2016 was full of unexpected outcomes. One of the best surprises was the fed market’s rally during November and December. The run began in earnest following the election (more on that later). This column noted that, “…the market woke up in the back half of November and strung together three consecutive weeks of better trade: $108, $111, and $114, respectively.”
The market then treaded water for a few weeks in early December, chopping back down to $110-$111 per cwt. And at that point, analysts were questioning if the market was out of gas. But sellers hung tough and surged the market back to $115 just prior to Christmas. And the following week was better yet as fed trade hit $118 to close out the year.
All in all, fed cattle finished 2016 by adding about $20 since the low marked in mid-October. What caused the year-end rally?
First, the action has been underpinned by consistently better wholesale beef prices. The Choice cutout traded sub-$180 in mid-October as fed cattle were priced at $97-$98. However, since then, stronger wholesale action, along with increasing currentness, boosted weekly feedyard bargaining position. The Choice cutout weekly average ended the year at nearly $202 – the best level seen since mid-July.
Stronger prices are especially important considering 2016 volume. Packers have been aggressive buyers and feedyards have been willing sellers. That means bigger kills and more beef for the market to absorb along the way. So, despite ample beef supplies, the wholesale market has been able to get some positive traction during the past several months. That reality lifted prices for both fed and feeder cattle.
Second, the rally has also been fueled by favorable action at the CME. Live cattle futures have staged an impressive rally. That’s occurred across both the front end and the deferred contracts. Most important, the front-end December contract closed at $101.65 on the day prior to the election. Since that time, the contract’s up-versus-down tally was 24 to 13 days respectively, with the contract ultimately expiring at $119.
With that in mind, let’s step back and view the rally from a broader perspective. Strength in cattle, especially on the futures side, has corresponded with impressive gains in the stock market. Much of it has been driven by money flow and a renewed risk-on sentiment in the financial sector.
That sentiment is best explained by Steve Auth, CIO of Global Equities, Federated Investors, in a recent opinion piece titled, “Wall of Hope.” Auth, in a follow-up interview by Bloomberg Surveillance, was asked about the equity rally following the election. His explanation:
“We’ve been through an 18-month mini bear market going all the way back to May, 2015. We’ve now exited that…Usually markets climb walls of worry; right now, this market is climbing a wall of hope. And it’s unusual, because it’s happening against a context of a long period where we’ve been told we can’t grow, productivity is declining, we just keep carving up the pie and business is under attack. I think now we’re seeing something different now – there’s something in the air; you can see it in the confidence indicators, you can see it in the stock market.”
But how does that translate to the cattle market? Some background is necessary to understand the connection. Typically, when speaking of futures markets, we define commercial traders as entities that use futures to hedge their business activities – they have the need to either buy or sell the actual product (e.g. cattle) and futures serve as a market risk management tool. Meanwhile, non-commercial traders are commonly considered as speculators. The CFTC describes the difference this way:
“For example, a financial organization trading in financial futures may have a banking entity whose positions are classified as commercial and have a separate money-management entity whose positions are classified as non-commercial.”
That said, go back to Auth’s observations about what’s occurring in the financial world since the election. Traders are seemingly viewing the world more optimistically. Therefore, one would expect increased position taking.
That’s precisely what’s occurred. Financial firms are generally categorized as commercial traders for the equity index (a part of their regular business activities) while being categorized as non-commercial traders for live cattle (where they’d represent speculators). In both cases, there’s a clear risk-on, accumulation going on since the election.
To that end, Figure 1 represents relative change in long positions since the election for:
- Commercial traders in the S&P500 mini-contract – up nearly 150,000 contracts prior to late-December squaring of positions;
- Non-commercial traders in the live cattle contract – up nearly 50,000 contracts.
Meanwhile, there’s a pervasive improvement in confidence occurring among the broader population. The Consumer Sentiment Index jumped to 98 in December, versus October’s 87 and November’s 93.8 final reading. That’s especially important to economic growth – Auth explains that: “The middle syllable of an economy is ‘con’ – confidence – an economy doesn’t go anywhere without confidence.”
Better sentiment should prove to be a positive catalyst for beef demand going forward – that is, consumer expectations are more positive and that likely spells more active spending in coming months.
That’s all good news – and a welcome reprieve from much of 2016’s market woes. However, it should also be somewhat of a warning flag. The market has work ahead in 2017. For more explanation, see this week’s Industry At A Glance. Moreover, there remains lots of political uncertainty as the new administration takes office. Traders will be watching carefully and likely prove reactive, given the recent run, to any negative news.
So, given this surge of optimism, now may be a good time to make at least partial sales going forward. And with that in mind, it’s useful to reiterate a note from last month’s column: “The absence of a meaningful plan leaves decision-making susceptible to emotion, especially negative, non-constructive emotion…”
In summary, as always, objective analysis and meaningful information are critical to business success. More than ever, producers need to ensure they’re vigilant about understanding risk management of all kinds and establishing a pre-determined marketing plan. In combination, those are critical steps to ensuring successful decision making for the operation.