El Niño is only half the story: The investment case for understanding ENSO

As climate phenomena go, El Niño often receives considerable media attention because of its dramatic effects on global weather. Yet it forms part of a larger oscillating system known as the El Niño-Southern Oscillation, or ENSO, which also includes the often-overlooked La Niña phase.¹

While El Niño and La Niña are considered opposite phases,² investors risk overlooking the fact that the climate and financial impacts of one are not necessarily equal to, or offset by, those of the other. Instead, investors should look beyond individual El Niño or La Niña events and consider ENSO as a larger dynamic system capable of creating compounding, multi-year effects.

From ocean temperatures to investment outcomes

ENSO originates in the tropical Pacific Ocean, but its effects extend across global weather patterns.^3,4 Under neutral conditions, trade winds push warm surface water towards Asia while cooler water rises near South America.⁵ During El Niño, the central and eastern Pacific become warmer than usual, and the trade winds weaken.⁶ Rainfall consequently shifts towards the central and eastern Pacific, causing parts of Asia and Australia to become drier.^7,8 By comparison, La Niña strengthens the normal circulation and associated weather patterns.¹¹

These changes matter because they alter the location and severity of droughts, floods, storms, and extreme heat.¹² The resulting financial-market impacts may include lower crop yields, disrupted mining operations, reduced hydropower generation, damaged infrastructure, adjustments to insurance claims, and changing commodity prices.^13,14,15

Yet accounting for these changes in portfolios should not simply mean allocating holdings to sectors or regions that may benefit from one phase, such as El Niño, and reversing those positions when the other appears. The same sector can sometimes be negatively affected under both phases. Furthermore, understanding these compounding risks is likely to be even more important as some emerging evidence indicates that climate change may be altering the strength, duration, and frequency of both. While uncertainty remains over the precise evolution of the system, evidence points towards stronger and more persistent El Niño events, as well as more frequent and multi-year La Niña conditions.¹⁶

When more rain does not mean recovery

Consider the drought-prone southwestern United States. El Niño can bring higher precipitation, potentially benefiting agriculture, mining and other water-intensive industries. But the timing and intensity of that rainfall matter.

After a prolonged drought, compacted soil and vegetation loss can limit water absorption, causing rainwater to flow across the surface rather than percolate into the soil and replenish groundwater.^17,18,19 Under heavy rainfall, the compacted soil may increase the risk of flooding rather than providing relief.²⁰ Additionally, where wildfires have removed vegetation, the same rainfall can trigger landslides.²¹ Consequently, an event that initially appears positive for water availability may also damage crops, mines, and infrastructure.

Climate events such as El Niño are not just macroeconomic phenomena but real-world stress tests for business models. Our focus is not on predicting the severity or duration of the next weather cycle as markets efficiently price in near term disruptions. Instead, we focus on identifying those companies whose business model durability is underestimated because they can adapt, recover, and expand their competitive advantage through a wide range of operating environments, including extreme weather events like El Niño.

 

– Matt Culley, Portfolio Manager, Emerging Market Equity Team

Worse yet, El Niño may be followed by La Niña, a transition that is more likely after stronger El Niño events.²² La Niña can then amplify normal conditions, making the region even hotter and drier. Rather than allowing the region to recover from reduced rainfall, La Niña may instead extend the drought and increase wildfire risk.

Combined, the overall impact to the region is flooding under El Niño and renewed drought under La Niña. Instead of cancelling each other out, they create successive operating and financial pressures for businesses in the affected region.

A comparable pattern can emerge in normally wet regions. In Indonesia, for example, El Niño-related drought would reduce agricultural output, including on crops such as palm oil.²³ A subsequent La Niña may bring unusually heavy rainfall and flooding, which can damage crops through a different mechanism.²⁴ Agricultural production could therefore remain under pressure across both phases for an extended period.

Why investors should pay attention to ENSO and how to respond

No two El Niño or La Niña events are identical, and their strength, frequency, and duration may be changing. Investors should therefore be cautious about relying on historical impacts. The more useful exercise may be to identify companies that can remain resilient across several plausible conditions.

For example, for a mining company, relevant considerations include the geographic diversification of production, water management, infrastructure resilience and the speed at which output can recover after disruption. For food and consumer businesses, supply-chain diversification, inventory management, purchasing power and the ability to reformulate products may be important. For insurers, investors can examine whether temporary reductions in claims are being treated as sustainable improvements or used to prepare for future loss years.

Overall, for investors, the central lesson is that El Niño and La Niña should not be viewed as isolated climatic events, but instead as drivers of sector dispersion and macroeconomic volatility whose effects may persist, overlap and compound. Understanding what may come after the initial shock can be just as important as understanding the shock itself.

This perspective complements our recent article and whitepaper on climate resilience in a super El Niño environment by considering how the broader ENSO cycle can create compounding effects across multiple years.