Outlook 2010: The Big Picture
The U.S. economy has endured the most challenging period since the Great Depression. In recent months, the rise in the stock market and talk of “green shoots” have many prognosticating that the recession has ended and the recovery commenced.
But the exploding stock market has expanded valuations beyond the bubble years of the late 1990s, and recent earnings growth was driven largely by firing workers and cutting costs rather than selling more products to customers. Real recovery involves selling more goods and services and hiring more people, and neither of these has happened to a significant degree yet.
Our own fuzzy crystal ball shows a number of “brown shoots” of concern:
- A huge overhang of consumer debt ($10-15 TRILLION) that must be slowly paid down over many years through a painful deleveraging process.
- An unfolding crash in the commercial real estate market unlikely to bottom before late 2010.
- A potential double dip in the housing market in 2010 driven by high unemployment and the need to refinance millions of Option ARM and Alt-A mortgages that are deeply under water.
- Widespread deflation that is already occurring in the retail, housing, and commercial real estate sectors.
Our view is that we are experiencing a burst of growth that has been fueled by government spending. Imagine the economy is like a log in a fireplace. A dry log can burn by itself but a wet log (think debt) needs some fuel to get it to burn.
For the past 12 months, we have dumped a huge amount of fuel on that log in the form of government deficit spending and bailouts. The U.S. taxpayer (via “Cash for Clunkers” and “Homebuyer Credits”) is essentially paying people to spend money. Is anyone really shocked that the fire flared up a bit (a 60% increase in the stock market)?
But what happens now? In our view there are four “macroeconomic outcomes” for that old log:
- Global Economic Meltdown. The log quits burning and we give up trying to dump more fuel on it. This seems highly unlikely — if there is one thing we’ve learned over the past year it’s that the government is unlikely to stop trying things (anything) to get that log to burn … even if our kids have to pay for it for their entire working lifetimes.
- Japan. The log burns a little but mostly just smokes and smolders. The Japanese have been trying for twenty years to get that log to burn and it seems to be slowly starting to burn now because they gave it a long time to dry out while they dumped fuel on it regularly.
- That 70s Show. We keep pouring the fuel on that log and we overdo it … creating a rip-roaring flame that results in a surge of inflation (especially in commodities) like we had in the 1970s.
- Global Reflation. Under this scenario the government pours just the right amount of fuel on that log to get it to burn strongly and evenly without a flame up. Have you ever tried to burn a wet log in your fireplace? This is tough to do. Not impossible, but very, very tough.
How will American agriculture do under these potential future conditions? Agriculture and commodities are likely to do significantly better than most sectors of the U.S. economy in the coming years. There are several reasons why U.S. agriculture is well positioned:
- Supply. Despite recent great harvests, the carryover supply of most grains is still near historical lows. This means any spike in market demand can have a disproportionate impact on prices.
- Demand. There are BILLIONS of people entering the middle class around the world. The first thing they do when they get more disposable income is eat more protein, and protein production requires grain. In addition, the ethanol industry, which barely existed seven to eight years ago from an economic perspective, is now consuming nearly half the U.S. corn crop.
- Liquidity. The government is running huge deficits and injecting massive amounts of financial liquidity (fuel) into the system. Odds seem high that ag commodity inflation will be an outcome.
- Currencies. Grains, oil, and metals are all priced in dollars but utilized globally. As the dollar continues to decline compared to other currencies (the cost of running the dollar printing press) the price of all commodities priced in dollars will increase.
- Arbitrage. We convert corn into ethanol which can substitute for gasoline produced from oil. This creates a direct arbitrage between a barrel of oil and a bushel of corn that never existed before. If oil prices rise as in 2008, corn will follow.
We see very weak U.S. economic growth for several years with a distinct possibility of a double dip recession. The high unemployment and deleveraging of consumers will create mild food price deflation and weak domestic demand for high end food products (see high end beef) and variable channel strength (eating at McDonald’s vs. the steakhouse).
In the long term, we see strong global food demand, commodity inflation, and a weak dollar creating a very strong market demand for U.S. grains. This will be a bumpy, lumpy ride, but U.S. ag commodities are very well positioned for the future.