[Excerpt from The Pickett Line November 2021 Issue]
And onward we go. Now more than halfway through the final quarter of 2021, we find ourselves leaning into the heart of the peak retail spending season while battling an array of global supply chain challenges that show little sign of easing anytime soon. In other words, welcome to crunch time. That said, the storyline from last month’s note remains for the most part unchanged. The “Everything Shortage” and “Chaos at the Ports” narratives continue to dominate the headlines. Consumers continue to spend and consume – however at a diminishing Y/Y rate. Shippers continue to secure and position as much inventory as they can get their hands on to capture as much of that spend as they can. And service providers up and down the supply chain continue to generate record profits for their role in keeping stuff moving regardless of what challenges continue to arise – whether they be new COVID variants, extreme weather events, spiking diesel costs, volatile demand shocks, or severe supply and labor shortages.
But just because the story remains the same and most of our primary macroeconomic and market trends remain directionally intact, that doesn’t mean we don’t have plenty to talk about in this November issue of The Pickett Line. As you may recall from last month, we were eagerly awaiting preliminary Q3 Consumption and Import data to see if there was any signal yet of the imminent Y/Y slowdown in the COVID-induced surge in goods demand, much of it satisfied by overseas sources (hence the parking lot of container ships anchored off the Ports of LA and Long Beach, and more recently Savannah and others). We were also looking forward to getting our first glimpse of both Q4 Industrial Production and Q4 Class 8 Net Tractor Orders with their respective October reads. And finally, as we stood vigilantly on “inflection watch” with the Cass Linehaul Index awaiting evidence to confirm or contradict Q2 as this cycle’s top for Y/Y US Contract TL rates, we now have its preliminary Q4 read to consider as well.
So with plenty to unpack, let’s start with the star of our show here at Pickett Research – the US TL spot market itself. With half of the quarter now behind us, our DAT US TL Spot market linehaul index sits at +13.7% Y/Y and $2.57/mi – up slightly from last month’s preliminary Q4 read of +13.3%. Rather than fade lower as expected, the market continues to hold relatively steady. To hit our +5% Y/Y Q4 forecast, the average for the quarter would have to slide 20 cents (or -7.7%) from current levels between now and the end of the year – a tall order given typical seasonal tightness coupled with persistent COVID-induced supply chain volatility. Though regardless of where we ultimately land, the remainder of the year should help signal where we really are in the balance between US truckload supply and demand as the implications of the long-term US TL capacity and rate cycle appear to come into direct conflict with current market sentiment and short-term expectations.
Now onto the US TL contract market, where the Cass TL Linehaul Index serves as our primary indicator. Recall that with our Q1 2021 close at +13.9% Y/Y followed by Q2’s slightly lower +12.9% read, we got our first potential inflection point for the inflationary leg of the current rate cycle. However, we would have to wait until Q4 began to develop before getting any real confirmation. Now that Q4’s preliminary read is in with October’s +11.0% Y/Y, the case for Q1 representing our cycle peak becomes much stronger. We will have to wait until the quarter closes to make it official, but for the time being, all signs point to a steadily decelerating Y/Y contract TL pricing environment with rates likely to go Y/Y negative by Q3 of next year if not sooner.
On the demand side, preliminary Q3 Consumption numbers released late last month finally shed some light on where wildly shifting post-COVID consumption patterns are likely to go next. Though the story really starts in Q2 2020 where, in the depths of the Coronavirus recession, overall consumption plunged to a historic low of -10.2% Y/Y. The decline however was incredibly disproportionate, with Services-related spending tanking all the way to -14.3% Y/Y while Durable and Nondurable Goods bottomed out at a much more benign 0.3% and -1.2% Y/Y, respectively. From there, the Services sector struggled to regain its footing as both national and local COVID mitigation measures rippled across the country. Goods-related consumption however took off like a rocket as gains in the housing and equity markets coupled with unprecedented federal stimulus programs fueled a recovery to historic highs one year later with Q2 2021 Durable goods spending clocking in at +33.7% Y/Y and Nondurables reaching +14.5%. Services meanwhile only saw a Y/ Y correction to +13.8%. Our expectation was that Q3 2021 would show a sharp deceleration lower as spending patterns began to normalize, and that is exactly what we got. Durable goods consumption came back down closer to earth at +5.7% Y/Y while Nondurables was cut in half to +7.6% along with Services which came in at +7.1%.
While the correction in Goods consumption was as expected, the relative weakness in Services was more of a surprise. As the Services sector continues to sputter back to life with rising vaccination rates, the hypothesis was that consumption patterns would again shift to favor Services at the expense of Goods. And while we see the “at the expense of goods” half of the argument clearly taking shape, we see Services slowing as well rather than recovering higher. It’s possible that this has more to do with an uneven post-Delta variant reopening than it does a US Consumer that is simply beginning to run out of steam altogether, and we may see another bounce higher in the quarters ahead. But we won’t know for sure until we get another quarter of two of data to consider. Should we get a broader slowdown in overall Consumption from here, that just means we should expect a lower for longer deflationary trough in the TL spot rate cycle in 2022.
The October print on US Industrial Production also supports this demand deceleration narrative, with preliminary Q4 now showing +4.4% Y/Y compared to Q3’s +5.6%. As with the Cass Linehaul Index, we’ll have to see how the rest of the quarter develops before drawing too many conclusions, but if the current trajectory holds, this gives us even more reason to expect an increasingly deflationary US Spot TL market next year. This could also, by the way, potentially whipsaw the larger global supply chain shortage situation in the completely opposite direction. When every shipper in the world is racing to stock as much inventory as they possibly can right now, it doesn’t take much creativity to imagine what might happen if and when consumers begin to tap the brakes on spending. And now with an emerging COVID-19 Omicron variant to contend with, this risk is likely to run even higher in the months ahead.
That said, with inventory levels still at historic lows, this is hardly an immediate threat. With Q3’s final Inventory to Sales Ratio read of 1.26 however, we finally got some evidence that a floor may have been reached with Q2’s 1.25. And if there really is an inventory glut forming out on the horizon somewhere, we should see evidence here with rapidly increasing reads in the months and quarters ahead. In any case, we’ll be watching closely as the post-COVID global supply chain recovery continues.
In line with the slowing Y/Y rates of Consumption and Industrial Production, our October read on the Cass Shipments Index also showed a sharp deceleration from Q3 – coming in at +3.2% Y/Y vs. the prior quarter’s +9.1% and Q2’s +29.9%. And with the Q3 ATA TL Volume Index closing at -4.9% Y/Y, while slightly higher than the QTD August read of -5.6%, both primary TL Demand indicators continue to signal slowing activity in the months and quarters ahead. After the unprecedented surge in goods-related consumption we recently experienced, a correction of this magnitude is only natural and to be expected. The only question then becomes how deep and for how long the correction runs as consumption patterns finally begin to normalize – and to what extent US TL Supply will have overshot during the surge higher this time around.
And what has proven to be perhaps the most consistent signal in past US TL cycles, with the preliminary Q4 October read on Class 8 Net Tractor Orders, we got our first negative Y/Y print with -51.0%. Across the last four complete cycles observed since 2007, both the US TL Spot Index and Class 8 Net Tractor Orders have flipped Y/Y deflationary in the same period (plus or minus a quarter) as the cycle transitioned from its inflationary leg. If this pattern proves consistent this time around, we should then expect to see Spot TL linehaul rates go negative Y/Y by next quarter – again, consistent with our general forecast. Or if things really are different this time, and the weakness in net order volume has more to do with production constraints and component shortages than with diminishing market demand, then it’s possible that Spot TL rates could linger inflationary for a bit longer. We’ll find out either way in the months ahead.
And finally, while most of our market and macroeconomic indicators currently signal a Y/Y deflationary US TL Spot market next year, trends in diesel prices suggest a different story. With November MTD national retail diesel prices now sitting +4.2% higher than just a month prior at $3.73/gallon, prices continue to march higher and higher. But again, as noted over the last few months, even at these levels, diesel prices are still not expected to dent motor carrier operating incomes enough to force any measurable capacity out of the market in the near term. Though should diesel costs remain elevated, as both Spot and Contract rates continue to decelerate in the quarters ahead, there will come a point where we will see enough compression on the operating income line that many fleets may have no choice but to begin idling or otherwise shrinking capacity – something we could see as early as Q2 or Q3 next year.
So with half of this Q4 now in the rearview mirror and the 2021 Hurricane Season with it, let’s revisit our two remaining market wild cards that we continue to believe will govern marketplace dynamics and behavior through what remains of peak season and the final weeks of 2022:
1.TL-Intensive US Consumer Spending: As noted, most market indicators remain mixed on just how much goods-related spending we will continue to see take place over this holiday season – even with October’s relatively strong retail sales number. While household balance sheets have arguably never been stronger, the jury remains out as to how that ultimately manifests itself in Q4 consumption. With stimulus programs still tapering, inflation surging, rampant supply chain shortages, and the specter of rising interest rates increasingly on the horizon, Consumer retail spending has never been more challenging to predict and position for. But with several of the big box retailers reporting stellar Q3 earnings and carrying plenty of inventory into the holiday season, there certainly seem to be more than a few that are finding their way.
2.Supply Chain Shortages: As Hurricane Season drops off the list of immediate concerns, inventory levels and supply chain shortages remain squarely in the spotlight. If Consumption, and therefore Industrial Production, continues to break lower through the holiday season, the question will continue to be whether it was due primarily to diminished appetite to spend or an absence of products on the shelf to consume – one of which is likely to resolve itself faster than the other. However, from a TL Demand and market cycle standpoint, it still doesn’t really matter. The demand for truckload transportation to move stuff is lower. And the longer it takes the supply side to detect the shift and respond proportionately, the sharper the market correction in Spot Linehaul rates we’ll ultimately see for the market to finally rebalance itself.
And with most of our Q4 storylines continuing to run their course, our advice for navigating what remains of the 2021 peak retail season remains mostly the same. Supply chain speed and agility remain king. Demand planning and inventory management remain challenging. And logistics remains at the forefront of the national conversation. The businesses that have taken advantage of the last 18 months of crisis after crisis to invest in their global sourcing, manufacturing, and distribution capabilities to get faster, more efficient, and more nimble will in all likelihood continue to outpace the competition this holiday season – as suggested in recent weeks by the wide disparity in Q3 earning performance and forward guidance across a number of industry sectors. And for those that haven’t, it’s never too late to start. So with that, we will close the same way we did last month. Happy Holidays to all and may the best (prepared and managed) supply chains continue to outperform.