Sort & Cull

If you've been lucky enough to travel along the long road of life with folks who like to laugh, chances are your worn set of luggage includes a stuffed satchel full of old jokes, all of which might not need telling in mixed company. But instead of being mercifully euthanized on the far side of the barn, these old and mangy firehorses somehow keep getting harnessed to answer the dubious bell of illustration.

Here's a sad, politically incorrect plug that might even be shipped to the glue factory by Donald Trump himself:

A man is jarred from deep sleep by a ringing phone in the middle of the night. It's tragic news. His mother-in-law has died in a bizarre accident while cruising in the Caribbean. Perhaps over served and lost in the Calypso beat, the poor woman somehow plunged headlong from the Lido Deck and never regained consciousness.

After waiting a few moments for the shocking news to sink in, the ship's captain gently asked what they should do with the body.

"We could bury her at sea, have her interred on the next island, or arrange for cremation."

Suddenly, the long-suffering son-in-law recognized the seriousness of the situation. "Let's take no chances," he said, wiping away tears, "Do all three."

All such inappropriate groaners involving mother-in-laws, little morons, and pollocks (not to mention a host of more offensive foils) should probably be burned in the name of world betterment. Yet I'm still old school enough to think that some of the crustiest of stories can redeem themselves by casting humorous light on matters of perplexing sobriety.

Take for example the similarity between this son-in-law's extreme caution and the crazy pessimism currently reflected in fourth quarter live cattle futures (even after Tuesday's reversal). I would argue that both situations represent unreasonable overkill with only the latter worth further discussion.

Since 2001, the 5-area steer average for the fourth quarter has failed to exceed the previous quarter's average only three years (i.e., 2001, 2008, and 2015). Yet bearish traders currently believe that late year cash will defy the historical odds and fall substantially below the late summer market.

On average (i.e., in 12 of the last 15 years), Oct-Dec feedlot sales exceed third quarter biz by roughly 6%. This rather pronounced bias is not difficult to understand. Not only do fourth quarter showlists tend to be more manageable thanks to seasonally light placements through the summer months, late-year beef demand typically recovers nicely from the lackluster retail buying of late summer and early fall.

Yet, given the large discounts currently traded at the CME, few cattle traders feel like betting on market history this year. Indeed, many seem to have no more use for late-year price prospects than a nosey, nagging in-law. When it comes to disposing of the body, six feet under may not be deep enough.

With the third quarter two-thirds spent, the 5-area steer average is running close to $117. Even if we assume the country trade continues to badly stumble through the month of September (say, losing $2 per week), the quarterly average stands to be no less than $113.60. In a normal year (whatever that is), such a Jul-Sep performance would set the stage for a fourth quarter average of approximately $120.50.

So why are the board's grave-diggers prepared to plant the late-year corpse as deep as $107 to $108?

Maybe some of this extreme caution is tied to fears of slaughter hog numbers potentially exceeding packer capacity. Perhaps part of the panicky anticipation is fueled by slumping corn prices and the possibility of surging carcass weights.

Yet, I'm tempted to point an accusatory finger at something more irrational, an oppressive psychology that dates backs to the backbreaking third quarter of 2015.

Though many have understandably tried to erase this black hole from their memory, the cliff-diving tragedy of late summer 2015 forever scarred the cattle market. With feedlot sales imploding nearly $35 in less than two months, it was a record-setting train wreck that literally came out of the blue (i.e., not prompted by a surge in supplies, a collapse in outside markets, widely recognized smoking gun/black swan).

Yes, that was the moment your wife's mother fell over the railing, the radical shift in psychology and assumptions (linked to culminating interest in herd expansion) that seriously changed the long-term marketscape. For the next four quarters, fed cattle prices fell sharply from year ago levels: Oct-Dec 2015, off 17%; Jan-Mar 2016, off 17%; April-June 2016, off 19%; Jul-Sep, off 21% (estimated).

How much longer will the market's rearguard sprint continue? Judging by current board discounts stretching far into 2017, the CME expects the mysterious death spiral (i.e., with declining prices remaining 15% to 20% below the previous year) to endure for another four quarters.

Until something works to meaningfully disrupt this brutal momentum, scatter charts predicting the impact of changes in per capita meat supplies on live cattle prices will be about as helpful as a vegetarian at a steak fry.

One of these days, the old cemetery standard of "six feet under" will be good enough for tired traders to put down their shovels and start thinking about laying sod. But we're not there yet, and risk managers should plan accordingly.

For more from John Harrington see www.feelofthemarket.com

(CZ)

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