Here Comes a “Godzilla” El Niño

Fri, Aug 28, 2015 - 10:24am

For first worlders, weather is often just an annoyance or a pleasure; Californians have started to become more attuned to the weather’s economic influence during the ongoing drought. However, weather influences global economics profoundly, as we have often observed in our commentary on the Indian monsoon and on ENSO, the “El Niño Southern Oscillation.” ENSO’s effects are most intuitively obvious for heavily agricultural economies dependent on rain — but those effects are complex, and ripple out through the global economy into other markets that are less rooted in agriculture. There have been few formal studies of the effects of ENSO fluctuations on GDP growth and inflation, but one was published by two Cambridge economists last year. They did indeed find statistically significant effects, extending four quarters beyond the initial “ENSO shock.”

ENSO Refresher

Under normal conditions, trade winds blow from east to west across the Pacific. They push water with them, sending warmer surface water towards Asia, and allowing deeper, cooler water to well up from the depths along the South American coast (a “thermocline”). An ENSO event happens when pressure systems change, and the trade winds abate, preventing that upwelling of deeper ocean water and creating a complex sequence of events in global weather, triggering changes in rainfall patterns around the world.

Source: International Monetary Fund

The following table shows the effects of an El Niño event on GDP growth for various countries, both immediate and out four quarters from the event:

Source: International Monetary Fund

And the following table does the same for inflation:

Source: International Monetary Fund

As you can see, some economies are helped, and some are hurt — and there is a wide variation in how much different countries are affected. Any investor in global markets is well advised to watch ENSO variations because of their macroeconomic effects — which may of course be blunted or exacerbated by other concurrent market trends. And a particularly strong El Niño will make the economic effects depicted above even more pronounced.

What’s Happening Now?

All year, predictions of a strong El Niño have been getting firmer from the world’s state meteorological bodies, and now the consensus is almost 100 percent. Most analysts believe that this fall will bring a strong El Niño, strong enough to rival historically significant and disruptive events like the one of 1997-1998, and perhaps, according to NOAA, the strongest on record. Anomalous sea surface temperature readings — the main way that meteorologists gauge a developing El Niño — have already gotten extreme, with plenty of warm water where the cool water should be:

Source: NOAA

Consequences for India

Typically, El Niño isn’t good for India, weakening the monsoon. Some analysts had thought that other meteorological processes at work this year might thwart El Niño’s negative effect and allow a good monsoon to play out, but this time, it is looking like India’s official weather agency has made the best call — for a poor monsoon, with cumulative rainfall tracking 11 percent below normal as of this writing.

Source: India Meteorological Department

(A poor monsoon, coupled with setbacks in Prime Minister Modi’s reform agenda and a weak Rupee, are keeping us away from any commitment to Indian equities.) But It’s Not a Done Deal Still, global climate is a chaotic system, and many variables could prevent a repeat performance of the 97/98 “Godzilla” El Niño. A key one is the trade winds. Although sea surface temperatures are extremely high — as high as they’ve been since 1997 — the trade winds have not reversed with the same strength as during that event. That, according to Bill Patzert, an analyst at NASA’s Jet Propulsion laboratory, could prevent a really extreme El Niño from developing. Even in the age of satellites and refined atmospheric modelling, predicting El Niño is not an easy task.

Investment implications: A very strong El Niño is in the offing, according to the nearly unanimous consensus of the world’s state meteorological agencies. El Niño has significant effects on GDP and inflation, varying widely across the world’s different national economies. All that remains to develop for an El Niño event that will rival the strongest observed since record keeping began in 1950 is a reversal of trade winds across the Pacific. We recommend that investors include the developing El Niño in their decision making process for global equity market exposure, and track its development in news releases from NOAA. Contrary to what some analysts had believed, El Niño seems to be having its usual effect on the Indian monsoon, which together with other macro trends makes Indian equities unattractive to us at present.

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Related podcast interview:
Evelyn Browning Garriss on Monster El Niño – Will It Save California?

About the Authors

Chief Investment Officer
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tdanaher [at] guildinvestment [dot] com ()