Will 2023 bring a recessionary hurricane or just a mild drizzle? … one sector that will outperform either way … specific ways to invest
Yesterday, Fed Chairman Jerome Powell said “I do continue to believe there’s a path to a soft landing.”At the same time, forecasts for a 2023 recession are growing more widespread.As to the severity of that recession, the predictions are all across the board.On Tuesday, Bank of America’s CEO, Brian Moynihan said he’s expecting a “mild recession” next year. He even took a jab at JPMorgan CEO Jamie Dimon.Several months ago, Dimon said he saw a “hurricane” out on the economic horizon. In Moynihan’s comments this week, he added “hurricane season is now closed.”On the other hand, there’s hedge fund manager Michael Burry, famous for his prediction of the 2008 housing crash, dramatized in the movie “The Big Short.”He’s calling for a massive, multi-year recession. In preparing for what he sees as vast economic and investment pain, Burry recently tweeted “You have no idea how short I am.”If we dig deeper, Burry fears that consumers are on the edge of exhausting their savings, which will swiftly crush consumer spending, kneecap corporate profits, and ignite a lengthy recession.In short, he fears the economic consequences of massive “demand destruction.”These different visions of 2023 leave us with a question…Is there a way we can invest today that positions our portfolio to do well regardless of whether a 2023 recession is mild or massive? Or even if that recession doesn’t materialize and Powell is successful in his soft-landing attempts?Earlier this week, our macro specialist Eric Fry threw his two cents into the mix. Here’s his top-line:
The “demand-destruction” story has inflicted so much stock-price damage in some sectors that excellent buying opportunities are presenting themselves.
Today, let’s look at one such opportunity. Whatever economic conditions we find ourselves in next year, this corner of the market is poised to treat your portfolio very well.
Demand destruction can only beat down this sector so far…
For newer Digest readers, Eric is our global macro specialist and the editor behind Investment Report. As a macro investor, he evaluates markets and asset classes from a big-picture perspective to identify attractive opportunities.Once a macro trend is in his crosshairs, he digs down to find the right, specific investment to play the opportunity.It’s been a powerful strategy. In his decades in the business, Eric has dug up more than 40 different 1,000%+ gaining investments – that’s more than anyone we know of in the newsletter industry.Returning to today’s opportunity, here’s Eric to set the stage:
To cut straight to the point, I am bullish on the fertilizer industry in general…Even if a recession causes consumers to cut back on [various discretionary items], it does not follow that farmers will cut back on crop nutrients – aka fertilizers.Nevertheless, the demand-destruction storyline is causing widespread stock-price destruction, especially in natural resources sectors like metals mining and fertilizer production.
To unpack this, let’s begin with the supply/demand/price situation in the fertilizer sector. It has grown complicated over the last year.Eric points out how fertilizer prices spiked last spring because of Western sanctions against both Belarus and Russia. Combined, these countries produce about 30% of the world’s potash supply and about 20% of all fertilizer exports.So, when this massive percentage of the world’s fertilizer supply disappeared from the global market, prices exploded. Since then, however, prices have begun to normalize.This has resulted in fertilizer prices that are up substantially relative to their long-term averages, but down noticeably from recent highs.We can get a better feel for this by looking at the Fertilizers Price Index.Below, we analyze it over the last five years. Notice the price stability from 2018 through early 2021 – that was around the level of 80.But in the back half of 2021, prices began to spike, peaking at nearly 255 in April of 2022.
Also, notice how prices have begun the normalization process Eric referenced.With this context, back to Eric:
Instead of focusing on these historically high fertilizer prices, many investors seem to be fretting about the recent price drops. But it’s unlikely that fertilizer prices will continue tumbling from their peak…The sanctions against Belarus and Russia remain in place, which should put a floor under prices.As farmers acclimate themselves to the “new normal” and resume buying, fertilizer prices should stabilize, if not move higher once again.
But as wise investors do, Eric tries to poke holes in his own investment thesis…
What about demand destruction from these higher-than-average prices?
Sure, prices are down from their emotion-based peaks, but they’re still higher than long-term averages.Won’t these higher prices hurt demand? Especially if we’re headed into a global recession next year?Back to Eric:
Relative to their five-year average prices…– Wheat is 37% higher…– Corn is 48% higher…– Sugar is 29% higher…– And soybeans are 29% higher.
Because the prices for these crops are well above their five-year average levels, farmers have ample incentive to “pay up” for the nutrients they need to maximize their crop yields.On the other side of the equation, the current phosphate and potash prices are high enough for well-positioned companies to produce sizeable profits.Looking down the road, most fertilizer industry observers anticipate strong long-term demand for all crop nutrients, especially phosphate and potash.
The built-in tailwind of investing in fertilizer
If 2023 is to bring a recession, we want to align our wealth with a product for which demand can only decline so much.That’s what we have with fertilizer. As Eric writes, “the relentless need to feed a hungry planet will power these demand trends.”Keep in mind, this isn’t an area where farmers can skimp. If they neglect fertilizer, it doesn’t just impact one year’s worth of harvest. It can have a damaging impact on the quality of the soil itself, which endangers years of future harvests.Here’s Eric with more details:
Many crops remove large amounts of potassium from the soil. For example, harvesting an average crop of…– Alfalfa removes about 450 pounds of potassium per acre…– Potatoes removes about 500 pounds of potassium per acre…– Tomatoes removes about 500 pounds of potassium per acre…– And sugarcane removes about 350 pounds of potassium per acre.Therefore, in order to maintain the viability of their fields, farmers must replace at least some of the lost potassium.
So, how can you invest?
The three largest fertilizer companies in the world are: Nutrien (NTR), Wesfarmers (WES.AX), and CF Industries (CF).A few notes…Nutrien’s current price-to-earnings ratio (P/E) is only 6.4. For context, its five-year average P/E is 46.8. It also offers a forward dividend yield of 2.35% at today’s price.Wesfarmers P/E is much higher, coming in at 21.7 though that’s still below its five-year average of 25.2. Its forward dividend yield is even nicer – 3.86%.Finally, CF Industries, like Nutrien, also has a rock-bottom P/E – 6.9. Its five-year average P/E is 22.3. It’s paying investors a 1.5% dividend yield going forward.Eric recently added his own fertilizer stock pick to his Investment Report portfolio. Here’s how he describes it:
I’ve spent considerable time looking into the trends and opportunities, and I recently rang the “buy” bell on a company that I think is in a good spot to profit.Based on current prices, it is trading for less than five times next year’s expected earnings. Fertilizer itself may not be cheap, but that’s definitely a discounted stock price.
Wrapping up, next year could bring a recession – or not. But the good thing about investing in a top-tier fertilizer company is that there’s a huge demand tailwind either way, which bodes well for the safety of your investment capital.Here Eric with the final word:
The outlook for fertilizer demand, both near-term and long-term, supports a bullish outlook for fertilizer pricing… and that bodes well for companies.Time looking into this opportunity would be time well spent.
Have a good evening,Jeff Remsburg
