Since nickel is used to strengthen steel, you could also expect steel prices to increase. In places such as Colombia, El Niño can bring about significant increases in malaria and dengue fever which obviously impact the economy in that region.

Climate Impacts and Tropical Diseases in Colombia

Back in the U.S. wheat, beef and commodity markets are already tight in many areas, so unpredictable weather could send these prices skyrocketing.

However, the effects of an El Niño could bring some helpful changes as well. Consider the severe drought California is currently experiencing, El Niño’s bring bountiful rain to this area (although sometimes way too much rain. Just ask the people with oceanfront mansions in Malibu that were swept away in the 1997-1998 event). It would also likely produce record corn and bean crops in the Midwest, as ample rain should be felt here as well. And for those living in hurricane prone regions of the U.S. it is likely that it would be a less active hurricane season, which is always a positive.

Now you can start to see how wide reaching the effects of a strong El Niño could potentially be.

What are the effects on the stock market?

So, you may be asking, what kind of effect can El Niño have on the performance of the stock market? Since the typical El Niño runs from October to March, we can go to the Ibbotson 2014 Yearbook of Market Results for Stocks, Bonds, Bills and Inflation and find out how the market did during times of a strong El Niño.

Time Frame

Large Company Stock Performance – Oct-Mar

1957-58

1.36%

1965-66

.82%

1972-73

2.31%

1982-83

30.09%

1987-88

-18.11%

1997-98

17.23%

   AVERAGE in STRONG EL NINO Years

5.62%

This average return of 5.62% in strong El Niño periods compares to the average return of the S & P 500 over the last 40 years in the Oct-Mar period of 5.79%.

So, maybe as a stock investor an El Niño does not appear to have too much of a detrimental effect on market performance. However, one of these years, 1987, also included the famous stock market crash of October 19, 1987 when the Dow Jones dropped over 22% in one day. (Remember, it did recover in just about a year). But, overall, as you can see, stocks have done rather well when the waters of the Pacific Ocean have warmed.

Again, it is still too early to tell for sure if we are in for an El Niño and if there is one, how strong it will be. Although the probabilities seem to be increasing, we will still have to wait several weeks before scientists are able to tell conclusively. But, if one does occur, we probably do not need to lose a lot of sleep over how it will affect the performance of the stock market.