The Inflation Cycle of 2002 to 2015 - Uhlmann Price Securities

Industrial Portfolio Strategy
The Inflation Cycle of 2002 to 2015 ⎯ April 19, 2002 -14- Legg Mason Wood Walker, Inc.
open to the improving conditions. The actual trend for real U.S. agricultural exports was 2.7% growth (PPI
index year 2000) from 1962 to 1996, and we see real growth of only 2.4% from 1996 to 2015E, or from
$64.3 billion of real U.S. agricultural exports in 1996 ($52.3 billion in current, 2001 dollars) to $100 billion
in 2015. U.S. agricultural exports have been volatile, with inflation-adjusted U.S. agricultural exports rising
from $27 billion in 1969 to a peak of $67.2 billion in 1980, but then plunging to $32.4 billion in 1986. Exports
then climbed to a peak of $64.3 billion in 1996, on the strength of developing country demand and
weather-related supply disruptions, but fell to $50.8 billion in 2000 before beginning a gradual recovery.
Generally speaking, we see higher commodity prices, a weaker U.S. dollar, and improved emerging
market economies, all of which support export prospects for U.S. farmers, in our view. The diminution
of European Union (EU) and Former Soviet Union (FSU) grain and meat import markets, which had been
the “story” of the 1970s and 1980s but burst in the 1990s, is key. While the EU and FSU have contracted,
the “new” markets in the Atlantic, Pacific and Middle East have continued to expand, which we believe is
key to U.S. export prospects. A weaker U.S. dollar cycle also would assist U.S. farm exports, since U.S. agricultural
exports fell 14.1% from 1995 to 2000, as the U.S. farm trade-weighted dollar rose 18.9% in that
period. Since the U.S. farmer competes with currencies that may appreciate along with commodity prices (e.
g., those of Canada, Australia, and the FSU), as well as against the low-priced European euro, the stage may
be set for stronger U.S. agricultural exports in the coming decade. The U.S. Department of Agriculture
(USDA) estimates agricultural exports of $54.5 billion in 2002, up 10.8% from the trough of $49.2 billion
in 1998, which we see as the beginning of a long-term recovery for various reasons outlined later in this report.
As a result, we expect DE stock to outperform the S&P 500 more frequently in the period from 2002
to 2015.
Although conditions have been less rosy for Deere in terms of U.S. agricultural trade since 1981, a favorable
side effect has been farm machinery industry capacity rationalization. As total U.S. row crop
tractor plus combine harvester unit sales fell from 94,700 units in 1979 to 23,482 units in 2001, the farm
machinery industry consolidated to a handful of global players. Also, the number of U.S. farms fell 10.9%
from 1979 to 2001, and U.S. planted acreage fell 7.9%. Were it not for farm subsidies, capacity would have
been reduced further, but we note that Deere targets larger, more profitable farms that tend to purchase and
turn over equipment fleets more frequently. We discuss the farm outlook in greater detail later in this report.
We view Joy Global (JOYG) as the quintessential coal play; seeking to participate in those cycles, we
upgraded our rating on JOYG stock from Market Performance to Buy. We view JOYG stock as a
prime beneficiary of the recovery of the worldwide coal, copper, and steel (via iron ore) prices, as well as
the recent strength in gold mining, since the company is a dominant niche producer of electric shovels and
underground coal mining machines. Having emerged from bankruptcy on July 12, 2001, with greatly reduced
debt, Joy Global (formerly known as Harnischfeger Inc.) has been buffeted by an unusually warm
winter that depressed electric utility output, and thus coal mining, since approximately 90% of U.S. coal is
used to provide electricity, and utilities have accumulated coal inventory left over from the mild winter. We
note, however, that coal inventory at electricity producers as a percentage of trailing 5-year average annual
usage was 13.9% in 2001, versus 11.1% in 2000, but still below the 10-year average of 14.6%. In addition,
electricity utility industrial production has begun to recover from the recession. Weak housing, auto and
electronics markets also have depressed the copper and steel (iron ore) markets to which Joy Global sells,
but those markets appear to be resilient and, as we said, we do not wish to fight the Fed anymore with respect
to those early cycle groups, at least for the time being. Given that Joy’s wagon is tied to coal, in Exhibit
7 we show that coal has provided 52% of growing U.S. electric power for the past 80 years with an an-