Weird Weather - Part I: Unusually high levels of rainfall and colder than normal temperatures have not allowed Midwest farmers to plant crops such as corn and soybeans. As of the third week in May, 49% of corn acreage had been planted compared to a 5-year average of 80% for this time of the year. Low grain prices from tariffs on farm goods and the further threat of a prolonged trade war with China have also disincentivized farmers from planting. Both corn and soybean futures had been sitting down around multi year lows as recently as mid-May (by press time on this note it is likely both have risen considerably due to the supply pressures outlined herein and short-squeezes). Another factor, crop insurance, is creating a triple threat of supply constraints in the corn and soybean markets. According to agricultural research firm AgResource Co., between 4 million and 4.5 million acres of corn and 1.5 million and 2 million acres of soybeans could go unplanted with farmers claiming what are called prevent-planting payouts. If this were to occur, it would represent a quadrupling (in the case of corn) and a doubling (in the case of soybeans) in the number of acres claimed for this type of insurance compared to last year according to the USDA. Farmers in some states are faring differently than in others. States such as Illinois have been hit particularly hard with only 24% of the corn acreage planted (compared to the national average mentioned earlier of 49% as of the third week in May) which could lead to some very large disparity between farmers in different regions this season.
Our Takeaways: The supply instability in these grain markets is likely to create large ripple effects that will be felt outside of the agricultural industry. Chemical and seed companies will feel the most direct effects as farmers are incentivized against planting crops and therefore have no use for those companies’ products this growing season. End users of corn products and byproducts may take some time before experiencing impacts to their business, but as the pricing pressure from supply constraints works its way through the supply chain everyone from livestock owners (who primarily use corn for feed) to breakfast food manufacturers (who use corn flakes for products such as cereal and grits) will be confronted with decisions over how to respond. If these businesses are able, they will likely try to pass on some of the increases to their customers whether those are everyday consumers or other commercial enterprises. However, depending on the specific dynamics faced by individual companies experiencing these pricing pressures, there may be opportunities to develop convincing short theses if particular companies are unable to respond to increased input prices in a manner that protects their bottom line.
Weird Weather - Part II: Extended bouts of cold weather and higher than normal rainfalls have impacted more than just U.S. farmers. U.S. Retailers from home improvement stores such as Home Depot (NYSE: HD) to transportation / shipping companies such as UPS (NYSE: UPS) to even restaurant companies such as El Pollo Loco (NYSE: LOCO) have gone as far as to cite specific weather related issues as challenges to their recent financial performance and future guidance on earnings calls. Weather can impact businesses in a variety of ways from decreasing the need in a given time frame for a particular good or service (e.g. a home improvement store not selling as much building material in the first quarter due to prolonged cold weather that impacts builder productivity and therefore misses on Q1 estimates) to impeding, or at the very least discouraging, potential customers from coming to the store or place of business (e.g. customers deciding to stay at home and eat instead of going to a restaurant due to inclement weather).
Our Takeaways: Typically investors would view weather related complaints or excuses by company executives on earnings calls with suspicion. However, meteorologists have the executives’ back this time around with several recent studies showing a connection between an overall warming climate, higher levels of atmospheric moisture, and extreme weather events such as extreme cold, flooding due to high levels of rainfall, and tornadoes/hurricanes. Due to the recent frequency of observable extreme weather events, it makes the case for buying into the story that weather is the actual cause for poor performance in some of these cases. However, a better understanding of how long run changes in the atmosphere affect weather patterns will be needed before reliable extrapolations into the impacts on businesses can be made.
Build It and They Will Come?: Mortgage applications continue to run at multi-year highs for this time of year. This is particularly important because the April to May time frame is historically the high point for applications in a given year. In conjunction with this, new home sales have rebounded after taking a steep nosedive and have accelerated to a near record pace. To round these developments out, home builder optimism is continuing to rise. It hit a trough at the end of 2018/the beginning of 2019 after hitting post financial crisis highs in 2017. It looked like it was going to stall out earlier in the year which was likely due to a rapid acceleration in the number of housing starts that, at the time, looked unsupported by sales volumes. However, a recent (and significant) drop in the number of starts coupled with the previously mentioned breakout sales numbers and mortgage applications has put builders in a potentially good spot. These factors also have the backdrop of multi-year low inventory numbers which means new product builders put in process now will have less of a risk of hitting an overly saturated market if the current inventory is slow to move.
Our Takeaways: The mortgage pricing data largely does not make sense because while on the one hand, yes, mortgage rates for common mortgage products such as a 30-year fixed are near multi-decade lows (currently sitting around 4%), on the other, they are up about 50 to 70 basis points off of historic lows reached in 2012 and 2016 for this product and the story is similar for other commonly used mortgage products. Furthermore, affordability is at record lows, particularly in new construction, which serves to price many would be buyers out of the market. Adding to these constraining factors, housing supply has been running near record lows as well (partially causing the low inventory mentioned previously), again particularly in new construction, both in terms of overall stock and rate of new supply to the market (whether that be new construction or listings of existing homes). Movement of new home product is causing speculation that housing starts may pick back up. This potential is likely leading to the increased builder optimism which has suffered since hitting record highs in the post financial crisis era at the end of 2017. Yet, the dichotomy still remains. Despite not particularly strong mechanics underpinning the sale of new homes, selling they are. This in turn is sending a signal to builders that things can continue a little while longer, so they build.
Too Much of a Good Thing?: April delivered yet another month of solid job growth in what has become a several year run of above expected growth. The unemployment rate fell yet again, however, labor force participation also fell. Participation has fallen at an aggressive pace that last couple of quarters in the particularly noteworthy “prime working age,” or 25 to 54 year old, category. Another sign of the times for labor are the flows from employed to unemployed. Readings on this metric haven’t been seriously tested since prior to the tech bubble bursting in the early 2000s. Other areas that have seen recent declines (or flattening of an upward trend) are year-over-year hourly and weekly wage gains, manufacturing employment growth, manufacturing weekly hours, and overtime hours. These trends are all likely being influenced by changes in productivity. U.S. labor productivity posted a significant (3.6% vs. 2.2% expected) increase for the 1st quarter of 2019 making 5 straight quarters of quarter-over-quarter gains and quarter-over-quarter gains for 15 out of the last 17 quarters.
Our Takeaways: In general, increased productivity is viewed as a good thing, but taken from the worker’s perspective, as some of the trends/numbers above show, it's not in and of itself a good thing. Taking this a step even further, some aspects of productivity can make interpreting data and making comparisons to other time frames for the purposes of extrapolating likely future outcomes such as with the declines in manufacturing employment growth, manufacturing weekly hours, and overtime hours which may signal a slow down in the manufacturing sector or perhaps just that manufacturing firms have been successful in making their operations more efficient. One lends itself to a bullish thesis and the other a bearish one. In general, given that the development of new technologies and techniques over the long run suggests it is more likely some of these recent trends point to more boom than gloom, it has become more important than ever to understand how specific companies are positioning themselves and not just relying on a high tide to lift all boats.
Speculations on Fed Rate Moves (and Our Speculations on Those Speculations): Despite all public and semi-private (i.e. comments by members from meeting minutes) indications that the Fed has no intention of cutting rates in the near term, this has not kept market participants from voting with their money. As of mid-May, the market implied probability of a rate cut in 2019 was making its way towards 80%. By press time, it will likely be at or above 80% if the current trend continues.
Our Takeaways: We will not actually attempt to speculate as to what the Fed may do in the coming months as the headline suggests. Such speculation would be merely that, and we find the more effective approach, in so far as investing is concerned, is to evaluate the range of plausible outcomes and develop an approach or establish a positioning to take advantage of the outcome if it does occur. The Fed’s current policy of maintaining rates is likely their most tenable at this point. Cutting rates would only serve to invite further scrutiny over the independence of the body and raising rates would be viewed very unfavorably both politically and in financial markets. Implied market data specifically signalling investors positioning on future rate movements aside, it’s clear market participants as a whole are uncertain at best about further tightening in monetary policy. The large downward movements in Q4 2019 (over the fears of further tightening) and the more or less sideways movement for what has become the better part of this year since recovering from the drops late last year are evidence of that uncertainty. However, as with a lot of things, waiting and doing nothing is only an option for so long. At some point (and for whatever reason - real or otherwise), the Fed will be compelled to take action. As things stand economically, the data does not support a reduction in rates to stimulate growth. A strong case based on economic data can be made for why the Fed should continue to raise rates at this point, but likely the most compelling case that could be made for this course of action would be to ensure they have ample options at their disposal to spur growth during the next recession (again, when not if). Given these factors, it is most likely that some outside force(s) will be the cause of any future Fed action and if behavioral psychology is any teacher in these matters, humans tend to respond faster and more decisively to negative/painful events.
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