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Friday, April 18, 2014

Friday, April 18, 2014 - Yes, We Have No Avocados

Financial Review with Sinclair Noe


The markets are closed today in observance of Good Friday.

No economic reports today.

Let’s take a look at next week’s economic calendar. On Wednesday, we’ll get reports on new and existing home sales. New home sales are expected to be up slightly, while existing home sales are expected to post a decline for the third consecutive month. Higher mortgage rates and rising prices have pushed some potential buyers out of the market. The average rate on a 30-year fixed mortgage is up almost a full percentage point from its recent low one year ago.

The softness in home prices in the first quarter has also hurt homeowners struggling with negative equity. The pool of underwater borrowers peaked at 12.8 million, or 29% of all properties with a mortgage, in the second quarter of 2012. Rising prices have lifted millions back above water. As of the first quarter of this year, some 9.1 million homes (or 17% of homes with mortgages) were "seriously" underwater, owing at least 25% more than property's estimated market value.

Next Friday, we’ll see the Consumer sentiment index, which has been showing a lack of enthusiasm reflecting the weak pace of hiring and meager pay raises for most households, which in turn results in sluggish consumer spending.

Thursday, we’ll get a report on durable goods orders. If economic growth is finding traction, you would expect to see businesses spending more on equipment, which should show up in the nondefense goods excluding aircraft, subcategory of the durable goods report. If businesses are seeing an increase in demand for their products, they would be expected to ramp up production. You can’t boost profits forever by just cutting costs.

Earnings season kicks into high gear next week. Apple, Microsoft, AT&T, McDonald’s, Netflix, and Facebook all report next week. S&P 500 companies' first-quarter earnings are projected to have increased 1.7% from a year ago. The forecast is down sharply from the start of the year, when profit growth was estimated at 6.5%, but has climbed from a low of 0.6% reached on Wednesday.

Yesterday, an international deal was announced in Geneva to defuse the East-West crisis in Ukraine; the pro-Russian separatists occupying buildings in Eastern Ukraine apparently didn’t get the memo. Leaders of gunmen who have taken over city halls and other sites in and around Donetsk this month in pursuit of demands for a Crimea-style referendum on union with Russia, rejected the agreement struck in Geneva.

Moscow renewed its insistence that it has no control over the "little green men" who, as before Russia annexed Crimea last month, appeared in combat gear and with automatic weapons to seize public buildings - a denial that Western allies of those who overthrew the pro-Russian president in Kiev do not accept. The White House renewed President Barack Obama's demands that the Kremlin use what Washington believes is its influence over the separatists to get them to vacate the premises. It warned of heavier economic sanctions than those already imposed over Crimea if Moscow failed to uphold the Geneva deal.

There’s no question the US can inflict great financial damage on the Russian economy, and there are indications that the Russian economy is already experiencing the early stages of a recession, but all is fair in love and war. And Russia can fight back with more than just restricting nat gas exports.  Russia's cyber-warfare experts are among the best, and they have already attacked – trial runs if you will – even though that information wasn’t really mainstream news. And the US is vulnerable, mainly because we are so dependent on technology.

So, let’s take a look at what’s on the menu for the holiday weekend. Higher prices, at least for food.

Almost everything you eat is costing more, or will. The US Department of Agriculture had been projecting about a 3% rise in the price of fresh fruits and vegetables this year; they will have to revise higher. The CRB Food Index takes a look at commodity prices for a range of foods; that index is up 20% since the start of the year. And it will likely get worse.

California has suffered a double hit: very little rain in the lowlands and a lack of snow in the mountains in the north and east. Snowmelt provides water for many of the state's farmers during the growing season and for the huge population centers in the south. Snow this year was only about 30% of the historical average. Now, the snow is melting, and in some streams and rivers there is so little water that wildlife crews have had to truck stranded salmon downstream so they could make it out to sea. This likely means some waterways will dry out this summer.

And while the West has been dry, the Midwest and Northeast had one of the harshest winters in more than 3 decades. So far this year, corn and soybean futures prices have increased 15%, and wheat prices are up 20%. Last year, high prices for corn saw farmers respond by planting the most acreage in 70 years, which in turn pushed prices down by about 40%. The USDA says farmers will plant just a little less corn this year and just a little more soybeans. Market conditions favor less corn, so other crops picked up acres from corn.

As always, the growing season is subject to weather, and the past 4 years have not been normal; either too dry or too wet to be ideal. Some farmers are expecting a return to normal, or at least hoping. And even if crop harvests are abundant, prices will be underpinned by exports. Of course, the weather might not be normal.

We seem to be undergoing a change in climate that resulted in Vermont posting its coldest month of March ever; while nearly two-thirds of the Great Lakes remained frozen by early April, impacting commercial shipping; the Northwest and Northern Rockies were wet – too wet, resulting in a fatal landslide in Washington state; and California and Arizona had a record warm start to the year, with temperatures in the first 3 months of the year more than 5 degrees above average. If you are looking for normal weather, that doesn’t seem to be the direction.

After a drought in 2012, farmers slaughtered huge numbers of cattle and hogs as feed costs soared. All that extra meat on the market helped keep a lid on prices in 2013, and now, the US cattle herd is at a 63-year low. If you are considering ham for your Easter dinner, hog prices are at a 7 year low, but it won’t last long. The smaller supply of animals ready for slaughter plus the expectation of higher feed costs have sent prices soaring.

Meanwhile, the California drought will likely result in higher prices for many fruits and vegetables. Professor Timothy Richards at Arizona State University recently published research on which crops will likely be most affected and what the price boosts might be. He estimates the following possible price increases due to the drought:

• Avocados likely to go up 17 to 35 cents to as much as $1.60 each.
• Berries likely to rise 21 to 43 cents to as much as $3.46 per clamshell container.
• Broccoli likely to go up 20 to 40 cents to a possible $2.18 per pound.
• Grapes likely to rise 26 to 50 cents to a possible $2.93 per pound.
• Lettuce likely to rise 31 to 62 cents to as much as $2.44 per head.
• Packaged salad likely to go up 17 to 34 cents to a possible $3.03 per bag.
• Peppers likely to go up 18 to 35 cents to a possible $2.48 per pound.
• Tomatoes likely to rise 22 to 45 cents to a possible $2.84 per pound.

Industry estimates range from a half-million to 1 million acres of agricultural land likely to be affected by the current California drought, and between 10 and 20% of the supply of certain crops could be lost.

Just as farmers in the Midwest can shift acreage from corn to soybeans, we will shift our sources for food. When prices increase, farmers outside of California, including foreign suppliers, will be incentivized to ship more crops to the US. That will in turn put downward pressure on costs. But with water-supply problems expected to persist for years, California farmers will have some difficult choices to make. They’ll need to determine which crops should receive the limited amount of available water, and which should be allowed to fall away. The long term consequences for California agriculture could be profound.

The cost of growing food accounts for only about 15 cents of every $1 we spend on it. The rest goes to processing, packaging, marketing and transportation. Most US consumers are in a position to cope by spending less on other goods or switching to other types of food. In other words, going to fewer movies or purchasing less beef and more chicken, the price of which has risen much less than beef this year. However, nearly 47 million Americans rely on food stamps, or SNAP – the Supplemental Nutrition Assistance Program, and as food prices go higher the number of enrollees is likely to climb. And even with food stamps, many families will find it difficult to provide sufficient nutrition.

Keep in mind the US enjoys the world’s cheapest food prices. There are even more significant implications for poorer countries, where consumers devote a far larger share of personal income to food. Remember the Arab Spring uprisings started a few years ago with food shortages and rising prices. Food shortages also figure in the unrest in Venezuela. The US is the world's biggest food exporter by a wide margin; whatever happens to domestic prices won't be confined to our shores.