Heat Wave Impact on Stock Market

It has often been said that while a normal summer may not create much of an impact on the equity markets, the recurrence of heat waves can bring about a disruption, leading to a fall in stock prices. To test the validity of such a theory, we carried out a study taking historical records and other data into consideration. The conclusion is interesting, to say the least 

April, fortunately, turned out to be a month in favour of investors. In fact, it almost seemed as if the magic was back to working its spell in the stock market. All the equity indices closed in the green except for the IT sector which closed marginally lower in this month. However, despite all the gains made in April, given the year-till-date data, most of the equity indices are still trading in the red. The reason is that in the first three months of 2023 we saw the indices giving negative returns in a row. There were various factors that led to such poor performance of the market in the first quarter of 2023, including the banking crisis on both sides of the Atlantic, which reminded many of the ‘great financial crisis’ (GFC) of 2008. Investors feared the contagion impact and its repercussions were felt globally, thereby affecting the global equity markets.  

Nina and Nino
 

It was not only the global factors that led to a fall in the Indian equity market. Even the local factors played a role. February was not too kind to the Indian climatic condition. India witnessed its warmest February in the last 146 years as per the data released by the Indian Metrological Department (IMD). This is not the first time that we are witnessing such a warm summer. For example, in 2022 the average number of heat wave days rose to the highest in a decade – there were 190 of them. 

This count was over six times higher than the previous year and was primarily due to La Nina, which means ‘little girl’ in Spanish. 

It is a phenomenon of periodic cooling of ocean surface temperatures in the central and east-central equatorial Pacific. Typically, La Nina events occur every 3-5 years or so but on occasion can occur over successive years. This ended towards the close of March. Now there is the fear of an emergence of El Nino, which in Spanish means a ‘little boy’. In the case of El Nino, the trade winds are even stronger than usual, pushing more warm water towards Asia. This change in climatic condition has direct as well as indirect bearing on the Indian equity market.  

Heat Waves and Equity Market

Heat waves have become more frequent, and more intense, almost everywhere due to climate change. The rise in heat waves in the current year is not a random event and there is a pattern to it. According to the IMD, most parts of India are likely to see above normal maximum temperatures from April to June. It is generally believed that since heat waves impact humans, they are also bound to affect economic growth too, and, of course, company balance-sheets and domestic budgets. The unusual hot weather ahead has raised economic worries as Indian is still recovering from the pandemic and its after-effects. 

The fall in productivity caused by extreme high temperatures could already be costing India 5.4 per cent of its GDP, according to the Climate Transparency Report published by environmental groups last year. It is also impacting the equity market. There have been several instances of intense heat waves in India in the past and the performance of the BSE Sensex during these periods has not been very benign. For example, during the summer of 2022, India experienced a severe heat wave with temperatures touching 45 degrees Celsius in some parts of the country. 

During this period, the BSE Sensex did not perform well with the frontline index dropping by around 10 per cent between the end of April and the end of June. However, it’s important to note that stock market performance is influenced by a wide range of factors, and the performance of the Sensex during this period could have been affected by other triggers such as geopolitical, economic conditions, global market trends and companyspecific news and events. To understand the pattern, we dug deeper and tried to understand if there is a way through which we can identify if warmer temperature impacts the equity market returns. 

Since 1995 we have seen seven major heat waves covering India (see list of serious heat waves in India). It is not surprising to note that in all these years we have seen higher probability of the equity market generating negative returns during these months i.e. April May and June. To understand this, we carried out a study where we analysed the monthly returns of Sensex since 1979. Out of the 528 months that we studied, we found that on a median basis every month has generated return of 1.03 per cent. Next, we segregated the returns based on specific months and years. The purpose of such segregation was to understand if there is any difference between the returns generated during the period of heat waves and a normal summer period.

We found that during the period of heat waves the Sensex on an average generated less returns compared to a normal period. For example, on an average, in the months of April, May and June, the Sensex generated negative return 3.5 per cent whereas in a normal period these three months have generated positive return of 6.33 per cent. The difference is huge – almost 10 per cent. For example, in 2002, when we saw the maximum temperature touching 49 degree Celsius during April and May, the Sensex gave a negative return of 6.38 per cent. Similar was the case in 1998 when the Sensex generated negative return of 16.49 per cent in the period of April-June. One of the reasons for such exaggerated negative return may be attributed to the ban imposed by various countries after Pokhran II tests.

The difference is not only in returns but also in the number of years this period has generated negative returns. In the last seven instances of above average temperature, five times out of seven the Sensex has given negative return or almost 71 per cent of the time. Compare this with a normal period when the monthly returns are in the negative only 31 per cent of the time.  

The fall in productivity caused by extremely high temperatures could already be costing India 5.4 per cent of its GDP, according to the Climate Transparency Report published last year. It is also impacting the equity market. 

This clearly shows that heat waves have a negative relationship with the equity market return. Nevertheless, all the sectors are not equally impacted by rising temperature. There are some sectors that get impacted more than others. For example, agriculture, automotive and FMCG sectors bear the brunt of higher temperature more than other sectors.  

Sectors and Heat Waves

Heat waves can impact the stock market in a number of ways, as mentioned earlier. It can have both direct as well as indirect impact. In case of direct effects on companies, intense heat waves can create disruptions in companies that operate in such sectors as agriculture, energy and construction. For example, heat waves can damage crops, increase demand for airconditioning and cooling systems and affect construction projects. If companies in these industries experience lower revenues or increased costs due to heat waves, their stock prices may decline. Similarly, ice-cream and beverages companies may see their stock price increasing due to the higher demand for such products. 

Heat waves can also have an indirect effect on the economy. For example, if heat waves lead to lower consumer spending or reduced economic growth, this could impact the earnings and revenues of many companies. Similarly, if heat waves lead to increased inflation or interest rates, this could impact the cost of capital for companies and the valuation of their stocks. These direct as well as indirect effects impacts consumer sentiments too. Intense heat waves can impact investor sentiment and confidence, which can impact stock prices. 

If investors become concerned about the impact of heat waves on the economy or specific industries, they may sell stocks or avoid investing in certain industries. This can lead to decline in stock prices even if the direct or indirect impacts of the heat wave are relatively small. Nevertheless, there are certain companies in industries such as agriculture, energy and construction that may be particularly sensitive to heat waves and their stock prices may be impacted if they experience lower revenues or increased costs due to the extreme weather conditions. 

For example, some international studies have suggested that El Nino causing higher temperature can lead to lower stock market returns in countries that are particularly sensitive to weather conditions, such as those with large agricultural sectors. Though India draws only one-fifth of its GDP from the agriculture and allied sectors, almost two-third of its population is dependent on this sector. The growth of other sectors and the overall economy hinges on the performance of agriculture to a considerable extent through backward and forward linkages. 

To understand the impact of heat waves on different sectors, we studied the performance of the sectoral indices in these periods. We took those sectors that form almost 92 per cent of the BSE Sensex weightage. Some of the major sectoral indices included for our study are banking, automotive, oil and gas and information technology, among others. Since we do not have a very long history of most of the sectoral indices, we studied only the last four instances of heat waves from 2015 to 2022.

Interestingly, we could not find any relationship between any sectoral performance and heat waves. For example, the FMCG index, which is supposed to be impacted most due to warmer summer, generated positive returns in the last three years out of four instances of heat waves. Barring one there was not a single sectoral index that consistently generated negative returns for more than two times during the heat waves. . The only index that has given negative returns for more than two times is, surprisingly, IT(Graph: Returns of Sectoral Indices During Heat Waves), which has the least to do with scorching heat. One of the reasons we did not find any correlation is because investors might not have understood the impact of heat waves on a company’s business. Therefore, we took the study one step further and analysed the performance of sectoral indices during the result season just after the heat waves. Hence, we analysed the performance of these indices during July and August when most of the companies report April-June quarter results. 

Even during the result season, we could not see an above average warm temperature during the summer months influencing the returns from any sector. The table alongside clearly shows that there is no clear relationship between a warmer summer and sectoral indices returns.  

Heat Waves and Sectors 

According to Wikipedia, a heat wave or conditions of extreme heat define a period of excessively hot weather, which may be accompanied by high humidity, especially in oceanic climate countries. While definitions may vary, a heat wave is usually measured relative to the usual climate in the area and relative to normal temperatures for the season. Temperatures that people from a hotter climate consider normal can be called a heat wave in a cooler area if they are outside the normal climate pattern for that area. The term is applied both to hot weather variations and extraordinary spells of hot weather which may occur only once a century. 

Severe heat waves have caused catastrophic crop failures, increased risk of wildfires in areas with drought and caused widespread power outages due to increased use of airconditioning. A heat wave is considered extreme weather, and poses danger to human health because heat and sunlight overwhelm the human body’s cooling system. Heat waves often have complex effects on human economies due to less productivity of workers, disruption of agricultural and industrial processes and damage to infrastructure not adapted for extreme heat. 

Intense heat waves can impact different sectors and companies in different ways, depending on the specific industries and products involved. Here are a few examples of sectors that may be theoretically impacted by a heat wave: 

Agriculture — Heat waves can have a significant impact on agricultural productivity, particularly for crops that are sensitive to high temperatures and water stress. Crops such as wheat, rice and sugarcane can be affected by heat waves, leading to lower yields and higher prices, which in turn can impact industries using it as a raw material. Also, it impacts the overall consumption and hence may impact FMCG companies. 

Automotive — The cascading effect of a sluggish rural economy will extend to tractor and two-wheeler sales as well. The extensive heat can hamper healthy growth cycle for tractors and delay the rebound of the two-wheeler space. 

Power, Utilities and Cooling Solutions — During heat waves, the demand for electricity and cooling systems increases significantly which can have a positive impact on companies providing cooling solutions. It will also impact positively the power exchange companies. Nevertheless, this can impact the operations of companies in the power and utilities sector as well as other industries that rely on uninterrupted power supply. 

Construction and Infrastructure — Heat waves can also impact construction and infrastructure projects, particularly those that are carried out outdoors. High temperatures can make it difficult for workers to perform physical labour and can also cause materials such as concrete to dry too quickly, leading to cracks and other defects. 

Tourism and Hospitality — Heat waves can also impact the tourism and hospitality sectors, particularly in regions that are popular summer destinations. It can increase the inflows of tourists to such destinations leading to higher revenues for hotels, restaurants and other tourism-related businesses. 

Conclusion — Extreme climate changes work in the favour of only a few sectors and adversely impact many sectors directly or indirectly. Extreme heat waves have a far-reaching impact on a country’s food security, consumption, labour productivity and citizens. Nonetheless, the impact is short-term in nature and in general it’s difficult to predict how the different sectors will perform during an intense heat wave or any other weather event as there are so many other variables at play. Investors should focus on their long-term investment goals and strategies rather than trying to time the market based on short-term weather conditions or other external factors.