North America and the world economy in general will move into contraction phase during 2020. Negative economic data is starting to come out for the first couple of months of the year. Early estimates have Canadian and U.S. GDP contracting by two to four per cent in the first quarter and as much as eight to 15 per cent during the second quarter.
Last summer, the U.S. government bond market experienced negative yield curves. This was an early warning signal to be prepared for slower growth or even recession. Sometimes these indicators can be prophetic as the course of events tend to confirm past signals. I received many calls over the past month from feedlot operators, backgrounders and cow-calf producers. The common question is “What should we be doing?”
While I try to calm nerves and put things in perspective, the real answer is to prepare for the changes in the fundamentals moving forward. If we look back at the 2008 and 2009 recession it can provide some guidance for long term-planning by the cow-calf operator.
Stock market indicator
The stock market is a leading indicator. When the stock market drops sharply, corporate earnings decline and businesses eventually lay off workers. An increase in unemployment causes consumer spending to slow and in extreme circumstances, perpetuates economic contraction. People stop borrowing money or only borrow for absolute necessities. In some cases, people can’t pay their mortgage or rent, which results in foreclosures. People sell their homes and downsize or try to refinance. Approximately 60 per cent of Americans are on hourly wages. Many people will not be going back to work in the short term. Consumer confidence will decline and people reign in spending because of job uncertainty or loss of jobs.
The graph below shows the monthly live cattle futures from 2008 through to 2011. It also shows GDP (Gross Domestic Product), percentage change from the preceding period annual rate for each quarter. During the second quarter of 2008, GDP was -2.1 per cent and third quarter GDP was -8.4 per cent. Fourth quarter GDP was -4.4 per cent followed by 2009 first quarter GDP of -0.6 per cent. During the third quarter of 2008, GDP was -8.4 per cent and the Dow Jones dropped from 11,867 on August 1 2008 down to 9325 on September 30 2008. This is a 22 per cent decline. The bottom of the equity market was in March 2009 at 7600 when 2009 Q1 GDP was -0.6 per cent. The economy started to stabilize and investors started buying in anticipation of stronger growth.
The cattle market was on a downward trend from July of 2008 through to late December 2008. The market traded in a sideways range throughout 2009 once GDP stabilized and moved into positive territory. This tells us it could take another three to four months before the market stabilizes.
Red ink for feedlots
Currently, feedlot margins on both sides of the border are in severe red ink. Feeder cattle prices have lagged the fed cattle market but will eventually feel the brunt of the situation. In a recent issue, I mentioned that the U.S. semi-annual cattle inventory report had the 2019 calf crop down 250,000 head from 2018. Statistics Canada reported that the 2019 calf crop was down about 46,000 head from 2018.
The recession will cause the herd contraction to continue for another two years as the market functions to discourage production. Back in 2009, the contraction lasted until 2014 so I may be somewhat conservative. U.S. cow-calf producers tend to base their decision to expand or contract on the financial returns of the past year. The bright news is that after the contraction period ended, the cattle market started a four-year upward trend until 2015. We all remember the lows of 2009 and the highs of 2015.
Those of you who have been following my articles for a long time note that during the recession of 2009, I was advising cow-calf producers to expand. The key to long-term profitability is to do the opposite of the U.S. cattle producer. Many investors state that they don’t start buying until there is blood on the street. The same goes for the cow-calf producer. One has to look at five years down the road. Over the next couple years, the Canadian cow-calf producer needs to slowly expand their cow herd to be ready for the rally that comes afterward.