Will extreme weather cause U.S. stocks to plummet?

Climate change is one of the most pressing issues facing humanity today. As humans burn fossil fuels and destroy forests, the concentration of carbon dioxide in the atmosphere increases, and the earth is warming. Problems such as extreme weather, sea level rise, and air pollution are particularly prominent and will continue to exist.

Since 2021, we have also seen various extreme weathers frequently. From high temperatures and heat waves to torrential rains and floods, from wildfires to extreme cold. In February, affected by the polar cold current, nearly three-quarters of the United States was covered by snow, and at least 20 cities encountered the lowest temperature in history. More than 5.5 million homes and businesses across the United States lost power, resulting in 26 deaths. In June, Seattle, the United States ushered in the hottest day in history, with temperatures as high as 42 degrees Celsius, which is about 19 degrees Celsius higher than the normal high temperature at this time of the year. In July, torrential rains and floods occurred in western Germany, and a 24-hour rainfall of 154 mm was measured, setting the previous record of the highest daily rainfall of 95 mm in 24-hours...

Although many economists and Wall Street experts around the world are trying to figure out how (or even whether) the weather will affect the performance of the stock market, so far, there seems to be no consensus.

This is a very interesting question, we might as well explore it.

Is there a real relationship between weather changes and stock market trading?

When the market drops due to weather events such as hurricanes or snowstorms, the market tends to think that it is caused by the weather-severe weather may cause companies to shut down, the supply chain will be blocked, consumers will stay closed, and even cause property damage and personal injury , So we will naturally associate the stock market decline with bad weather.

This is indeed a relatively common point of view, but not everyone agrees. Gemma Godfrey, director of investment strategy at Brooks Macdonald, is skeptical. She pointed out that weather problems have not had much impact on the stock market. Her argument is that contemporary weather forecasting science can already achieve a very accurate forecasting function. Before extreme weather occurs, the market has predicted and reacted in advance. Indeed, according to the data results of financial research, in fact, not all extreme weather will cause the stock market to fall.

On the other hand, a theory of behavioral finance believes that the weather does affect investor sentiment. So, this argument does seem to provide a good argument for "weather affects stock returns", but it is not convincing enough to convince the market.

It is not enough to prove that weather affects emotions. It must be proved that the fact that weather affects emotions will affect investors' trading decisions. Although scientists have indeed done some research on the weather changing savings and consumption habits, the research on stock holdings has not really made him find the answer.

Interestingly, from 2009 to 2011, a study of this type conducted on the Borsa Istanbul Stock Market in Turkey found that investors’ behavior is not affected by sunny, cloudy, or sunshine duration, but may be affected by The influence of "cloudy sky and temperature". In the same year (2011), the University of California, Berkeley, published a study in the "Undergraduate Economic Review" magazine, which showed that in the past half century, sunshine has a "significant relationship" with the U.S. stock market. That is to say, sunshine seems to have a positive effect on Americans. The impact is greater.

The huge difference between the two studies also shows that model-based regression economics has not really dealt with the complicated relationship between climate and the stock market. Therefore, there is no final conclusion about whether weather changes and stock market trading are really related.

What is the difficulty in demonstrating the relationship between weather and stock investment?

You might think that it is not difficult to discuss this issue. You only need to compare the climate map drawn by climatologists with the public stock market performance. However, in fact, the scientific methodology commonly used in physics, chemistry and other fields is not easy to use here. In the field of scientific data research, independent tests are controllable because variables are isolated. However, we cannot conduct controlled tests on the macroeconomic and global ecosystems. This system is too big and too complicated. Therefore, for researchers, one can only expect to get a relevant data, not a causal relationship.

A well-known example is the report "Weather-Induced Mood, Institutional Investors, and Stock Returns" (Weather-Induced Mood, Institutional Investors, and Stock Returns) released by Case Western Reserve University in 2014 showed that the study found that relative Increased cloudy days will increase people's perception of overpriced individual stocks, which will lead to institutions selling more stocks.

However, another study from "Stocks and the Weather: An Exercise in Data Mining or Yet Another Capital Market Anomaly?" published by "Empirical Economics" in 1997 shows that stock prices will be affected by systemic weather changes. . However, the 1997 study overturned this hypothesis and finally admitted: "It seems that there is no systematic relationship."

Summary: a consensus

The first thing to be clear is that, though, there is no clear argument in the market to show that the hurricane season in the Gulf of Mexico will have any significant impact on the valuation of US stocks and the optimism in the market. However, the trading market cannot be completely isolated from the climate problem. It will definitely have some impact, especially for certain industries.

A report jointly issued by the world-renowned consulting firm Mercer Consulting, IFC, the United Kingdom’s Department for International Development, and the German Federal Ministry for Economic Cooperation and Development shows that investors cannot ignore the impact of global climate change on their investment portfolios.

The name of this report is called "Investing in a Time of Climate Change" (Investing in a Time of Climate Change). The report assesses investment exposure to climate risk, predicts the impact on investment returns by 2050, and provides investors Suggestions are made on how to improve the flexibility of the investment portfolio.

The report pointed out that the energy industry may be the most affected industry, coal will be the biggest loser, and renewable energy is expected to be the biggest winner. It is estimated that the average rate of return in the coal industry will drop by 26% in the next ten years, while renewable energy is expected to increase by 4% to 97%.

Moreover, climate change will have an impact on earnings. If it is assumed that the temperature rises by 2 degrees Celsius, the financial reports of long-term diversified investors will not be harmed by the investment opportunities created by the world’s transition to a low-carbon economy.