El Niño Is Back, And You Just Might Want To Weatherize Your Portfolio

The world is still trying to bounce back from the Covid-19 pandemic, while simultaneously grappling with high inflation and recession risks, and now the return of "El Niño'' – the most powerful global climate event – is set to put additional stress on an already fragile world economy. It’s a risk too big for investors to ignore – so let’s take a look at how you can protect your portfolio from its potentially cataclysmic effects.

But first, what is El Niño exactly?

El Niño (“little boy” in Spanish) and La Niña (“little girl”) are opposite phases of a natural climate pattern across the Pacific Ocean that swings back and forth on average every three to seven years. Together, they are called ENSO, which is short for El Niño-Southern Oscillation. The ENSO pattern in the Pacific can take one of three forms: El Niño (the warm phase), La Niña (the cool phase), or neutral.

El Niño happens when the surface temperatures in the central and eastern Pacific Ocean, near the equator, become warmer than usual. This warming can affect atmospheric conditions and, consequently, alter the weather globally. El Niño often results in wetter conditions in the southern part of the US and drier conditions in many parts of the tropics.

La Niña is essentially the opposite of El Niño. It's when the same region of the Pacific Ocean cools down instead of warming up. This also affects global weather patterns, typically resulting in drier conditions in the southern US and more rainfall in the tropics.

Neutral is when conditions are near their long-term averages, and that’s the case most of the time.

How the El Niño and La Niña climate patterns play out across the Pacific Ocean. Source: National Oceanic and Atmospheric Administration.

El Niño and La Niña episodes typically last nine months to a year. They tend to develop during the spring (March to June), reach peak intensity during the late autumn or winter (November to February), and then weaken during the spring (March to June). Both can last more than a year, but that’s rare for an El Niño event. La Niña events, on the other hand, can last two years or more.

What’s the likely impact?

The return of El Niño for the first time in almost four years is expected to have big implications around the world, sparking a possible chain reaction of dangerous weather, food shortages, and blackouts that could disrupt supply chains and stoke inflation. Coupled with more extreme weather and higher temperatures due to rapid climate change, the world could be on the brink of experiencing the most expensive El Niño cycle since weather experts started recording such events.

The arrival of El Niño is expected to have profound impacts around the world. Source: Bloomberg.

That’s likely to result in major disruptions for people – and for markets.

1. Commodities

The global commodities market and, in turn, commodity-price inflation, often end up whipsawed by the unpredictable weather patterns El Niño can bring. And agricultural commodities tend to get the brunt of it. For instance, reduced monsoon conditions could impact rice, cotton, corn, and soybean output in India, while Australia could suffer damage to its wheat production because of severe droughts and forest fires. The disruptions to crop yields subsequently exert upward pressure on commodity prices, stoking inflation.

The price of rice typically shoots up during El Niño events. Source: Bloomberg.

El Niño can upend metals prices just as easily: it could trigger heavy rains in Chile, for example, which would, in turn, restrict access to the mines that supply almost 30% of the world’s copper – an essential commodity used in construction, transportation, infrastructure, and more.

Bloomberg Economics modeling suggests that past El Niño events added about 3.9 percentage points to non-energy commodity prices.

2. Growth

El Niño tends to rain down particularly hard on economic growth, particularly in Australia and emerging economies.

Countries typically use gross domestic product (GDP) – which is, basically, the broadest gauge of the goods and services produced in a particular region – to measure economic growth. According to Bloomberg Economics, the weather phenomenon could reduce annual GDP growth in India and Argentina by almost half a percentage point, while Peru, Australia, and the Philippines could see reductions of about 0.3 percentage points. Additionally, long-lasting repercussions of El Niño episodes suggest that these events have the potential to permanently alter economic growth trajectories.

Looking back, Dartmouth scientists estimated that the 1997-98 El Niño resulted in $5.7 trillion in lost global GDP over the following five years. Their modeling estimates that by the end of the century, El Niños will have blocked some $84 trillion in GDP.

El Niño's impact on economic growth and inflation. Source: Bloomberg.

3. Other impacts

For a “little boy”, El Niño can have a pretty expansive reach. It can trigger extreme heat that can strain power grids, leading to frequent blackouts, particularly in countries transitioning to renewable energy. Consequently, there might be increased demand for fuels – including coal and gas – for power generation.

Furthermore, changes in weather patterns tend to affect public health, and increased temperatures can lead to heat-related illnesses, exacerbating public health crises. Severe weather events can also damage infrastructure like roads and homes, further straining economic resources.

Finally, drought induced by El Niño can hit supply chains by causing water levels to drop in rivers and canals, limiting the ability to transport goods effectively and economically. And drought has been known to hit manufacturing activity in China too: dry conditions last summer led to reduced electricity output at the Three Gorges Dam – the world’s biggest power plant. That prompted Chinese officials to shut off power to factories for nearly two weeks, disrupting supplies for manufacturing giants, including Apple and Tesla.

So how do you hedge against these risks?

Let’s face it, you’re not going to stand in the little boy’s way. But you might consider investing in an ETF that tracks agricultural commodities: that’d give you a strategic hedge against the risks posed by El Niño.

Recall that El Niño disrupts typical weather patterns, potentially leading to droughts or floods in various parts of the world, which can significantly impact the yield of key crops. When crop yields are negatively affected, it can lead to a decrease in supply, which, in turn, can drive up the prices of these commodities. By investing in an agricultural ETF, you could potentially profit from these price increases, thereby offsetting any negative impacts of El Niño on other parts of your portfolio.

The Invesco DB Agriculture Fund (ticker: DBA; expense ratio: 0.91%) is one to consider here. The ETF is up 7% this year, outperforming the wider Bloomberg Commodity Index by 17%.