[Excerpt from The Pickett Line August 2021 Issue]
As many of you may recall, the theme of last month’s issue was ‘Back on Track’. With Q2’s Uri-driven kink finally behind us, July data through the 25th pointed to a Q3 read that implied that the TL Spot Market Rate Cycle had returned to a trajectory much more in line with past freight cycles. And should that trajectory continue over the next few months, we should expect a deflationary Y/Y TL Spot Market as early as next quarter (Q4 2021) with the Contract Market following a couple of quarters behind. Yes, that means lower Y/Y US TL Market rates to close out 2021 and run through 2022, not higher. And if this indeed came to pass, it would run counter to just about every US TL market forecast we have seen published in recent weeks.
With ongoing ocean market constraints and port congestion, a financially healthy US Consumer poised to keep cash registers ringing this retail peak season, and a historic bipartisan infrastructure spending bill making its way through Congress, there are plenty of logical arguments to be made for TL spot rates to continue marching higher and higher for the foreseeable future. But without both the luxury of historical context and a conviction in its relevance to future market behavior, we expect the safety of the herd will remain a pretty comfortable place for those in the US TL Market prediction business through the end of the year. That said, it is important to remember that the herd isn’t always wrong. We just find that it tends to be around major cycle inflection points where market direction has changed but not enough that enough of the market feels it yet. In any case, suffice it to say the next couple of quarters will be incredibly interesting for those with any financial or intellectual interest in the US Trucking Market – and really the entire US Transportation Industry and the broader economy that it powers.
Now with another month of data now accounted for and Q3 over 60% now baked, while the outlook remains far from crystal clear, our view of the market cycle remains unchanged – as you’ve probably guessed if you made it through that last paragraph. So for lack of a more creative theme, this month can then be characterized as ‘Back on Track…Still’.
With our initial July Q3 US DAT TL Spot Index coming in at +21.6% Y/Y last month and down sharply from Q2’s +56.1% Y/Y, we have basically treaded water over the last four weeks to arrive at our revised Q3 read of +21.1%. And while we did expect more of a pullback than the 50 basis points we got, recent sequential index behavior implies there is likely more room to run lower between now and the end of the quarter. Whether we get the full -9.1% from current levels to land at our Q3 forecast of +10% Y/Y (or $2.24/mi) remains to be seen. But we do expect the market to land closer to forecast as opposed further away by quarter close.
After closing Q2 at +13.9% Y/Y, we also got our first glimpse of the Q3 Cass Linehaul Index, our proxy for the Contract TL Market, with a July read of +11.7% Y/Y – materially lower than our Q3 forecast of +15.0% Y/Y. If it closes below Q2’s +13.9% once August and September are baked in, it would suggest that this Contract Rate Cycle’s inflationary inflection point will have arrived one quarter early vs. forecast – which would further support our current projection for a deflationary Y/Y Contract TL Rate environment by Q2 of next year.
Though with all of that said, we also need to remember that that US TL Spot Market is not the US Economy – a point we have repeated in past issues. It remains entirely possible for each to be running in the opposite direction for a number of quarters – something we observed as recently as the back half of 2020 with Spot rates surging higher Y/Y in the midst a sharp and painful COVID-instigated economic recession. So while it may seem pretty counter-intuitive to talk about a stable to growing economy while Spot TL rates collapse Y/Y deflationary, it is not without historic precedence (e.g. 2012, 2015, and 1H 2019).
And with that as our segue to the US economy, we also got a raft of fresh demand-side data points to consider this month. And as is often the case, they painted a mixed picture. On the one hand, we saw the strongest Y/Y rate of Consumption growth in 73 years last quarter at +16.2%. Though to be fair, that came only after Q2 2020’s equally historic collapse to -10.2% Y/Y during the depth of the COVID recession. But it is worth nothing that we did see continued strength across all three Consumption buckets – Durable & Nondurable Goods and Services. While we have proposed in recent issues that at some point in the not so distant future we would likely see a disproportional slowdown in spending on Goods vs. Services as vaccination rates accelerated and more of the Service sector opened back up, that “not so distant future” is clearly not here yet – at least not as of last quarter. We could certainly see evidence of such a transition in Q3, but we will have to wait until preliminary GDP data is released at the end of October – which puts us out to the November issue to dissect. But all things considered, Q2 delivered a monster set of Consumption and economic activity numbers that were every bit as stellar as expected given the soft Y/Y comps.
Though as we get our first peek at Q3 Industrial Production with July’s read of +5.9%Y/Y, we see signs of a pretty sharp deceleration as compared to Q2’s rocket ship +14.4%. But as weak as that looks next to last quarter, if it holds it represents the strongest Y/Y quarterly performance since Q1 2011 – so nothing to sneeze at. We also saw comparable weakness in the July Cass Shipments Index which came in at +7.2% Y/Y, also down sharply from its final Q2 read of +29.2%.
As we’ve said in the past, one month hardly makes a quarter. And with the COVID Delta variant running rampant across unvaccinated population clusters and perhaps denting Consumer confidence on top of continued shortages and bottlenecks up and down the supply chain, one could argue that July’s numbers reflect only transitory constraints and that the case for a post-pandemic euphoric exhibit of Consumer demand remains strong in the months and quarters ahead. But with July’s relatively slow start, it does certainly question how much rocket fuel remains in the tank of the US Consumer as stimulus programs begin to taper. And the Y/Y comparisons certainly get tougher from here as the economy continues to stabilize overall.
Finally, while Diesel prices continue to edge higher, with August MTD’s $3.35/gallon notching +38.03% Y/Y, we do see signs of the growth rate continuing to level off – up only 1 cent vs. July’s $3.34 for example. But again, even at these levels, they are not expected to dent motor carrier operating incomes enough to force any measurable capacity out of the market given current spot and contract rate performance. If they remain elevated through 2022, that could raise the floor on the next deflationary leg of the cycle. But we generally find that that during the inflationary leg of any TL cycle, which is where we have been since early 2020, net capacity tends to enter the market not leave.
So as this 3rd quarter of 2021 continues to take shape and the crystal ball gets a little less cloudy, we will continue to focus on the same two wild cards that we introduced as we closed Q2 as the primary drivers for the shape of market through the remaining 36 days of the quarter:
1. TL-Intensive US Consumer Spending: Especially given the choppy start with July Industrial Production, the Cass Shipments Index, and some of the early Retail Sales numbers, this one remains our primary demand-side market force as the pace of the recovery likely slows a bit as stimulus programs taper off, inflation builds, and fed policy begins to tilt more hawkish over the coming months. And now with the COVID Delta variant continuing to hamper the pace of the economic reopening overall, the Services sector will likely get dealt another blow as mitigation measures continue to re-activate across counties and states with trending infection and hospitalization rates.
2. Hurricane Season: As we experienced with Winter Storm Uri, a storm of sufficient magnitude, duration, and geographic impact can have a material effect on the US TL market. Not enough to change the shape of the cycle overall, but certainly enough to create a temporary kink. And given the Atlantic hurricane season officially runs June 1st to November 30th, we aren’t even halfway through yet. Though as mentioned last month, given where we are in the cycle, it would likely take a Category 4 or 5 storm churning along the gulf coast and impacting population centers with active port operations or other supply chain infrastructure like Houston or New Orleans. A swipe at Florida or anywhere along the Eastern seaboard likely wouldn’t do it – as we just saw with Tropical Storm Henri. Regardless, for those with operations located in at-risk regions, now would be the time to plan for any potential weather-related disruptions should they come to pass in the months ahead if you have not yet done so.
In summary, as we grind through yet another quarter of what has been a volatile post-COVID US economic recovery, there is a lot to like about where we are and what to expect as we head into Q4 and the retail peak season. We expect underlying Consumer demand to remain strong overall – maybe not a strong as the last couple of quarters but strong nonetheless. The euphoric release of pent up post-COVID Consumer enthusiasm and demand may have already happened, but that doesn’t mean there isn’t some rocket fuel left in the tank. It will just be a question of how those Consumers consume (E-commerce vs. Traditional, Goods vs. Services, etc.) and which Retailers can position enough of the right products in the right places at the right times at the right prices to capture the most spend. But barring another catastrophic weather event to delay our journey any further, history suggests that our descent down the US TL Market Curve will continue and that the US trucking environment will be a much more forgiving place for Shippers through the end of the year and into 2022.
So while the white-knuckle portion of our proverbial roller coaster ride may be behind us, keep those seat belts fastened. If we’ve learned anything through this particular US TL Market Cycle, it’s that a few unexpected twists and turns likely remain before we hit our next deflationary inflection point in the year ahead.