Q32020, Part 1

COVID-19 Staying Power


In this four-part series, excerpted from the 2020 Higby Barrett Quarterly Insights (October), contributor Alan Barrett breaks down the quarter’s pivotal market-shaping events, starting with the COVID-19 pandemic’s longer-than-expected global stomping, followed by analyses of Phase 1 of the U.S.-China trade deal, the connection between world ag acreage and Brazil’s continuing currency dive, and commodities investing as a hedging tool against inflation.

As the World Turns

In the short-term, the badly battered U.S. economy shrank at a record 32.9% annual pace in the second quarter of 2020. While it is the deepest recession in history, unlike with war, assets are in place to rebound if people return to previous spending habits.

Some spending habits will be permanently changed because the COVID-19 pandemic sped up existing trends in the marketplace, especially related to technology. People were not only forced to make investments necessary to work from home, cook at home, and shop online, some people will never go to an office again, which will impact energy and eventually automobile sales. Supply chain vendors have made investments to go truly paperless to avoid human contact. There is no reason to believe companies will revert to the old system. Offices and travel are relatively expensive items on a profit and loss statement, so it is hard to see a path forward where company budget committees do not resist resuming travel. For example, in the last week of July, itineraries purchased by corporations were down 97% from a year earlier, according to Coupa Software, a California-based, business-spending management firm. Industry insiders estimate approximately 15% of the business-travel market is lost forever because of technological substitutions. Also, the opportunity to take advantage of a recession to push standard office costs to the employees is highly likely, especially if the employees view working from home as a benefit.

COVID-19 put the existing trend of buying textiles on-line into hyperdrive. Retailers (True Religion Apparel, J. Crew, Neiman Marcus, Stage Stores [Bealls, Goody’s, Palais Royal, Peebles, Gordman’s, and Stage Parent], JCPenney, Lucky Brand, Brooks Brothers, Ascena Retail Group [Ann Taylor, LOFT, Lane Bryant, Lou & Grey, and Justice], Lord & Taylor, Stein Mart and Tailored Brands [Jos. A. Bank and Men’s Wearhouse]) have already filed for bankruptcy with three months remaining in 2020. Clothing stores are experimenting with stores in which customers try on outfits in front of a full-length mirror with technology that suggests other items to buy, to be delivered to the residence. The key is how to adjust to changing markets and turn a profit.

Global Supply Chain – Before and After

The other major impact from the trade war and COVID-19 is market players expanding and diversifying supply chains that will bring long-term damage to the U.S. and Chinese agricultural economies, while benefiting South America, Africa, and Asia. Market players are also more aware of the importance of better environmental controls and health standards. Implementing environmental and health standards is often an expensive fixed cost. To this end, the modernization of the animal industries achieves several policy goals for China and the world.

Market players that already developed new supply chains reducing dependency on any one country made a fortune. For example, Chinese companies that invested heavily in the Southeast Asia textile industry have done extremely well. Likewise, the investment in the African textile industry is encouraging cotton production at the expense of the U.S. growers and Chinese textile mills.

For this year and next, the world Gross Domestic Production (GDP) prospects have declined dramatically because of COVID-19. In April, the International Monetary Fund still had much of the Asia economic growth as positive. Currently, all regions’ 2020 GDP projections are negative except for China, at 1%. In2021, the growth rate for emerging market and developing economies is projected to strengthen to 5.9%, largely reflecting the rebound forecast for China (8.2%).

Many nations whose economies were hit hardest are wealthy countries and agricultural surplus countries. A declining dollar should help the U.S.’s competitiveness for agricultural exports, but Brazil (covered in detail in Part 3 of this series), Argentina and Ukrainian currencies have declined faster. COVID-19 is lowering domestic demand by restaurant owners. U.S. and European consumers spending less on food does not necessarily mean lower food consumption, but it is extremely painful for the food sector.

Major energy surplus countries are expected to have significant declines in food consumption. Because the Middle East is a significant net importer of food, any decline in consumption requires lower prices to clear the market.

Other Industry Concerns

COVID-19 has had a major impact on gasoline consumption, which has directly impacted ethanol consumption. Brazil and the U.S. have massive ethanol industries, but Brazil’s primary feedstock is sugarcane, while the U.S.’s primary feedstock is corn. It is believed that once the economy is reopened after shelter-in-place restrictions are lifted across the U.S., ethanol corn consumption will return. One long-term unknown is the number of people who continue working from home.

The agricultural industry is still learning the impacts of a global pandemic. In the U.S. and other wealthier nations, some of the lost income will be covered by government payments, but many farmers and ranchers will go bankrupt. Higby Barrett assumes the farmland will change hands but remain in production.

Nowhere has the impact been felt more harshly than in the livestock industries. The cattle herd had already begun to contract as part of the typical five-year cycle. The closing of packing plants created a shortage of meat at the retail counter and a glut of meat waiting to be processed. The end results were record packer margins with lower volumes of retail meat, record high retail meat prices, dairy cow herd reduction, a feeder pig crop being aborted, chicks being euthanized, and cattle being left on grass to slow weight gain. That being stated, by and large the breeding stock numbers have not been reduced significantly, which means animal numbers can rebound quickly.

Most of the grain and soybean meal is consumed by integrated hog and poultry industries that control production from eggs or feeder pigs to packing plant. Owning the packing plant offsets some of the loss on the animal side of the equation. By 2021 and beyond, it is assumed the larger integrated animal operations will offset the decline in smaller operations, and feed ingredient consumption will increase. With the breeding stock still intact, animal numbers are expected to quickly bounce back and expand. Some of the 2020/21 marketing year impact from COVID-19 is being offset by the Chinese government aggressively expanding its hog and poultry operations, which ensures strong corn and soybean meal consumption expansion.

Next, Part 2: The U.S.-China Trade WarꟷMore Than Just a Phase?