Yogi Berra should have been a market analyst. One of my favorite Berra “isms” goes like this: “In theory there is no difference between theory and practice. In practice there is.” No one ever said markets always make sense. That’s been especially true in recent months with all of the various macro-factors surrounding the market. It’s also an unfortunate reality and what can make trading so incredibly frustrating at times (and also exceedingly interesting!).
November’s opening cash trade reinforced Mr. Berra’s observation about the real-word disconnect between theory and practice. The first day of the month saw a $4 swing over at the CME. The December contract was drifting its way lower in the overnight trade and ultimately touched $117.60. However, following the morning break the contract surged limit up ($3 from the previous days close) to close at $121.60. And follow-through over the next several days pulled the contract all the way up to $125+.
Much of that action was driven by sharply higher trade being facilitated out in the country. Feeders and packers were unusually busy at week’s outset, agreeing to trade at $119 on Monday (Oct 31) with some follow-through on early Tuesday morning (Nov 1). But then, all of a sudden, higher prices broke out as cattle traded at $123 just hours later. That jump was partially driven by news that Japan will begin to accept cattle up to 30 months of age (from the current 20-month upper threshold). That’s good news but certainly doesn’t change the near-term dynamics – most notably, the cutout hasn’t provided any additional buffer for higher prices so the packer takes yet another hit from a weekly margin perspective.
The market will likely chop its way through Thanksgiving. However, it won’t be long before the market begins to really sort out the spring 2012 outlook: where will the fed market find its highs? Traders will be looking for strong cues from November’s WASDE report and potential inferences surrounding relaxation of the Japanese age requirements for U.S. beef imports (not to mention fundamentals surrounding the corn market). Current dynamics are very favorable and some analysts have ratcheted up spring high estimates as high as $135. Remember, though, packer margins are deeply negative and higher prices will mandate a massive move upwards in the cutout.
With that segue, let’s turn to some perspective I provided last month on the widening Choice-Select spread. There wasn’t room to include Wal-Mart’s influence on that particular dynamic – namely, the company’s new retail beef strategy built around attracting customers with more disposable income. To understand that better, though, it’s helpful to provide some framework from discussion included in the Monthly Market Profile back in 2003 (overwhelmingly, that column conjured up more reader feedback than any other single topic I’ve covered over the years with the exception of GIPSA):
…the production sector is increasingly recognizing the importance of the retail marketing sector and the interrelated nature of all components within the beef complex. The most convincing empirical evidence of that connectedness: Wal-Mart. Food industry consultant Glen Terbeek (Agentry Agenda, c. 1999) argues that productivity of alternative food-retailing formats (versus traditional grocery stores) is more efficient because it allows companies, such as Wal-Mart, to feature top-performing items in a supermarket category and reduce prices in response to the selected items’ turnover efficiencies. Lower prices attract customers, build store loyalty among consumers, and ultimately stimulate traffic within the store’s higher-margin departments, thereby increasing overall store yield. Wal-Mart’s business strategy according to Terbeek: “Instead of viewing top-performing categories as ‘stand-alone business units’ the alternative formats make them part of the store’s overall marketing strategy…the yield approach, allowing low prices on certain items (usually core items) to create a price image and to generate traffic, and then make up profits (and return on equity and overall space) with high-margin items.”…The retail food industry is changing and becoming increasingly competitive…Those changes equate to the value chain becoming increasingly interrelated and dynamic. In response, the beef industry will adapt to maintain viability. Most importantly, issues surrounding market transparency, price discovery and bargaining disparity become increasingly complex…
Now let’s put that into context of the current business environment. Wal-Mart’s annual revenue has been $405.9B, $408.6B and $421.8B in 2008, 2009 and 2010, respectively. That represents relatively flat year-over-year sales growth (zero and 3% in ’09 and ’10, respectively). That’s not surprising; the company’s customer base is busy making ends meet while deleveraging their personal balance sheets – there’s little room for discretionary spending.
Contrast that scenario to the upper tier of the consumer market; discretionary spending took a huge hit in the hear t of the financial crisis but has dramatically recovered from the bottom. The outcome of that reality is represented in the graph below which depicts Wal-Mart’s relative market value versus the SPDR Consumer Discretionary ETF (ticker: XLY) since 2000. Highend consumers are faring much better than those with little disposable income. The graph underscores last month’s discussion about “a tale of two consumers.”
Topline growth is essential to growing shareholder value. How does the company do that? It works around a proven strategy – store yield. But now Wal-Mart is targeting the higherend consumer via Choice beef products (and other high-end food offerings).
That clearly has huge implications for the beef industry going forward. First, Wal-Mart isn’t going to bail on the strategy right away – the company will give it adequate time to ascertain the effectiveness of the plan. Therefore, the spread isn’t likely to substantially reverse in the coming weeks or months. Second, it leaves Select product having to compete with pork and poultry on a price basis in the meat case. And as noted last month, that’s an uphill battle – “…especially challenging amidst current and ongoing consumer woes.”
Theory and practice – always a balancing act. Stay posted!