Sunday, March 20

Week 246 - Corn Belt Prosperity: Is It Gone?

Situation: The farming counties of the Corn Belt are in a recession due to the collapse in corn price per bushel, but the US economy is still growing. “In the past 50 years, every recession has seen the number of jobs in the economy decline by at least 1%. And jobs have never declined by that much outside of a recession. Today, the number of jobs in the U.S. has been growing briskly—up 292,000 in December and up 2.7 million over the past year. This is why many economists remain confident the U.S. can avoid recession.” That quotation from the Wall Street Journal summarizes the way we measure growth vs. contraction in the economy but jobs are a “lagging” indicator. The country is already on the brink of recession because of the “knock-on” effects of slow growth and high indebtedness in emerging market countries, mainly China. Their plight is made worse by our Federal Reserve’s policy of raising interest rates. The “capital flight” that has been happening in emerging market countries simply gets accelerated as the dollar gets stronger and as interest rates move higher. In other words, investors are pulling money out of emerging markets but those are the very markets where real growth is happening. A third of the revenue for S&P 500 Index companies comes from those countries. Earnings for the S&P 500 Index will fall as those countries head into recessions, triggered in part by our strong dollar. News Flash: almost all of the 45 major stock markets around the world are currently in a Bear Market.

Mission: Drill down on the Corn Belt centered in Illinois, Iowa, southern Minnesota and the eastern half of Nebraska, where 57% of US production occurs. That’s also where almost half of US ethanol plants are located. Cropland in those states has been falling steadily in price/acre for 3 years, and 2015 showed no hint of relief. The average price per acre in those 4 states in 2015 was $6418, which is 2.9% lower than in 2014. For Iowa, where 2015 values were $8200 per acre, prices were down 6.3%. But farm incomes have fallen 55% in the past two years, so it is only a matter of time before cropland values start to reflect that loss in productivity. 

Execution: Let’s see how large AgriBusiness companies based in North America are doing, specifically those that meet our quality standards: Monsanto (MON), Potash (POT), DuPont (DD), Dow Chemical (DOW) and Deere (DE). Looking at this week’s Table, we see that they mirror what’s happening to commodity producers everywhere, namely, too much supply is being generated just when demand is collapsing for a variety of reasons. 

Administration: What you can do, as an investor, is to remember that this is a very rewarding group of 5 stocks to own over 2-3 market cycles (see Column C in the Table). Mostly, you need to avoid taking action. Don’t go out and buy cropland, don’t sell any of these stocks that you already hold, and keep dollar-averaging into those that you do own long-term. The thing about commodity markets is that during bear markets producers either fail or barely survive. Production eventually falls enough that remaining companies have to struggle to catch up with demand (demand that is no longer being satisfied). It will not be difficult to ramp up operations at that point because stocks (and bonds) issued by commodity producers will be snapped up by investors. However, these capital expenditures won’t take effect for a while because so much investment has to be directed at replacing fixed assets and skilled labor lost during the downturn. But production eventually catches up to (and then exceeds) demand. That is why these are called long-cycle investments. Boom-bust-boom turnarounds typically span two or three stock market cycles.

Bottom Line: This commodity supercycle is finished. Most estimates show that global commodity-related production is approximately 150% of demand. Farm commodities are no different. Those produced in the US have to be marketed at too high a price in foreign countries, because of the “strong” dollar. That means farmers in Brazil, Argentina, the Ukraine, Australia and Canada have a competitive advantage over US farmers. The US-based AgriBusiness companies that have worldwide operations will recover faster than US farmers but a difficult decade lies ahead. In rural counties of the Corn Belt, prosperity is unlikely to recover soon.

Risk Rating: 8 (on a scale where gold-related investments are 10 and inflation-protected US Savings Bonds are 1).

Full Disclosure: I dollar-average into MON, and own stock in DD, ADM, and DE.

NOTE: Metrics in the Table are current for the Sunday of publication; metrics highlighted in red denote underperformance vs. VBINX, our key benchmark. Total Returns in Column C of the Table date to 9/1/2000 because that marks the peak of the S&P 500 Index before the “” recession. There have been two peaks since, in 2007 and 2015, so we’re entering the third market cycle since 2000.

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