[Excerpt from The Pickett Line January 2022 Issue]
Well, here we are. After an exhausting 2021 ride on the US TL Spot Market roller coaster, we have now punched our ticket for round two and the journey into 2022 begins – where most of the market could probably do with perhaps a little less excitement this time around. Welcome to the first installment of this year’s The Pickett Line, where we will attempt to make some sense of recent US freight market conditions by examining them in the context of historical patterns and recurring cycles. From there, under the general assumption that Mark Twain’s observation “while the future doesn’t always repeat itself, it often rhymes” continues to hold as true in the US truckload freight market as it has over the past 15 years that we have been paying attention, we will chart a course of potential outcomes over the months and quarters ahead. Along the way, we will spotlight the short list of key market drivers that we expect to dictate just how scary this ride will be, to what extent they are likely to impact the balance in supply vs. demand, and what that ultimately means for both spot and contract TL linehaul rates in the US this year.
So with a lot of ground to cover, let’s start with a recap of the Q4 we just tied a bow on. As of December 21st, when the last issue was published, the Q4 DAT TL Spot Linehaul Index sat at $2.59/mi or +14.6% Y/Y. Down the home stretch through Christmas and New Year’s Eve, it picked up a penny to close the quarter at $2.60/mi or +15.0% Y/Y. While well within the +13-16% range that we expected in last month’s analysis with 10 days left to go in the quarter, it was well above our forecast of +5.0% set the previous quarter. But as compared to the previous quarter’s +22.1% Y/Y, the deceleration from our technical inflationary cycle peak of +56.1% in Q2 continued nonetheless – and makes Q4 the 6th consecutive quarter of Y/Y spot market inflation, tying the mark set by the last cycle’s inflationary leg that ran from Q2 2017 through Q3 2018. Based on that trajectory, our forecast line projected the market to land Y/Y deflationary as early as this quarter before fading to a low of -20-25% Y/Y in Q3 then inflecting back toward market equilibrium three quarters later in early 2023. However, some early new year spot market fireworks now suggest a revised outlook which we’ll get to after closing the book on the Q4 contract TL market and reviewing the latest macro indicators released so far this month.
In last month’s update, the Q4 Cass Linehaul Index (our proxy for US TL Contract market rates) sat at 150.2 or +10.4% Y/Y – and was closing in on our Q4 forecast of +10.0%. Given the runaway inflation in the Spot market throughout most of the year and our Spot forecast line stuck in a seemingly endless game of catch-up following Winter Storm Uri back in March, it was reassuring to finally see an actual and a forecast line begin to converge. With the addition of December’s read of 148.0 now baked in, the final Q4 mark has been revised down by another 50 basis points to +9.9% Y/Y – again, compared to our forecast of +10.0%. Ladies and gentlemen, it doesn’t get much closer than that. Now if we can just get our arms around the Spot market.
As with December, we don’t have a ton of new data to dig into on the demand side this month with preliminary Q4 Consumption and Imports not due out until January 27th – which by the way should make next month’s issue one of the more interesting in the series as we get to peak further into the ongoing battle for US Consumer wallet share between Goods vs. Services. While Team Goods has been dominating this contest for the past 18 months of COVID disruption, it looked as if Q4 would have Team Services coming off the top rope with a flying leg drop to finally overtake Goods with regard to Y/Y Consumer spending growth as more of the economy continued to open up. But now here comes Team Service’s new arch-nemesis Omicron (total bad guy) out of nowhere with a steel chair to make its finishing move much less certain. Will Team Services come tumbling to the mat in a heap or will it finish the move, drop the leg, and pull ahead of Team Goods after all? Stay tuned for the February issue of The Pickett Line and we can all find out together.
And while we’re on the topic of Omicron and the prospect of more restrictive COVID mitigation policies, you may recall that in last month’s note we commented that “it will be interesting to see what impact [Omicron] has on Goods spending this time around. Will the global supply chain get some welcome breathing room to continue its recovery? Or is it possible there remains a slug of pent-up demand still out there for Pelotons and patio furniture that didn’t get fulfilled during the last shutdown? We’ll find out soon enough.” With regard to those Pelotons at least, it looks like we’ve already got our answer. As reported by CNBC last week, Peloton appears to have wildly overestimated ongoing demand for their products over the holiday season – so much so that they would be taking immediate action to “right-size” their production and inventory levels to reset for more sustainable growth. As one might expect, the stock market then took its own immediate action to “right-size” their enterprise value by sending their shares tumbling lower by 24%, however with some recovery the following day to be fair. In any case, we’ll have to wait and see whether Q4 Consumption data sheds any light on Peloton as an anomaly or as a signal of more right-sizing to come. But now that I think about it, is it possible that I’ve jinxed the entire patio furniture sector as well with last month’s comments? Will they be the next Peloton? Could The Pickett Line excerpt become the equivalent of the “Madden Curse” (RIP John Madden) for the US economy and freight market? Now that’s a sobering thought. Alright, this is getting a little weird even by our standards. Let’s move on.
So enough dwelling on all of the data that we didn’t get – let’s shift focus to what did get released, starting with US Industrial Production (IP). In last month’s note, Q4 IP through November came in at +4.8% Y/Y which was a slight improvement compared to October’s +4.4%, but well under Q3’s +5.6% thus supporting the ongoing deceleration narrative after the COVID recovery-induced peaks seen in Q2. With December now in, the final Q4 read on IP closed at +4.5% Y/Y, negating the November gain for the most part. But the general uncertainty around the root causes for relative IP weakness remains. Does it have more to do with an actual slowdown in Consumer appetite to spend or a lack of available production capacity due to inventory and labor shortages, only now exacerbated by Omicron-related staffing challenges? We will no doubt be looking for more signals in the months ahead before we can build any conviction on this point one way or another.
After last month’s first October look at the Q4 Inventory to Sales Ratio showing 1.24, we commented that by reporting lower than the potential Q3 bottom of 1.26, it appeared that no such bottom had been found as inventory levels continued to fall behind relative to sales. With November now in, our Q4 read revised ever so slightly higher to 1.25 so arguably at least moving in a more stable direction. And the potential for a bottom at 1.26 is back on the table pending the December update. Again, yet another dramatic storyline we can look forward to some resolution on in next month’s issue.
So with Industrial Production taking a baby step lower and Inventory to Sales taking a baby step higher, we also saw divergence in in our two primary TL market volume indicators. The Cass Shipments Index continued its slow but steady sequential rise throughout the quarter with Q4 closing at +4.3% Y/Y – compared to +3.9% through November and +3.2% the month before. That said, the high level trajectory remains negative as we continue to decelerate off the Q2 2021 COVID recovery peak of +29.9% Y/Y and it continues to track the Industrial Production line just as it has over most of the past 20 years. In fact, with Cass Shipments at +4.3% and IP at +4.5%, the two lines closed virtually on top of each other last quarter.
Our second volume indicator, the ATA TL Volume Index faded slightly lower with its November revision down slightly to -1.9% Y/Y vs. the prior month’s -1.2%. So we remain negative year over year, but increasingly less so as compared to Q3’s -4.9% Y/Y and as our two indicators finally begin to converge after running in opposite direction over much of the last 6-7 quarters of COVID disruption. What happens then? Well, we believe we could get a repeat of 2019 where the Cass Shipments Index ran decidedly Y/Y deflationary with Spot TL rates while the ATA TL Volume Index broke decidedly inflationary as unprofitable carriers eventually began idling capacity or exiting the market altogether. While it is difficult to envision such an outcome with Q1 Spot TL rates up here at +24.4% Y/Y, if history does indeed continue to rhyme, patterns suggest that we somehow find our way there before the end of the year.
Now onto Net Class 8 Tractor Orders, perhaps the greatest head scratcher of them all in this cycle. We have remarked in recent issues that net tractor orders had proven to be perhaps the most consistent signal over past US TL cycles. 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. Just like clockwork, so go Y/Y net orders so go US TL Spot linehaul rates. But with the continued supply chain constraints faced by the Class 8 OEMs this cycle, arguably entirely unprecedented as compared to past cycles, it is easy to make the argument that things are indeed at least a little bit different this time around. And that negative Y/Y Net Tractor Orders have much more to do with a record 14-month OEM order backlog than diminished appetite for new capacity. So now with our preliminary December read taking the final Q4 mark to -61.1% Y/Y, while we showed some slight improvement from November’s -65.4%, we nonetheless closed decidedly deflationary for the first time since Q3 2020. And the question now becomes how indicative this particular trendline is of the direction of US Spot TL rates from here. Based on January MTD spot rates alone, the answer would be not very. That said, the quarter is far from over and we’ll have to wait another month or two to find out.
Finally, with inflation continuing to accelerate across many commodity categories, we have an update on last month’s early sighting of a potential top in Y/Y US retail diesel prices. After surging higher over much of the year, December closed at $3.64/gallon (+40.9% Y/Y) – 9 cents lower than November’s $3.73 (+53.3% Y/Y). We remarked that “if we get further sequential weakness in the weeks and months ahead, made only more likely with the continued global spread of the COVID Omicron variant, we could see a reversal in quarterly Y/Y diesel prices as early as Q1 2022. And the lower diesel prices fade, the more accommodative it is for a deflationary US TL Spot market environment next year.” While it’s way too early to make this call, January MTD is showing down another penny to $3.63/gallon and +35.6% Y/Y. And should prices remain in this range through the rest of the quarter, Q1 retail diesel would close at +25.6% Y/Y – well off Q4’s +48.5% Y/Y and a potential signal of a more persistent trend lower over the balance of the year. That said, WTI crude oil hit a 7-year high last week so the outlook remains cloudy at best.
So with a year chock full of supply chain disruptions and freight market challenges finally behind us, let’s cover our short list of the wildcards that we believe will shape the quarter ahead – in order of expected relevance. While the three that we covered last month remain squarely in play (though in different order), ‘tis the season for potential winter weather disruptions, as we have already experienced only 23 days into the new year. So we’ll once again be adding weather risk to the conversation while hoping that we don’t get another Winter Storm Uri this year. And now with Omicron jumping into the top spot, let’s run down our list.
1. The Omicron Variant: The pace and ferocity at which the Omicron variant has spread across the globe over the last two months has been nothing short of terrifying. While it is too early to tell how bad this will ultimately get and for how long as we await evidence of a national peak in the US, we already have evidence that it has begun to hamper the pace of overall economic activity growth – especially for Team Services whose battle against Team Goods was documented at some length earlier. Additionally, as we saw first-hand with Peloton, the continued volatility in consumption patterns will continue to make demand planning, inventory management, and market forecasting all the more difficult. As noted last month, Omicron’s impact on the US TL market could go either way: a possible tailwind to spot prices if the incremental demand for goods exceeds the decline in demand for services, or a likely headwind if not. And with the United States requiring proof of vaccination for foreign drivers attempting to cross land borders or ferry points of entry effective January 22nd, it’s hard to imagine a supply outcome that isn’t at least somewhat inflationary in nature. Suffice it to say, the next few weeks will be super interesting.
2. TL-Intensive US Consumer Spending: As noted, most market indicators remain mixed on just how much goods-related spending we should expect to see in the months and quarters ahead – with October retail sales coming in relatively strong while November and December both disappointed. Was this just the result of a pull forward in holiday demand to get ahead of potential fulfillment and delivery delays? Or the sign of an increasingly tapped out US Consumer as federal stimulus programs taper off and household savings rates return to pre-COVID levels? With inflation proving to be less transitory than expected (at least so far), fed monetary policy shifting increasingly more hawkish as a result, and now the specter of the Omicron variant threatening the pace of economic recovery and putting a dent in Consumer confidence altogether, the outlook is trending decidedly less constructive vs. recent months.
3. Winter Weather Disruptions: Given our experience with Winter Storm Uri crippling Texas and much of the Southern US last February and the storms that have already left a mark on the TL market in this new year across the Northeast and parts of the Southeast, the Midwest and the West Coast, it would seem that both the severity and frequency of such events are only increasing. There was once a time when a market-moving Polar Vortex was a relatively novel event given their sporadic appearance. Anyone remember the “original” Polar Vortex of Q1 2014? It seemed like a ridiculous term at the time, for a dubious concept – that some cold weather and snow could severely disrupt US transportation networks and supply chains for any meaningful duration. At the time, it was thought that only major hurricanes like Katrina could make that kind of impact. Now it seems we should expect multiple vortices every winter, and we have learned the hard way just how disruptive they can be. So as we work our way through another winter in the northern hemisphere, we remain mindful of the inflationary impact any major event can have on US TL spot rates – depending on magnitude, duration, and geography.
4. Supply Chain Shortages: With ocean and inland transportation networks remaining persistently congested, inventory levels and supply chain shortages remain front and center as we look to predict the direction of the economy and US trucking industry over the coming months. If Consumption, and therefore Industrial Production, continues to break lower in the months ahead, the question will continue to be whether it is 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. That said, from a TL Demand and market cycle standpoint, it still doesn’t really matter. The demand for truckload transportation to move stuff is simply lower when the industrial activity that drives it slows down. And the longer it takes for the supply side to detect the shift and respond proportionately, the sharper the market correction in Spot Linehaul rates that becomes necessary to rebalance. If OEM production constraints really are limiting how much net new Class 8 tractor capacity can enter the market over the next 18 months, it may end up being a blessing for the Suppliers that would have otherwise placed those orders and taken delivery in the midst of a deflationary US TL Spot market. The only real question remains ‘When?’. When should we expect to see this correction begin, as it certainly hasn’t shown up yet in sequential rate activity in a meaningful way. We should get some answers in the weeks ahead as winter weather hopefully dissipates a bit and Omicron-driven labor challenges begin to resolve, removing significant sources of short-term distortion from the marketplace.
While we make no guarantees that 2022 won’t be every bit as chock full and challenging as the last year, the US Truckload cycle at least suggests much calmer waters ahead. But before we get there, we will have to get through the current spike higher in US Spot TL rates – much of which we believe is driven by short-term weather disruptions and Omicron-induced labor shortages as opposed to structural supply vs. demand imbalances. To that point, as remarked at the top, given the MTD spike higher in spot rates, we no longer believe that the spot market will reach Y/Y deflationary territory this quarter as previously forecasted. So we have revised this Q1’s spot market forecast from -10% Y/Y to +10% and shifted the entire forward curve ahead by a quarter – as you will see in the charts that follow. This projects the market to land negative Y/Y next quarter instead, for the first time since Q2 2020 thus marking the end of the inflationary leg of the current US TL rate cycle and the beginning of our deflationary journey as the market slowly begins to rebalance. The contract market will continue to follow a quarter or two later before reaching Y/Y deflationary territory itself by the back half of the year.
And as our 2022 US TL roller coaster ride begins, despite the challenges that clearly lie ahead, there is a lot to be optimistic about. Whether it be the hope that this current Omicron wave helps usher out the crippling COVID-19 pandemic of the last 2 years once and for all, that the average US Consumer remains financially strong and gainfully employed (if they want to be), or that the prospect of global supply chains clearing bottlenecks, resolving shortages, and finally catching up to recent demand appears within reach. We expect that Consumers will continue to consume – we’re just not as clear on what they will consume (services vs. goods) or how they will choose to purchase (e-commerce/digital vs. bricks-and-mortar). So as was the theme through most of the recent peak holiday shopping season, it will pay to be nimble if you are in the business of catering to that appetite to consume. Speed and flexibility remain king. And while we expect capacity challenges to persist for some time across the more inelastic modes of transportation in the US – be it Ocean, LTL, Intermodal, or even small parcel – given the trends that we discuss here at great length, we believe that the more inherently elastic Truckload market will offer some attractive optionality on a relative basis in the months and quarters ahead. So to echo last year’s January guidance as the proverbial 2021 train left the station, please remember to fasten your seatbelts and keep your arms and legs inside the ride at all times. While numerous twists and turns no doubt await us on the track ahead, this year’s ride so far appears likely to be much less stomach churning. Well, at least if you are on the buy side.