Impacts of Drought on Stock Market Indices: Evaluating Lag Effects Across Agriculture, Water Management, Industrial Manufacturing, and Food Services

Drought has crucial impacts on socioeconomic sectors. Unlike other natural hazards (e.g., flood), drought has a creepy nature (initiates, propagates, and terminates gradually). Drought has significant impacts on socioeconomic sectors, yet its gradual and prolonged nature makes its effects challenging to quantify, particularly on financial markets. Consequently, its impacts on the stock market have been poorly quantified. This study aimed to analyze the relationship between drought severity, calculated using the Drought Severity and Coverage Index (DSCI), and stock performance in key sectors, including agriculture, water management, industrial manufacturing, and food services. Data for drought and stock market in the U.S. were obtained from the U.S. drought Monitor (USDM) and Nasdaq, respectively. Using Pearson correlation coefficients, we examined the relationship across monthly, quarterly, and yearly periods, considering no lag and other different lag times up to five years to account for delayed effects. The results revealed weak to strong correlations between drought severity and stock indices, varying with drought intensity and sector-specific characteristics. In particular, the agriculture and water management sectors showed strong negative correlations, with peak impacts observed after a 3-year lag. In contrast, industrial and food service sectors displayed weaker correlations due to their global operations and diversified supply chains. The weak correlation can be attributed to the impacts of the COVID-19 pandemic, as drought trends generally align with stock market performance, but this relationship was disrupted in 2019. These findings fill a critical gap in understanding the economic consequences of drought on financial markets and offer valuable information for forecasting stock market trends and helping businesses, investors, and policymakers better understand and address the financial risks associated with droughts.