Third quarter is a key time for extreme weather events. Here's what to expect for exposed stocks

Published Tue, Jul 4 20236:54 AM EDTUpdated Wed, Jul 5 20239:38 AM EDT

The third quarter is a key time for extreme weather events. And there's a bevy of stocks across the utilities and insurance spectrum that could be impacted by what Mother Nature has in store. An El Niño weather pattern is widely expected for 2023. It means that sea surface temperatures will be periodically warmer in the east and central area of the Pacific Ocean, which has a knock-on effect on the Pacific jet stream. This typically means Canada and the northern U.S. are more dry and warm, while the Gulf Coast and greater southeastern U.S. often will see more rain, putting the region at a higher risk of floods, according to the National Oceanic and Atmospheric Administration. La Niña, on the other hand, refers to when stronger trade winds make the sea surface cooler and in many ways has the opposite effect. It's a period typically associated with more extreme winter weather. It's usually warmer than usual in the South and colder in the North. The southern U.S. is more likely to see a drought, while the Pacific Northwest and Canada have higher flood risk. La Niña can also prompt a more severe hurricane season. And this year's El Niño — which, like La Niña, typically lasts anywhere from nine to 12 months — is expected to be a strong one, according to KeyBanc analyst Sophie Karp, whose firm consulted with a climate expert. That has implications for stocks. "Following three years of La Niña, climate scientists expect 2023 to have El Niño conditions with near-100% certainty given current signals," Karp said in a note to clients last month. "Unlike in some prior cycles, which had weaker El Niños, 2023 is expected to feature a historically strong El Niño, perhaps comparable to the conditions experienced in 1982/1983 and 2016." Impacted industries As a whole, she said those expectations don't bode well for utility stocks, while noting the companies based in California and the Northwest could be in a "relatively brighter spot." More specifically, she said it's bad for Michigan-focused CMS Energy and DTE Energy , as well as for WEC Energy , which operates in a handful of states in the Midwest. Read more in CNBC Pro's Quarterly Investment Guide The options for weight loss treatment are about to explode. The stocks investors need to know A.I. enthusiasm drove up stocks this year. Here's how investors can catch the next opportunity Recession worries are likely to carry over into the second half of 2023 Wall Street analysts reveal their top ideas for the second half, including this red-hot solar name The AI-powered rally to start the year could broaden out in the third quarter A challenging macro backdrop could dampen bitcoin's upside in the third quarter WEC also has more risk because of the possibility of surprise wildfires, Karp said. That puts it in a group of stocks that could be hurt by wildfire that also includes Xcel Energy , Avista and Portland General Electric , which also service the American West. On the other hand, California utility stocks Edison International and Sempra could benefit if there is a relatively muted fire season compared with recent history, she said. On the opposite side of the country, she said a severe storm event in the Gulf of Mexico could hurt Southeastern utility stocks Entergy , CenterPoint Energy , Southern Company , Duke Energy and Nextera Energy . Energy and utilities stocks have struggled across the board this year after some were able to avoid 2022's downturn amid rising oil costs. In the S & P 500 , the utilities and energy sectors have been the two worst performers since 2023 began. Insurers are also among the stocks to typically move in relation to extreme weather events. Morgan Stanley analyst Andrei Stadnik said last month that an El Niño year typically leads to 40% less catastrophe expenses than a La Niña year, though the best environment for expenses is a neutral year. Insurance Australia Group and Suncorp , which both have U.S.-listed shares, could see one-time profit boosts, Stadnik said. But the analyst predicts the companies will need to increase their catastrophe budgets in the long term amid rising climate and reinsurance retention risks. IAUGF SNMCY YTD mountain The two Australian insurers' U.S. shares over 2023 A 2023 hurricane trade? This year should be a fairly typical one for hurricanes, as El Niño is typically linked to a less severe season. On the market front, JMP analyst Matthew Carletti doesn't see a clear trade like there has been historically. The trade normally goes something like this: Around mid-February, reinsurance stocks with catastrophe exposure take a dip in valuation as investors ready for the season. Then, as the period with the biggest threat period moves into the rearview, usually around September, they start to recover. But that may not be in the case this year, as he said there hasn't been any pre-season valuation compression, which he said is likely due to a strong pricing environment. And though the historical trade is well known, he said there hasn't been a consistent pattern of valuation moves in relation to the season in several years. Jefferies analyst Yaron Kinar, meanwhile, sees some specific stocks that could be plays. He said a handful of brokerages and reinsurers with exposure to Bermuda could outperform in the short term after a hurricane landfall. For insurers, Kinar pointed to Arch Capital Group , Everest Re Group and Renaissancere . His brokerage ideas were Brown & Brown , Arthur J. Gallagher and Aon . Extreme weather and Wall Street To be sure, the forecast for El Niño is part of broader expectations for the climate as concerns surrounding the health of the environment become increasingly paramount. Those short- and long-term forecasts have implications for the business and finance world, too. Generac 's shares shot up last week after Bloomberg reported that CEO Aaron Jagdfeld said that the company had seen a "dramatic increase" in demand for generator and battery backup systems during the Texas heat wave. And when explaining El Niño's potential impacts on stocks to clients, many analysts noted increasing uncertainty around forecasts as climate change makes extreme weather more common and hard to predict. Morgan Stanley analyst Bob Huang said that elevated losses and unrelenting catastrophic risks, in addition to lingering inflationary pressures, can push up pricing for U.S. insurers. And that's especially true, he said, in an environment where limited reinsurance capital and high losses from catastrophe are "disrupting the supply/demand equilibrium." He said property and casualty stocks have outperformed the S & P 500 in "hard" market periods with price increases over recent history — and this hard market should be no different in terms of share returns. But he isn't bullish on the whole group. After initiating coverage on the sector and 14 names within it, he's overweight on just two: Arch Capital and Everest Re Group. — CNBC's Michael Bloom contributed to this report