[Excerpt from The Pickett Line April 2022 Issue]
With a wildly volatile first quarter finally behind us and as we march further into Q2 and our first preliminary Y/Y deflationary read of the current US TL Truckload Spot Linehaul Rate Cycle, we thought it appropriate to kick off this April 2022 installment of The Pickett Line the same way we opened our inaugural December 2020 note:
‘To quote Sir John Templeton, “The four most dangerous words in investing are: this time it’s different.” The same can be said about the US Truckload Freight Market.’
While the past two years have certainly tested our conviction in this statement, and despite the bevy of black swan events we have encountered along the way, the cycle persists. The COVID-19 pandemic didn’t cause this most recent 2020-21 Y/Y inflationary US TL spot market. Too many trucks forced to exit the market in 2019 did. And a slowing US economy isn’t behind the rapid decline in spot TL rates over the last few weeks or the Y/Y deflationary quarters still ahead of us. Too many trucks entering the market over the last two years is. Sure, the impact of dramatic COVID mitigation policies in Q2 2020 and the surge in goods consumption that followed helped shape our inflationary journey, but they were only secondary drivers at best. And yes, while Winter Storm Uri in Q1 2021, Hurricane Ida in Q3 2021, and extreme winter weather in Q1 2022 all left visible kinks to our market curve in their wakes, they appear to have made no lasting impact on the mechanics of the cycle itself. So onward we go, into the Y/Y deflationary leg of this 5th US TL market cycle (since we’ve been tracking them), just as we did in the four cycles that preceded this one. And just like we will again in early to mid-2025 to complete the 6th cycle. So, was it really any different this time? No. No it wasn’t. But the mainstream freight media, investment community, and market pundits sure had plenty to point to as they tried to convince us otherwise.
And with that as our backdrop, let’s begin unpacking the first 24 days of April and Q2. Unfortunately, just about all of the depressing market forces that we commented on last month remain in play: Russia’s invasion of Ukraine, Omicron BA.2 running rampant, US consumer inflation at 40-year highs, nosebleed-level diesel prices, and a Fed desperately playing catch up with regard to US monetary policy. And as if that wasn’t enough, we now have another monster global supply chain dislocation potentially in the works courtesy of widespread lockdowns in several major cities and ports in China as they battle their own wave of COVID-19 infections. But while the jury remains out as to whether some combination of these ultimately tips the US economy into recession anytime soon, it is unlikely that we see anything arise that will derail the deflationary correction we expect to see in the US TL market over the balance of the year and into 2023. The only real questions will be ‘how low will we go?’ and ‘for how long?’. Of course, we have guidance to share on both, which we’ll get to. But first, let’s take a moment to review all of the new data points released over the past few weeks as we summarize current market conditions.
While much of the plunge in our US DAT TL Linehaul Spot Index last month could arguably be blamed on the +27% M/M surge in diesel prices, with linehaul Van rates dropping -8.4% while all-in rates fell only -1.3%, no such argument exists in April for the wishful thinkers out there. With diesel remaining flat M/M at $5.106/gal, linehaul Van rates took another -10.0% step lower while linehaul Reefer rates dropped another -10.2%. And after an impressive surge higher in March to buck the down trend, linehaul Flatbed rates have leveled off and remain…well, flat so far in April. And all of this in a month where early produce and construction season activity is supposed to begin tipping rates higher across the board. So much for typical seasonal patterns. But then again, that is exactly what happens in the deflationary leg of the TL Market Cycle where we have plenty of surplus capacity to adapt efficiently to short-term dislocations like the annual harvest, hurricanes, and even a potential surge of imports from China as lockdowns are removed and supply chains are reactivated in the weeks and months ahead. While all of these things may well come to pass and distort freight flows in the US over the quarters ahead, we don’t expect Spot TL rates to spike materially higher as a result. So, if you are looking for historical models to provide any predictive insight for this upcoming produce season, we recommend you go back to 2019 or even 2016. As if your forecasts are based on the last two years alone, you’ll likely be missing the mark to the high side all year long.
With all of that said and with our Q1 US DAT TL Linehaul Spot Index now revised slightly lower to +17.3% Y/Y ($2.64) vs. the +17.8% ($2.65) reported last month, we now kick off Q2 with a preliminary read of -6.7% Y/Y ($2.24) vs. our forecast of -10.0%. And just as in past cycles, while we have been decelerating steadily since the Winter Storm Uri kink in Q2 2021, the broader market didn’t really feel it until we crossed our x-axis and finally broke deflationary Y/Y. And just as in past cycles, if you waited until now to do anything about, it is probably too late to create any real competitive advantage around this initial break – regardless of whether you are a Shipper, a Carrier, or a Freight Broker. That said, now that we’re down here, it’s never too late begin positioning for the next move as we anticipate our deflationary inflection point in the quarters ahead and prepare for the next Y/Y inflationary surge higher in mid to late 2023.
And while we have our first glimpse of Q2 and the deflationary leg ahead of us in the Spot TL market, we won’t get our first Q2 read on the Cass Linehaul Index (our proxy for the US TL Contract market) until next month. In the meantime, we did get a comparatively strong March print of 163.4 – after back-to-back 158.0s – to bump the final Q1 read to +13.2% Y/Y and all the way back up towards our cycle peak of +13.9% observed in Q2 2021 and well over our forecast of +7.5%. That said, just as our Q1 kink in the Spot TL index has resolved itself sharply lower this quarter, we expect the Q2 Cass Linehaul Index to snap back towards our forecast line to land somewhere in the neighborhood of +3-5% Y/Y before going deflationary itself in the back half of the year.
We’ll finally get preliminary Q1 2022 GDP and Consumption data later this month on the 28th, so look out for a potentially explosive May issue should we finally get some signal around the expected shift in post-COVID consumption patterns to favor Services at the expense of Durable and Nondurable Goods. But if US Industrial Production is any indicator, it would suggest that the reports of the demise in Goods spending have been greatly exaggerated. After opening the quarter with a January read of 5.1% Y/Y before revising slightly higher to 5.2% in February, the March number takes the final Q1 close still higher to +5.4% Y/Y and a full 100 basis points over Q4 2021’s +4.4%. So, if there is a recession coming up just around the next bend, we’re not seeing the deceleration lower in Industrial Production that historically comes first to signal its impending arrival – at least not yet.
Moving on to Inventory levels, recall that we got our first glimpse at Q1 with the January read on the Inventory to Sales Ratio coming in at 1.25, compared to the previous quarter’s 1.26. And given the narratives around a potential overshoot in retail and wholesale purchasing during last quarter’s peak retail season to mitigate against global supply chain disruptions and potential stockouts, we had expected this number to come in somewhat higher as a signal that inventory levels were finally rebuilding after the historic run-up in goods consumption throughout the pandemic. And as the potential for another disruptive surge in imports from Asia is unleashed in the months ahead as China eventually emerges from COVID-related lockdowns, relative Inventory levels will likely move front and center as we search for signal given all of the economic crosscurrents in play. In the meantime, the February read took us only slightly higher to 1.26 – so arguably in the right direction, but not by much. That said, if we look beneath the aggregate Total Business number, we see some potentially troubling signals. While that number has remained rangebound at 1.25-1.26 for much of the past year, Retail Inventory to Sales has jumped 6 bps from 1.08 to 1.14 over the last three months with Manufactures and Wholesalers holding mostly flat. Yes, Retail inventory levels remain well below historical levels even with this recent move. But if this trajectory holds, it could ultimately signal a slowdown in Consumer spending and the initial signs of the dreaded bullwhip effect, which would only be amplified should be begin receiving a slug of delayed imports from China that we ultimately find US Consumers no longer have an appetite for.
Now as we turn our sights more directly to US TL volume demand, we find that our ‘convergence and crossover’ narrative around our two primary indicators has gotten even more dramatic. Recall that one of the more interesting story lines in recent months has revolved around the continued convergence and expected eventual crossover of our two TL demand indicators with Cass Shipments collapsing lower while ATA TL Volume trended slowly but steadily higher. And that if the current trajectories hold with March’s final revisions, we will see the crossover confirmed in Q1. And if that came to pass, that would suggest 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 not accounted for in the ATA data eventually began idling capacity or exiting the market altogether. As we commented last month, a crossover in Q1 seemed all but certain with Cass Shipments posting -1.8% Y/Y and ATA TL Volume showing +0.4% through February. But now with Cass revising back to the inflationary side of the axis to close at +0.5% Y/Y and now slightly north of our ATA TL Volume line, that outcome has become far less certain. So, it all comes down to the March read on the ATA index which posts at the end of the month. Will we get our crossover signal in Q1 or not? You’ll have to tune in next month to find out.
And moving on to the first of our primary Supply indicators, US Net Class 8 Tractor Orders which up until recently was perhaps the greatest head scratcher of them all in this cycle. We have remarked consistently in past 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, as 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 was easy to make the argument that things were indeed different this time around – that Net Class 8 Orders as a directional US TL Spot market indicator couldn’t be trusted. And that negative Y/Y Net Tractor Orders have more to do with a record +14-month OEM order backlog reported in recent months than diminished appetite for new capacity. But after diverging the last two quarters with Net Tractor orders closing negative Y/Y (Q1 closed flat to the last February revision at -49.4% Y/Y) while TL Spot rates remained conspicuously inflationary, based on our preliminary Q2 read on our US DAT TL Linehaul Spot Index, it would appear that we are back on track. As US TL Spot rates continue lower over the course of this Y/Y deflationary leg of the cycle, we should expect US Net Class 8 Tractor Orders to run increasingly Y/Y deflationary as well. From there, it will be interesting to see how correlated these two data series remain through the TL rate cycle’s deflationary inflection point and as we break Y/Y inflationary once again next year. Will the two-quarter lead Net Tractor Orders had on Spot TL rates over the last leg persist, with Net Tractor Orders breaking Y/Y inflationary a quarter or two before the TL spot market in 2023? Or will historic patterns resume once all of the COVID-induced supply chain distortions of the last two years are finally resolved?
Finally, on to diesel costs and the global energy market where there we remain in a relative holding pattern after last month’s fireworks. After seeing +$4/gallon in February for the first time since May 2014 and +$5/gallon only a month later with March closing at $5.105, April is tracking flat so far at $5.106/gallon. So while we had hoped that Q4 2021’s +48.5% Y/Y would represent our cycle peak, April’s preliminary Q2 2022 read of +59.0% Y/Y dashes those hopes, at least for now. And should we close Q2 anywhere near these levels, it will take out the previous high-water mark of +56.3% Y/Y observed in Q2 2008 on the front end of The Great Recession of December 2007 to June 2009. The only difference this time around is that US TL Spot rates had already risen to record levels, allowing the market to absorb the diesel shock without forcing Carriers out of the market in material numbers. So the only role that diesel costs will play from here will be in helping to set the market bottom where our Y/Y US DAT TL Linehaul Spot Index line will ultimately inflect higher as sufficient surplus capacity is forced to exit as their operating margins compress towards zero, or worse. If diesel runs still higher from here, we likely reach a shallower bottom sooner. And if it corrects lower, the market bottoms at a lower level and it takes us an additional quarter or two to get there.
Now with our first month of Q2 mostly in the rearview mirror, while the outlook for the broader US economy remains uncertain at best, the future direction of the US TL market continues to become clearer as historical patterns look to repeat themselves – as historical patterns tend to do. So as the TL Spot market crashes lower in the quarters ahead in search of equilibrium, the focus turns to inflationary or deflationary catalysts that could either stunt or accelerate that journey. And with Omicron BA.2 staying at bay for the most part (knock on wood), our short list of wild cards to pay attention to in the months ahead remains relatively short. That said, we do have one to add to the list this month while the list itself gets reshuffled a bit as market conditions evolve. So without any further ado, let’s get on with it:
1. TL-Intensive US Consumer Spending: While Russia’s unprovoked invasion of Ukraine continues to be a humanitarian crisis of epic proportions and represents an ongoing source of geopolitical risk that could still lead us into World War III, it is the inflationary impact to US Consumer spending that will leave the most direct mark on the US Trucking market in the months ahead. So, from that perspective, we bump this one back to the top of the list. And here we have two major market forces in play to consider, neither of which are particularly constructive to US TL Demand. On the one hand, we have the March CPI coming in hot at +8.5% Y/Y which by itself would be a cause for alarm. But then we compound that with the only real response the Fed can have here which is to raise interest rates, which even if done so gradually and carefully still makes a lot of the debt consumers took on through the pandemic more costly to service. And makes new debt to make up for the ongoing erosion in purchasing power cost prohibitive in many cases. So that’s market force one, less discretionary income to finance incremental consumption going forward. The second revolves around the reopening of the Service sector of the economy as COVID mitigation policies and mandates are lifted. As at least some of the diminishing pot of discretionary spending is reallocated towards travel, entertainment, and eating out, there is less to spend on Durable and Nondurable goods. So, while the US TL market enjoyed a ‘storm of the century’ demand environment through much of the pandemic, it is possible that as the weather turns in the months ahead, there could be an equal and opposite reckoning to contend with. To be clear, we aren’t seeing this in the macro data just yet but see enough reason for concern that we’ll be paying closer attention to every potential demand signal we can get going forward.
2. China COVID-19 Lockdowns: By now, many of you have probably seen the images showing a mass of snarled marine congestion off the east coast of Shanghai and around its port making their rounds on social media and mainstream news outlets. Or the images of idle container ports and factories with no people available to load and unload vessels or operate the production lines. So as China eventually lifts its COVID lockdowns in the weeks ahead and Asia-centric global supply chains begin to restart, it is difficult not to immediately think ‘well, here we go again!’. Eventually a bunch of those containers will find their way to US ports and trigger a new wave of US supply chain congestion that will drive logistics costs even higher thus fanning inflation to burn even hotter. And while we very well could see some version of that import surge play out in the months ahead, we don’t believe it will have a material impact on US TL Spot or Contract rates aside from perhaps slightly stalling the rate of decline for a quarter at most. It’s also quite possible that this is all inventory that has now missed its market demand window and ends up clogging inland supply chains such that Industrial Production is forced to react by ratcheting lower until the surplus is burned off, which means less demand for US TL capacity as a result not more. Hopefully, we’ll find out soon enough either way.
3. Russia’s Unprovoked Invasion of Ukraine: Given the inflationary effects noted above, the range of likely consequences to both the Demand and Supply sides of the US Trucking market seem to have revealed themselves for the most part at this point. The most direct impact has almost certainly come from the rapid spike higher in diesel prices, which we have already addressed. Should diesel surge still higher from here, the breakeven point for motor carriers rises and we likely see our deflationary inflection point sooner. And should they correct lower, we get the opposite effect and Spot Linehaul rates ultimately run lower for longer. So far, the impact of cyber warfare on the market remains negligible at best. But will that remain the case should the conflict somehow escalate further? In any case, this one will remain top of mind and heart but at the bottom of this month’s wild card list as the tragic situation evolves.
Last month we noted that “while we stood on the precipice of what we expect[ed] to be a steep drop in Y/Y US TL Spot Linehaul rates in coming quarters, it remain[ed] as important as ever not to panic or overreact.” Now that we’ve taken the first step of that steep drop, now is as good a time as any to take pause and re-assess your positions, regardless of what side of the market you’re on. And again, not to panic or overreact. To reiterate, through the first 24 days of April our preliminary Q2 US DAT TL Linehaul Spot Index sits at -6.7% Y/Y vs. a forecast of -10.0%. And our projection for the balance of the year pegs our deflationary inflection point at -25.0% Y/Y in Q4. For this to happen, that only means there is another -13.0% to go from current levels by the end of the year. Whether this math ultimately makes for a “bloodbath” or not depends entirely on how prepared (or not) the industry is to compete in this environment by the time we get there. And rather than operating on blind hope and wishful thinking, we encourage cold pragmatism and seeing the US TL market – and the world for that matter – for how it is rather than how we wish it to be.
To that end, while we outlined the set of market behaviors to expect in the months ahead as we shift from a state of relative supply scarcity to relative supply surplus in last month’s note, we will summarize again here for any new subscribers. As spot rates continue to break materially lower as compared to contract rates, we will see a continued rise in primary tender acceptance across most contract Shippers – not because of anything that the procurement or operations organizations have done differently (no, it wasn’t your new ‘Shipper of Choice’ campaign), but because more attractive options for Motor Carriers or Brokers increasingly cease to exist. On-time service levels gradually and steadily improve and the rate at which Carriers or Brokers give back previously accepted load tenders goes down. Nobody in procurement gets fired or forgoes their target bonus for blowing the linehaul freight budget this year. Along the same lines, be wary of procurement consulting firms or platforms offering huge savings from bid optimization and re-engineered workflows in this market. Much of that will happen naturally from the rate cycle alone, regardless of how you go to market or who manages the bid.
With that said, almost immediately we will see a surge in transportation procurement events with an avalanche of mini-bids, if not complete re-bids, unleashed by contract Shippers that seek not to renege on previously awarded contract freight, but only to ‘adapt and re-calibrate to an increasingly dynamic market environment’ – a term which they are all-too-familiar with from the wave after wave of supply-driven re-contracting that occurred in 2020-21. And finally, as spot TL rates continue to fade lower and contract rates are reset in the same direction, many of those recent investments in standing up or growing private fleets or expanding dedicated fleet contract commitments will begin to look ill-advised in retrospect relative to the broader market – so expect some reshuffling there for organizations that don’t have the stomach or the discipline to stick to their long-term strategies in the face of short-term opportunity and temptation. Contract-biased TL Carriers and Brokers will keep their fingers and toes crossed in hopes of retaining their awarded contracts for as long into the term as possible, many of which are probably already unwinding as we write this. Spot-biased service providers will find themselves increasingly out of position and work feverishly to increase contract exposure if they have the capability to do so. For spot-biased providers that are unable or unwilling to service contract commitments, times get increasingly tough as the market seeks to restore equilibrium. And unless an explosion in new demand shows up to save the day, that equilibrium can only come from surplus supply eventually exiting the market. So as stated last month, the name of the game will be survival. And the key to survival will be in maximizing the profitable revenue opportunities that exist in the market today, even if it takes some creativity and operational innovation to find and capture them. As the providers that can consistently max out closest to their maximum weekly profit potential will stand the best chance of survival through the downturn and position their organizations to outperform less disciplined or capable competitors as the US TL spot market surges higher Y/Y once again in late 2023.