Cold Cash

by Michael Todd

photography by Sofie Kirk

If you want a bigger return on your investment dollar, you might want to watch the weather channel and digest some insights into stock behaviour from Ming Dong, an associate professor of finance at York University’s Schulich School of Business, and PhD student Andréanne Tremblay.

Their research, recently featured in The Economist, offers up some interesting observations on how global stock returns and the weather may go hand in hand.

“Economists have long known that sunshine is good for stock markets, perhaps because nice weather makes people more optimistic,” notes The Economist. Now new findings by Dong and Tremblay suggest cold weather can have an upside too.

They hypothesized that weather’s effects on mood depended on climate, so they investigated the relationship between stock returns and each variable, for each temperature region and each month. The researchers then summarized the patterns of the weather effects across climates and seasons. “We uncovered many interesting patterns … but one thing that stands out is that the weather’s effects on mood appear to be stronger during seasons when individuals expect to spend more time outdoors,” says Dong. “This is of course quite intuitive because if we stay indoors we won’t be much impacted by the weather.”

The Economist reported that Dong and Tremblay “used data from Thomson Reuters’ global equity indices to examine the effect of local weather on the main market index in 49 countries from 1973 to 2012.” They investigated the effects of five weather conditions: sunshine, wind, rain, snow depth and temperature.

“It is true that there is already research about stock market seasonality, such as the length of daylight affecting market cycles,” says Dong. “But we examine a different kind of effect: how short-term, day-to-day fluctuations of conditions affect the market. Seasonal variables such as length of daylight are perfectly predictable, but we examine the effects of daily weather variables for different climates and seasons.”

The researchers found that the effects of weather on returns were indeed contingent on climate and season, and more pervasive than previously documented. According to The Economist, they learned that “warm weather sends prices higher (such as in September in the cold region), but too hot weather causes the relationship to break down.” It may seem counterintuitive, but a striking finding by the researchers was that while weather and investors can be fair weather friends, very cold weather can also be good for market returns.

Why that would be so is not entirely clear, but according to The Economist, the researchers surmised that “cold stimulates risk-taking, referring to psychological studies in which participants reported increased aggression as temperatures dropped below -8 C.”

Dong and Tremblay suggest a hedge strategy that exploits the daily return predictability of the weather generated up to 25 per cent annualized out-of-sample gross profits during the period 1993-2012 and that the patterns of weather effects across climates and seasons suggest weather does indeed influence investor psychology.

“The systematic patterns of weather effects across climates and seasons, together with the relationship between the strength and timing of weather effects and individuals’ seasonal propensity to spend time outdoors, suggest a plausible mechanism through which weather-induced mood influences index returns,” says Dong.

“We are not the first to look into the relation between weather and stock returns, but this topic is rather controversial because markets are supposed to be only affected by financial news, and weather is hardly related to economic fundamentals. This is an area known as behavioural finance, which posits that markets are affected by investor psychology and emotion, in addition to fundamental news. Our hypothesis is that when good weather leads to an upbeat mood, investors will be more likely to buy stocks, and vice versa.”

Dong admits there are many challenges to the angle his study took. He notes that stock returns are driven by many factors, primarily by financial news.

Today’s weather may be nice, but if the markets worry about North Korea’s hydrogen weapons, stock prices may fall,” he says. “Therefore, we need a very large sample of observations to cancel out non-weather effects. Second, it is hard to predict what specific weather conditions lead to good or bad moods, or people’s risk-taking tendency. Even psychologists debate on how various weather conditions influence people’s moods.”

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