Friday, October 15, 2010

First there was QE2, now La Niña
Economic trends
• Investors are always looking out for “the next big thing”. Currently investors are fretting whether the US economy will experience a double-dip recession, in turn debating whether the Federal Reserve needs to apply more stimulus – more quantitative easing, or QE2.

• But closer to home there is a weather trend to watch – La Niña – an event associated with cooler, wetter weather. There hasn’t been a major La Niña event since the late 1990s and it has implications for a raft of businesses.
• Overnight, the World Meteorological Organisation released its latest El Niño/La Niña Update and warns of moderate to strong La Niña conditions over the coming 4 to 6 months.

El Niño, La Niña – what is it all about?
• Over time, Australians have heard a lot about El Niño. This is the weather event that most people associate with drought. And given that most of the noughties were characterised by drought, there has been plenty of discussion about El Niño in recent years.
• But now the discussion has shifted to La Niña. This is essentially the opposite of El Niño, associated with cooler, wetter weather in eastern and northern Australia. The Bureau of Meteorology (BOM) also notes that there tends to be more tropical cyclones in northern Australia when La Niña events occur.
• In late September, BOM indicated that La Niña was well established in the Pacific and indicated that it will last until at least early 2011. The Climate Prediction Centre in the US has projected that La Niña will persist until at least the Northern Hemisphere Spring of 2011 – that is to around March 2011. The CPC says “many models forecast La Niña to strengthen through the November 2010 – January 2011 season before beginning to weaken.” In the US, La Niña autumn/winters tend to be warmer and drier for the Southwest but increasing the possibility of rain and snow in the Pacific Northwest.
• The CPC says that the last El Niño event extended from May 2009 to May 2010. Effectively there have been rolling El Niño events from April 2002 through to 2010, with only a brief La Niña from August 2007 to Jun 2008. The last major La Niña was a two year period from June 1998 to June 2000.
• In contrast to the dry noughties, the 1990s tended to be wetter than normal with a La Niña event occurring from 1995 to 1996 and then another event covering 1998 to 2000.
• The World Meteorological Organisation has just released its latest El Niño/La Niña Update, warning of moderate to strong La Niña conditions over the coming 4 to 6 months. And like the CPC and BOM, the WMO expects the La Niña event which began in June and July 2010 to extend until at least the first quarter of 2011. The WMO said the current La Niña became “moderate to strong” in August and continues at the same strength.

Wet weather on the way?

• The climate models say that cold, wet weather is on the way. Most people in the eastern states would say that it is already here. Queensland had its wettest September on record and Brisbane yesterday had its wettest October day on record. In addition, temperatures have been below-average in eastern and southern states. It was the coldest and wettest September in South Australia in 18 years. Melbourne had its coldest September in 16 years while Sydney had the coldest September in five years.
• The last major La Niña was in the late 1990s, and it is clear from the charts that this was the last time that rainfall across the capital cities was well above normal. For most of the noughties the rolling total of capital city rainfall was below average. But it’s worth noting that over the year to September 2010 that capital city rainfall was in line with the long-term average.

Implications of a La Niña weather event

• A raft of businesses and industries will be affected if a major La Niña event occurs across the summer months in Australia. Amongst those potentially affected are:
• Retailers of seasonal goods – clothing, electrical goods, outdoor equipment, swimming pool operators & equipment
• Utilities – reduced demand for power (air-conditioners, fans etc)
• Insurance companies – potential for floods, more traffic accidents
• Rural producers – effects will vary depending on where and when the rain falls, and in what quantities
• Builders/construction – potential for weather delays with more frequent rain days
• Good rains in recent months through Queensland, NSW and central Australia have served to lift dam levels, fill lakes and boost water flows in key river systems. But somewhat perversely the ending of the drought may reduce the urgency for reform of water allocations in the Murray Darling basin and delay moves to get more appropriate pricing of water to better reflect its scarcity value.
• While the ending of the drought will reduce demands on the Federal Budget for special assistance grants, the occurrence of major floods could result in different demands on government spending.
• The CPC has also noted that a deepening of the La Niña event could lead to more hurricanes in the Gulf of Mexico, disrupting oil production. So far the hurricane season has been relatively uneventful, but it does extend for another month or so until late November, so it bears watching.

What are the implications for investors?

• Retailers are already under pressure given that conservative consumers are reluctant to spend, so a mild, wet summer would represent an additional challenge. Myer currently is in the middle of a Mid Season Sale (ends October 17) with the catalogue dominated by Men’s and Women’s clothing items.
• It is hard enough for investors to account for the vagaries of the economy, let alone the vagaries of the weather. And while La Niña events have predictable effects, climate models aren’t able to accurately determine whether a mild La Niña event is in prospect or something more severe. Still, for investors it is a case of forewarned is forearmed.

Source Craig James, Chief Economist, CommSec

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