The Three Horsemen of the Grapepocalypse, Part 2: The Coming Recession
Three weeks ago, I posted my first installment of this series about the coming Grapepocalypse, which discussed the effects of the changing grape market cycle. I promised some more doom and gloom, but it took me a bit to get this article out. Unfortunately, both of my young children fell ill and in the 4th incident in 15 months of PG&E equipment failure on my homestead, my computer was fried, among other damage done.
So, I apologize for the delay.
Of course, there is no better way to cheer up after a utility company nearly burns down your house (again), like talking about an imminent recession! So, pop your Prozac and let’s talk some doom and gloom! In this post, I’ll explain why I think a recession is coming; deliberate when it will come; weigh how bad it will be; and give some guidance on how it will affect the wine industry.
I am not an economist. The macroeconomic “analysis” in this post is based on information gathered from asking questions, listening and reading. It is far from comprehensive, but will nonetheless likely cause a temporary increase in your wine consumption. And, if you have useful feedback, critique or correction, please do weigh in by e-mailing, calling or even tweeting.
One warning: this is a long post. If you’re not interested in all the details, you may want to skim it until you get to the denouement: analysis of the coming recession’s effect on the wine industry.
Why Do I Believe a Recession is Coming?
You would have to be living under a giant piece of rock candy to not have noticed that everyone is talking about the coming recession. I’m just glad to have a moment where my typically gloomy perspective fits right into the Zeitgeist and I’m no longer viewed as Eeyore with a graphing calculator. In light of this conventional wisdom, I will try – but likely fail – to not spend too much time explaining the warning signs.
The Bull Market is Getting Old
As of November 6, 2018, the bull market was 3,529 days old. Though we had a recent correction, it was less than 20%. Since I first started writing this, we’ve had another correction, but technically, at least, the bull market continues to charge on. Just judging from history, we can assume that the bull market is likely to end soon. According to the Financial Industry Regulatory Authority, the only time we had a longer run-up was from October 1987 to March 2000. It is, by definition, nearly unprecedented to be in the second-longest bull market and my layman’s assumption is that the markets could crash at any moment.
Securities are Getting Frothy
Another cause for concern are today’s high P/E10 ratios. Nobel laureate economist Robert Shiller is well-known for devising useful metrics for measuring markets. P/E10 stands for Price / Equity 10-year and is the price of equities, divided by the annual average earnings over the past decade. Shiller refers to it as CAPE. He also calculates what he considers to be a more accurate CAPE (for Cyclically Adjusted PE), called TR CAPE, which accounts for share buybacks.
See the graph below, from Shiller’s website, for November 6, 2018. I know the graph is busy, but the important thing is that the TR CAPE is 36.5. This is well within the top quintile of historic ratios, which is often a harbinger for a precipitous fall in prices. To put a fine point on it, this is one of the highest levels for the period from 1871 to now. The 1929 peak that preceded the Great Depression was 39.5 and the tech bubble peaked at 48.1.
Finally, you may have noticed an important dynamic in the chart: increases in long-term interest rates pull down the TR CAPE. The Federal Reserve’s most recent forecast anticipates continued, but moderate, rate hikes ahead, increasing from 2.25% now to 2.4% by year's end and 3.1% by the end of 2019. With high levels of employment, a frothy stock market and a federal budget that is unprecedentedly profligate in its non-wartime, non-recession spending, I would assume that these rate hikes will come to fruition. In some ways, this is actually a good thing, as it reduces the likelihood and scale of a potential downturn and increases the Fed’s ability to mitigate such a downturn. It will, however, reduce equity valuations.
The chart below, (also from November 6, 2018), shows that stock prices are more than double what one would predict from a linear regression. In simple terms, current equity prices greatly exceed the long-term trendline. We would need a much larger correction than we saw this past October to bring us in line with historical norms. Much of this may be due to a longer-term, justified and/or stable increase in equity valuations. Still, even if you drew a trendline starting in 1990, current prices would be well-above that trendline.
Home Prices are Getting Frothy, Too
We are also seeing home prices climb. The chart below, also from Shiller, is also busy. It shows the change in home prices, building costs, population and interest rates. Interest rates, in basis points, are on the left axis. Population is on the right axis. The left axis also shows the normalized values for home prices and building costs, with a value of 100 for home prices in 1890. Building costs are given as a ratio to home prices.
The takeaway here is that we’re pretty far above the trendline. We’re not nearly as far above the trendline as in 2007, but we’re moving in that direction. Only twice in history have we seen housing prices exceed the long-term trend by more than this. In 1894, this was followed by a decline of roughly 50% through 1921. In 2007, well… you know.
Words of Warning from the International Monetary Fund
As I stated before, I am not an economist. So, I read what the top economists have to say about the economy. One source of insight is the International Monetary Fund’s Global Financial Stability Report. The report breaks down the IMF's concerns into three categories: short-term, medium-term and long-term risks. Here is a very abbreviated summary of what the October report has to say:
There are moderate near-term risks stemming from economic weakness and increased global trade tensions. The latter is referring not just to President Trump’s policies, but also to Brexit. The IMF worries that: “An intensification of concerns about emerging markets, a broader rise in trade tensions, the realization of political and policy uncertainty, or a faster-than-expected tightening in monetary normalization could all lead to a sharp tightening in financial conditions.”
The medium-term risks are all debt-driven. Advanced economies are seeing rising commercial and personal debt. Emerging markets are borrowing worrisome amounts from abroad. Banks are “stronger than before the crisis, [but the financial system] is exposed to highly indebted borrowers as well as to opaque and illiquid assets and foreign currency rollover risks.”
Long-term risks have been reduced since the crisis, but there is still plenty of work to be done.
In summary, the IMF says that we still need to shore up the global economy to reduce the likelihood of major recessions; our borrowing may catch up to us in a couple of years; and our most immediate threats are from emerging market weaknesses and/or political volatility leading to bad policies.
Let me add to this that I am not sure the Euro-area debt crisis will remain dormant. Italy, for instance, has a debt-to-GDP ratio of over 130%. Its deficit is equal to 2.4% of GDP, while GDP growth is only 1.5% annualized. It has little capacity to deal with a downturn and the specter of default is still out there. Italy is a big domino and the EU has plenty of other dominoes for an Italian crisis to topple.
The Yield Curve is Flattening
The flattening of the yield curve is another negative indicator. The yield curve is moving toward a possible inversion. Short-term bonds normally pay a significantly lower interest rate than long-term bonds. A flattening of the yield curve occurs when the gap between short-term and long-term rates shrinks. An inversion occurs when short-term rates are higher than long-term rates. An inversion has preceded each and every recession since the Great Depression.
Inversions are associated with recessions because banks normally borrow at short-term rates and loan at long-term rates. The smaller the gap between these rates, the less money banks can profitably make available for investments and purchases. An inverted relationship will seriously reduce lending.
The two most common loan terms compared are the 3-month and the 10-year. They’re not yet flattened, but the gap is shrinking. At the beginning of the year, their rates were 1.44% and 2.46%, respectively. As of November 6, 2018, they were 2.35% and 3.22%. The gap shrank from an already non-robust 102 basis points to a more worrisome 87 basis points.
OK, So When Will the Recession Hit?
I have three honest answers to this question. The first is “later,” as in, sometime after this moment. The second is, “If I knew for sure, then I wouldn’t tell you. I would make money off it.” And the third is the long-ish bit of analysis that follows.
My A Priori Assumptions
First, let’s start with how I answered this question on July 9, 2018:
[if !supportLists]· [endif]There is a 95% chance that we'll see a recession within the next 5 years;
[if !supportLists]· [endif]There is a roughly 5% chance it will begin with a contraction this year;
[if !supportLists]· [endif]15% chance in 2019;
[if !supportLists]· [endif]15% chance in 2020;
[if !supportLists]· [endif]30% chance in 2021;
[if !supportLists]· [endif]35% in 2022 or 2023.
[if !supportLists]· [endif]My probability distribution could be shattered by sudden shifts from a wide range of disruptions from either natural or policy disasters.
What I'm Hearing from Other Forecasters
As a professional forecaster, I have the pleasure of meeting forecasters from many fields other than my own. Of course, pretty much every field of forecasting is other than my own – really, how many wine industry forecasters do you know? While many forecasters go to where their passions are (climate, politics, wine), many of the very best go to where the money is (finance, commodities, real estate.) I listen to the guys in the latter category when I need to know where the economy’s going (which is always). I’d like to say that they listen to me when they need to know where Santa Cruz Mountains Cabernet Sauvignon grape prices are going, but they never need to know that.
Most of the forecasters I’ve been speaking to are planning around the assumption that the next recession hits in either 2020 or 2021. The fact that they are making these assumptions, of course, reinforces my belief that a recession is coming. I will share with you that one forecaster I spoke to has a gloomier outlook than the others. Shiran Vaknin, a Ph.D. student at Duke’s Fuqua School of Business has focused her research on sovereign debt markets and GDP forecasting. Her estimate is that there is a 95% chance of a recession starting before the end of 2020.
Other Indications
Let me just circle back to two other indications. First, if this bull market continues for as long as the previous record-holder, we will settle into a bear market in 2021. Second, the IMF indicates that there are short-term risks that could cause an abrupt “financial contraction.” Its report also expresses substantial concern with medium-term risks. In another IMF report, October’s World Economic Outlook, the IMF states that, while US “momentum is still strong as fiscal stimulus continues to increase, … the forecast for 2019 has been revised down due to recently announced trade measures … US growth will decline as fiscal stimulus begins to unwind in 2020, at a time when the monetary tightening cycle is expected to be at its peak.”
My Revised Estimates
After reviewing the evidence, I feel that my earlier estimates were too cheery. Let me revise them and change my estimates for a recession to:
25% chance a recession will begin by the end of 2019;
40% chance in 2020 (65% cumulative chance);
30% chance in 2021 (95% cumulative chance);
5% in 2022 or later (100% cumulative chance).
I you CAN take much more of this, then read on...
How Bad Will the Recession Be?
The Good News
The conventional wisdom is that the coming recession will be shallower than the last one. The reasons for this are obvious. Unemployment is near an all-time low. Even if a recession causes some moderate layoffs, we could still be near what we have historically considered to be full employment. Equities are so over-priced, that even a major correction could leave the market with healthy growth over multi-year periods. Real GDP growth for the year may end up being nearly 4%. Even were this to contract significantly, so long as it’s outpacing population growth (0.7%), that sounds tolerable to me. I’ve also heard the opinion that changes made to the economy since the Great Recession have made it more resilient.
In fact, many forecasters, investors and managers I respect think the next recession will be shallow. The argument for a shallow recession is simple, so I’ll keep it short. Note that I am keeping it short because the argument is simple, not because I’m convinced the next recession will be deep.
That being said, as is my nature, I still have some worries and think it is worth considering some serious risk factors. I hope that our current fundamentals are sufficiently improved to weather the coming storm without too much pain. But I think there is a significant chance that such wishful thinking is unjustified. This might be a good time to pour yourself a glass of something nice.
The Deficit is a Problem
Take a look at this chart below, derived from Congressional Budget Office data:
Deficit spending is very high and growing, especially considering that unemployment and interest rates are low, the stock market and housing prices are high and we are not involved in a war of global proportions. This projection shows deficit spending as a percent of GDP leveling off around 5.5% per year.
The bad news is that 5.5% of GDP per year is really high. More unfortunately, these numbers, from the Congressional Budget Office, are not based on realistic estimates of GDP. Not only are they not projecting a recession, but the CBO assumes a 5.1% increase in GDP for 2019 and an average 4.0% increase over the next decade. Note that these figures are given in nominal, not real terms – we usually talk about GDP in real terms (which means, adjusted for inflation.) If we assume inflation of around 2.5%, then real GDP growth would average 1.5%. These GDP assumptions could be viewed as realistic, except that they do not account for the coming recession. And when the recession comes, the budget is not automatically adjusted.
In fact, during downturns we usually increase deficit spending. But I’m getting ahead of myself here. Let me first tell you why, even now, this deficit spending is problematic. And no, this is not going to be a lecture about total debt – that will come later.
The Federal Reserve is faced with a difficult balancing act right now. It needs to raise interest rates. It needs to raise rates so it has room to reduce them when the recession hits. It needs to raise rates to keep inflation in check and keep the cost of living at tolerable levels: with rising wages and profligate deficit spending, inflationary pressure is greater than it’s been in over a decade. It also needs to raise rates to prevent dangerous equity and real estate bubbles.
The problem is that, while the Fed is facing pressure from this deficit spending and the risks it engenders, higher interest rates present their own risks. An increased cost of money reduces investment. It also increases risks to the over-leveraged corporate sector. And households that rely on variable debt, like home equity lines of credit and credit cards, feel a serious squeeze in disposable income and default more when rates are increased. Finally, it increases the costs of borrowing for not only the Federal Government, but also states and municipalities.
A separate issue is that, if we go into a recession with high deficits, we are not able to spend our way out of a recession. When the Tech Bubble burst, it happened while we had a surplus. A relatively tiny amount of deficit spending was able to inject money into the economy and ease the harm. This is standard economic policy theory: save when things are good, rely on spending to ease things when the economy is in rough waters.
Right now, that type of stimulus spending is already priced into the economy. When the recession comes, we may not be able to spend more. Further increasing the deficit will likely push up inflation and/or interest rates. In fact, even maintaining current levels during a recession could lead to a runaway train effect. But what’s the other option? Austerity measures during a recession? In today’s volatile political climate?
The Debt is Too Damn High!
Our deficit spending increases our total debt load. Take a look at the chart below, based again on CBO data:
Federal debt is at unprecedented levels, in nominal terms and as a percent of GDP and it is rising. But if this seems bad, keep in mind that the situation is worse than it looks in the chart. This chart is from the same rose-tinted outlook that led to the deficit chart above it. It is quite possible, with the coming recession, debt as a percent of GDP (orange line) will look just as bad as the nominal numbers (blue bars).
And this is only part of the story. The CBO likes to talk in terms of debt held by the public. But the government holds much of its own debt. Agencies will park funds in Treasury bonds. During the Great Recession, the Federal Reserve, as part of its quantitative easing program, bought up massive amounts of Treasury notes. If you include intragovernmental holdings, the debt-to-GDP ratio was around 125% in 2017 (as opposed to the 76.5% indicated in the chart.)
Worse yet, these numbers do not include the implicitly guaranteed loans of Fannie Mae and Freddie Mac. Nor do they include unfunded liabilities, primarily future Medicare and Social Security payment obligations.
What does all this mean? These are long-term issues that the US will have to deal with, but that long-term might sneak up on us. High debt-to-GDP ratios are associated with economic stagnation and inflation. This could further temper any efforts to spend our way out of the next recession. It could also increase the length of the next recession. Most worryingly – but least likely – it could push up the cost of living, even during a weakening labor market.
Fed Rates are Too Low
I won’t take long to explain this issue. During recessions, one way to alleviate the pain is to reduce the cost of borrowing. Lower borrowing costs encourages more investment. Take a look at this chart of the past 63 years of Fed rates from the St. Louis Fed:
One pattern you may have noticed is that during recessions (the gray areas), the effective federal funds rate is reduced and the recession ends. You may have also noticed that our current rate is lower than at any time a recession hit during the period examined. That means that, if a recession comes now, we have less ability to juice the economy through rate reductions than we ever have. The prognosis for increasing rates by much is doubtful, as the Fed's own projections indicate a rate of 3.1% at the end of next year.
Unconventional Means of Spurring Recovery
During the Great Recession, two extraordinary measures of intervention were used to assuage investor fears and push the market toward recovery: quantitative easing (QE) and the Troubled Asset Relief Program (TARP). The former program involved the Fed expanding its holdings of Treasury notes from roughly $750B to over $2T. This not only increased the money supply, but, by increasing prices for Treasuries, it pushed down bond yields. Reducing bond yields made other investments more attractive. Other central banks bought bonds from private financial institutions to accomplish the same goals.
The Troubled Asset Relief Program involved spending over $400B to purchase private financial institution equity and “toxic” mortgage-backed securities; to inject capital into automakers; and to a very small extent, to provide homeowner foreclosure assistance. This program produced a nominal profit for the federal government.
These programs were and are controversial. Quantitative easing harms retirement accounts and pensions by reducing yields. This not only results in reduced income for those on a fixed income, but it could precipitate its own crisis by undermining underfunded pension programs. QE has also been criticized for increasing wealth inequality by primarily benefiting homeowners and those whose income is derived from profits, not salaries. These concerns could prevent the government from re-instituting QE.
The government does have other options that could replace QE. It could alter debt maturity structures, as it did in 1961’s Operation Twist. It could also deploy so-called “helicopter money”, which is the distribution of money directly to citizens to stimulate the economy.
TARP was even more controversial and less likely to be re-instituted. At the time, this bailout was criticized as creating a moral hazard. Should we see financial institutions need another bailout, this criticism will seem to have been validated and grow stronger. As in the Great Recession, the Secretary of the Treasury’s ties to Goldman Sachs and other financial institutions could also turn the public against a TARP-like plan, especially in today’s highly polarized political environment. TARP did trigger widespread protests, at a time when politicians were, relative to now, generally united and generally civil in their policy disagreements. As with QE, alternatives were suggested at the time and might be more politically palatable than TARP.
Overall, it may well be more difficult to implement unconventional recovery plans in today’s political environment, especially since many Americans will likely look back on previous efforts as failures. Even traditional responses could be hindered by America’s political environment.
A Final Dose of Bad News
As discussed in the previous section, I am concerned that America’s current politics could lead to paralysis in the face of a crisis. Worse yet, it could lead to actions that exacerbate a crisis, such as price and wage controls, nationalization of key industries, escalating trade wars or an unwillingness to coordinate global recovery efforts with other countries. Our volatile political environment is difficult to predict and political pressures could lead to a wide range of counter-productive reactions to the next recession.
Our country is not the only one facing political volatility. The next recession may find a world with governments that react to a recession with economic nationalism and citizens who pressure their leaders toward extreme or irrational responses. Clearly, this would hinder global coordination.
As mentioned before, the EU remains vulnerable to debt crises. Emerging markets have also increased external debt. In a situation where the EU and the US institute quantitative easing, thereby weakening their currencies, emerging markets will see their export volumes decrease. Not only will this reduce household incomes and government revenues, but the lack of foreign currency inflows could spark a crisis.
The Verdict: Hope for a Mild Downturn, Be Prepared for the Worst
I don’t have a crystal ball. I don’t know what the next recession will look like. It may be shallow and short. It may be shallow and persistent. It may be the type of event that defines a generation. Heck, as far as I know, we may be plowing our fields with oxen and sewing our own clothes by the middle of the next decade.
I will give the same advice as I gave after the 2016 election: prepare for a wide range of possibilities. How? Well, that’s the subject of Part 4 of this series. First, let's look at the effect a recession may have on the wine industry.
What Will Be the Recession's Effect on the Wine Industry?
If this post hasn’t yet driven you to get drunk and stop reading, then mazel tov, we’re at the most important part of the article. What will happen to us in the wine industry? Depends, of course, on the severity of the downturn and what you do in the wine industry.
What Will Happen to Wine Consumption?
It’s a common belief in our business that, in recessions, people drink more wine, but cheaper wine. Let’s look at the data. First off, note that the most recent data is on the left for this chart. I got too tired wrestling with Word to try to flip it and I gave up. The blue area represents the number of gallons consumed per man, woman or child living in the US in each year, plotted against the left-hand axis. The bars indicate recessions. Any year that saw a contraction of GDP is indicated with bars. The height of the bar is equal to the height of a given recession’s total GDP contraction, measured in percent and plotted against the right-hand axis (not the annual or annualized contraction).
As you can see, recessions do not generally reduce wine consumption. The chart below looks specifically at sales of wine from California. The two top bars indicate sales in liquid terms. The bottom, gray bar indicates estimated retail value, in billions of dollars:
According to these two charts, based on Wine Institute data, the 2008 recession hit us with a few rocky years in terms of wine sales by liquid volume, but it wasn’t quite so bad in dollar terms.
This next chart really gets at the heart of the matter. It’s based off of figures from a University of Adelaide’s compendium of wine statistics:
American consumers spent roughly 7% less on wine in 2009 than they did in 2008. By 2010, spending had inched just above 2008 numbers. Those two years saw negligible inflation. A 7% drop in sales is a tough pill to swallow, but, the recovery came on soon, though it was slow at first.
Presumably, if a shallow recession comes, the effect on wine sales will be easy-ish to manage. If we have another Great Recession, there will be significant pain, but well-run brands should be able to weather it. If we have a Great Depression-scale event, the good news is that people will continue to increase their wine consumption. The bad news is that we may have trouble selling them that wine at profitable price points.
One last thing to be aware of is that not all price segments will see the same amount of pain. The following chart is from Euromonitor, but I found it in Silicon Valley Bank’s State of the Industry Report. The dotted blue line is sales growth of fine wines, Champagne and spirits in the US. Even in 2008 and 2009, sales grew by at least 4% per year.
What Will Happen to Wine Grape Prices?
The chart below shows prices over time, in constant, 2017 dollars for various types of wine grapes. I picked the grapes to look at arbitrarily – whatever data was handy. I also labelled them with my own abbreviations, in a continuing, vain and likely futile attempt to create standardized abbreviations. The categories are:
D4 CbS: District 4 (Napa County) Cabernet Sauvignon;
D4 TW: District 4 (Napa County) All Wine Varieties (TW = Total Wine);
D18 TW: Statewide All Wine Varieties;
D2 TW: District 2 (Lake County) All Wine Varieties;
D3 PtNp80: District 3 (Sonomarin) 80th Percentile Pinot Noir;
D3 SaB: District 3 (Sonomarin) Sauvignon Blanc.
I know, it’s a tangle of strings - which I will unravel. Let’s go through this graph chronologically. Remember, we are talking in constant dollars.
The early 1980s recession lasted, depending on whom you ask, from 1980 to 1982 or 1981 to 1982. It was characterized by high inflation, high unemployment and high interest rates. It was also characterized by serious grape price volatility. Below is a table, with the recession years in yellow, that shows the way prices moved (pardon the poor resolution):
Overall, the stronger grapes weathered the storm better and there seems to be a lag between the recession and the effect on grape prices. We see another economic downturn in 1990, but the effect, if any, is unclear. It certainly seems to be a weaker effect than the grape market cycle. Same goes for the tech bubble burst.
Taking a look at the recession of 2007-2009, we do see a significant, lagged effect. All categories saw prices drop in 2010 between -5.17% and -10.44%. All except Statewide All Varieties (D18 TW) saw some fall in prices in 2009, too, though smaller. These lag effects are likely linked to pricing terms included in contracts that delay price reductions. By 2011, all of these grapes were recovering, though the D18 TW recovery has been much rockier.
So, what is the takeaway? Long-lasting recessions certainly hurt grape prices. For the grapes we looked at, prices dropped by no more than 13% overall (Lake County Sauvignon Blanc). Prices dropped the least for the top-end and the bottom-end (Napa and Statewide). In the past, I have roughly estimated that the total reduction in inflation-adjusted price from the past recession was about 8%. These numbers seem to agree with that.
I think for most growers that is somewhat encouraging. It seems to be palatable. But let me throw at you three warnings.
First, look at numbers for whatever it is you are growing. I know that some growers saw much more pain than others in the past recession. My Grape Data Tool makes it easy to pull up those numbers.
Second, even an 8% price reduction can hurt a great deal. That’s not an 8% decrease in profits, of course, but in revenue. For many operations, this could put a profitable business in the red. Additionally, the total reduction in prices is only one data point – the duration of the price reduction is also important. Depending on the grape/region, this could be one year, three years or maybe even more.
Finally, I think there is a significant chance that we are seeing not just a future recession, but a natural ebb in wine grape prices that would occur regardless of the broader economy's performance. These two factors could compound each other to catastrophic effect.
What Will Happen to Vineyard Land Prices?
As previously, I have included here charts based on whatever data I happened to have ready to go. In this case, I had Monterey County and Lake County land prices readily available. Both charts are based off data from CalASFMRA’s “Trends” reports. The purple line (TW Price), shows the average price per ton for grapes of all wine varieties. The other lines show the maximum (blue) and minimum (red) sales prices per acre of vineyard. The green line is an average of those two values. Unlike in most of my graphs, these numbers are in nominal dollars, unadjusted for inflation. Adjusting for inflation revealed no new insights, but did make the graphs a bit more difficult to quickly interpret.
For Lake County, we see that vineyard prices responded to the recession before grape prices started to rapidly drop. Once grape prices dropped, this further depressed vineyard prices. In fact, vineyard prices fell quite a bit further than grape prices. This is likely because, for instance, an 8% drop in revenues may mean a 40% drop in cash flow and, therefore, a commensurate drop in asset value. It is also likely due to vineyard land prices’ correlation to the broader real estate market, which was hit hard.
In 2008, the midpoint price was $32,500 per acre. In 2011, it bottomed-out at $16,000 per acre. This represents a 51% reduction in asset value in only three years! The high and low prices moved roughly in tandem. The conventional wisdom is that Lake County land prices are more volatile than other regions. This seems to support that assertion.
Growers in regions like this should keep this in mind when crafting their financial plans, if they rely upon asset value to backstop their business. The same forces that will squeeze your cash flow will reduce a business’ ability to tap into asset value to weather bad times.
On the other hand - and I can attest to this from personal experience - if you can time your entry into the market, a great opportunity exists to buy Lake County vineyards during a downturn. If you purchased a vineyard in 2011 at the midpoint price, it would be worth 234% of your initial investment only 3 years later. Note that there was a one-year lag between the recovery in grape prices and the recovery in vineyard prices. With perfect timing, a newly purchased vineyard may well be able to generate positive cash flow shortly after acquisition.
The graph for Monterey County is drastically different. The recession may have knocked down grape prices for a year or two, but land prices only stagnated. They did not fall. Why not? My top theories are: salads, berries and broccoli.
A great deal of Monterey County’s vineyard land is well-sited for growing high-end food crops. Many of these crops are more profitable than grapes (Monterey County raspberries sell for about $7,000 per ton!) As difficult as the Great Recession was, it was not the Great Depression and we are one of the most prosperous societies in human history. By-and-large, people can still afford the groceries they like to eat. This creates a backstop for Monterey County vineyard land prices.
But some Monterey County growers can have their cake and eat it, too. Judging from the blue line, it seems that rising grape prices still push up prices for top vineyards. For Monterey County growers, therefore, it is reasonable to assume that, should the next recession be similar to the last, they can probably rely on any untapped asset value in their land. They should keep in mind, however, that banks will be very reticent, in a downturn, to loan to entities without strong cash flow. They may find that, to access the equity, they have to sell their vineyards.
Unlike in Lake County, a downturn in Monterey County, should conditions repeat themselves, will not present opportunities to invest in vineyards. Returns on investment will have fallen with upside limited only to top sites.
Every locale and variety is going to have a different dynamic during a recession. Furthermore, we do not yet know what type of recession we’ll have, which matters a great deal. I would encourage my readers to take a look at their own region to understand what might happen during the next recession. My assumption is that the two areas examined above are pretty close to being a “best case / worst case" analysis. Most regions are likely to exhibit a dynamic somewhere between the two.
Concluding Thoughts
The recession may be mild and quick, it may be mild and long, but I think there’s a significant chance that it could be worse than last time.
It will probably commence prior to the end of 2020 and almost certainly by the end of 2021.
Unless it’s truly a big one, it will cause a major hiccup in wine retail sales, but should not be catastrophic, nor very long-term.
Growers should be prepared for a few years of rough waters. In some areas, these could include some pretty serious shocks to revenue streams and profitability.
In some areas, land prices could be pretty seriously affected. For some growers this will compound their cash flow issues with liquidity issues. For investors, this may create opportunities for once-in-a-decade returns.
How the coming recession will effect your business, depends on your business. If you want to look into that question or any others, reach out to me and let’s talk. In any case, stay tuned for my next post: The Three Horsemen of the Grapepocalypse, Part 3: Rising Costs.