[Excerpt from The Pickett Line May 2022 Issue]
While Spring has sprung across the Northern Hemisphere, bringing with it the promise of more favorable climate conditions in the months ahead, the outlook for both the US TL market and the broader economy continues to deteriorate. But as is the nature of seasons, for good or for worse, they don’t last forever. Conditions change as the cycle progresses and the actions taken during the previous phase eventually trigger the necessary reactions that follow. And that is where we find ourselves at this moment in time in the US Truckload Freight Market – in the midst of a phase change where the excesses of the inflationary leg of the cycle must be resolved before balance can be restored thus signaling the end of the current cycle and the beginning of the next. But regardless of which side of the market you operate on and therefore how the deflationary reckoning ahead ultimately impacts your business, remember that ‘this too shall pass’. That said, we also encourage you to make yourself comfortable. We’re gonna be down here for a while.
As we make our way further into this Y/Y deflationary leg of the 2020-23 US TL Spot Linehaul Rate Cycle, the narrative will shift decidedly from whether a material downturn is ahead of us (it’s already started) to how low will it go and how long it will last. So with the tone set, welcome to the highly anticipated May 2022 issue of The Pickett Line – where in addition to the normal monthly market update, we will resolve two of our more interesting open plot lines from recent months. After two quarters of stalemate, who will prevail as our post-COVID consumer wallet-share Champ? Will it be the volatile and unpredictable ‘Team Goods Consumption’? Or the wily and resilient ‘Team Services’? And with our two TL demand indicators converging in recent quarters, did we get our crossover signal in Q1 to suggest bearish TL rate conditions ahead, or not? All will be revealed as we unpack this most recent month of market data, but first thing’s first. What’s going on with US TL Spot and Contract linehaul rates?
Now over halfway through the quarter, our revised Q2 US DAT TL Linehaul Spot Index sits at -11.7% Y/Y ($2.12) vs. the -6.7% ($2.24) reported last month and our Q2 forecast of -10.0%. After dropping -11.4% from March to April, we have so far seen another -6.9% slide through May MTD. Though we also have to keep in mind that the DAT fuel surcharge also surged +12.5% over the same period, which puts all-in Spot TL rates only slightly below where they were the same time last year. It will be interesting to see if any short-term DAT index inflation shows up in the week ahead due to last week’s CVSA International Roadcheck. But if it does, we expect it to be just that – short-term. As noted in the past, while expected seasonal market dislocations like Roadcheck, the annual harvest(s), or even major hurricanes may temporarily arrest the slide in US TL Spot rates, or even spike them higher for a short period of time, a more permanent floor won’t be found until enough surplus capacity is unfortunately forced to exit the market. And while the first casualties are likely to be those Carriers most exposed to the spot market (vs. Contract or Dedicated) with the highest cost structures, no Carrier will be immune to these market pressures. For example, any Carrier regardless of size that took on additional fixed costs over the last two years under the assumption that Spot and Contract rates would remain elevated in the years ahead could find themselves operating under some fiscal duress over the next few quarters. As Warren Buffet said, “only when the tide goes out do you discover who’s been swimming naked”. And the tide just went out.
But while the Q2 US DAT TL Linehaul Spot Index is running right on forecast, the preliminary read on the Cass Linehaul Index (our proxy for the US TL Contract market) came in surprisingly strong at +12.9% Y/Y vs. last quarter’s +13.2% and our forecast of +3.0%. We had expected a more pronounced correction lower this quarter after our Q1 Omicron kink, as observed with our Spot Index line. But so far at least, Contract market rates remain stubbornly elevated. That said, we believe it is only a matter of months before enough of those contracts reset lower in accordance with Spot market trends and are maintaining our current forward guidance which has the Cass Linehaul Index closing Y/Y deflationary as early as next quarter.
Now, onto the macro. Back in January, we kicked off a Wrestlemania-themed narrative around the shifting consumption patterns observed throughout the last two years of COVID disruption – from Services to Goods during US pandemic lockdowns and then presumably back to Services as the economy reopened. ‘While Team Goods had been dominating this contest since the onset of COVID mitigation policies, it looked as if Q4 2021 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 then came 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.’ As a result, Durable & Nondurable Goods and Services all closed range-bound at +6-8% Y/Y for the second consecutive quarter. But with preliminary Q1 2022 numbers now in, will we finally get some resolution? It turns out the answer is Yes. Yes, we will. Based on this most recent data, Pickett Research is pleased to finally crown ‘Team Services’ the winner in the battle for post-COVID Consumer wallet-share growth with its Q1 read of +6.8% Y/Y, compared to a slide in Nondurable Goods to +3.3% and Durable Goods to -2.6% Y/Y and its first deflationary read since Q2 2020 and all of the way back to Q3 2009 before that. And with that, we put this corny narrative to rest and are now focused on the continued reckoning ahead.
At the aggregate level, Consumption faded lower to +4.7% Y/Y after hovering around +7.0% for the last couple of quarters, perhaps signaling a Consumer that is finally starting to show some weakness given the mounting economic headwinds. That said, the latest read remains well over pre-pandemic levels and you’d have to go all the way back to Q3 2000 to find a higher rate of pre-pandemic Y/Y growth. But largely as expected over much of the past year, the unprecedented run on Goods consumption at the expense of Services is finally normalizing. Now on the face of it, this should be a welcome development for global supply chains strained to great lengths over the last two years just trying to keep up with demand. But as we are already starting to see in a number of recent retail earnings reports, we now have a very different problem – too much of the wrong inventory in the wrong place at the wrong time. Just like the US TL market overshoots on capacity when market rates peak, supply chains overshoot on inventory, property, plants, and equipment when market demand peaks (consider Peloton to be Exhibit A). And both will face their inevitable reckoning in the quarters ahead as both surplus inventory and surplus capacity must be burned off before the economy and the trucking market can advance higher – which they will, eventually. Remember, this too shall pass.
But if Consumption data is indeed signaling an imminent slowdown, Industrial Production hasn’t gotten the memo. After closing Q1 at +5.4% Y/Y, we got a preliminary Q2 read of +5.7% that was slightly higher, not lower. As noted in past issues, a slowdown in both Consumption and Industrial Production have preceded just about every US economic recession over the past 70 years. And any divergence in the two, which we now have with Consumption fading lower and IP pointing higher, rarely lasts for long. So one will very likely reverse course to join the other in the months and quarters ahead, depending on which is more representative of the underlying strength and future direction of the economy. If Industrial Production is telling the truth, look for a softer economic landing and strong sustained growth ahead. If on the other hand it’s Consumption, then we should expect the opposite.
Now moving on to Inventory Levels, where we got our final Q1 revision on the Inventory-to-Sales ratio with March in at 1.26 –the third consecutive quarter at 1.26 since bottoming out at 1.25 in Q2 2021. Though as noted last month, while continuing to signal relatively low levels overall and thus constructive for future industrial activity and the demand for TL capacity, ‘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, the Retail Inventory-to-Sales ratio has jumped 6 bps from 1.09 to 1.15 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 be signaling a slowdown in Consumer spending and the initial signs of the dreaded bullwhip effect, which would only be amplified should we begin receiving a slug of delayed imports from China that we ultimately find US Consumers no longer have an appetite for.’ And with March’s numbers, we saw more of the same. Furthermore, if Walmart and Target’s Q1 earnings calls are in any way representative of the broader market, which they very likely are, we may be hearing the term “bullwhip” an awful lot in mainstream media in the months ahead. And we may once again find that too much of a good thing can very quickly become a bad thing.
And speaking of overdoing a good thing, this brings us to our second open plot line in need of resolution – ‘to converge and cross over or not to converge and cross over?’ Specifically, after converging steadily over the last few quarters, would our two TL demand indicators finally cross over each other and signal a Y/Y deflationary US TL Spot market ahead? If you’ve been following along this year, you’ll recall that while our Cass Shipments Index has been collapsing lower since peaking at +29.9% in Q2 2021 our ATA TL Volume Index has been inching higher since bottoming out at -4.9% Y/Y in Q3 2021. And that if trajectories held with March’s final revisions, we would see the cross over 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 cross over in Q1 seemed all but certain with the final Cass Shipments read posting -1.8% Y/Y while ATA TL Volume showed +0.4% through February. Now with our final Q1 ATA TL Volume read in at +1.2% Y/Y, we see that our Q1 cross over is indeed confirmed. Furthermore, with our preliminary Q2 Cass Shipments Index now on the board at -4.4% Y/Y and its first Y/Y deflationary read since Q3 2020, that cross over is even more pronounced. This gives us yet another reinforcing signal supporting our Y/Y deflationary forecast for US TL Spot Linehaul rates over the balance of the year. Going forward, we expect Cass Shipments to break lower and lower while ATL TL Demand climbs higher and higher as the Supply side re-calibrates to surplus truckload market conditions. We also expect Cass Shipments to serve as a leading indicator for Industrial Production over this leg of the cycle, which means that IP may have no choice but to break lower in the months ahead as our Q2 read revises further.
Now moving along 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 current 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 went Y/Y net orders so went US TL Spot linehaul rates. But this time around, we observed two quarters where that relationship diverged for the first time, with Y/Y Net Tractor Orders plunging deflationary in Q4 2021 and Q1 2022 while TL Spot rates remained stubbornly Y/Y inflationary. However, that divergence was resolved this quarter with Net Tractor Orders remaining deflationary with April’s preliminary Q2 read showing -45.0% Y/Y (vs. -49.4% Y/Y in Q1) while TL Spot Linehaul rates finally joined them with its own deflationary preliminary Q2 read of -11.7% Y/Y. From here, and now that we are back on track, 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.
Finally, on to retail diesel costs where after holding relatively flat M/M in April at ~$5.10-$5.12/gal we moved another material leg higher this month to reach $5.58/gal MTD – with many parts of the country already registering well north of $6. Now at +73.5% Y/Y for May, we are officially in record territory as we take out the prior mark of +66.6% Y/Y from June 2008. Our revised Q2 2022 now sits at +59.0% Y/Y, also another record. So here we are back to diesel inflation levels not seen since The Great Recession
of December 2007 to June 2009, which resulted in an unprecedented wave of carrier bankruptcies and defaults. But as noted last month, the key 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 – at least not yet. And the only role that diesel costs will likely 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 finds a way to run still higher from here, we likely reach a shallower bottom sooner. And if it corrects lower, then the market bottoms at a lower level than currently projected and it takes us an additional quarter or two to get there.
So now over halfway through Q2 and with another month of market data accounted for, we find that while the outlook for the broader economy has deteriorated somewhat, our expectations for the US TL Spot and Contract Markets over the balance of the year remain unchanged. And the same goes for our short list of wild cards to pay closest attention to in the months ahead as TL spot rate crash further in search of market equilibrium. So as outlined in last month’s note, they are as follows:
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. And here we continue to 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 April CPI coming in at +8.3% Y/Y, only slightly cooler than March’s +8.5%, 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 nudge interest rates higher, which even if done so gradually and carefully still makes any floating rate debt consumers took on through the pandemic more costly to service. And makes any new debt taken on to make up for the ongoing erosion in consumer purchasing power more burdensome as well. 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 and entertainment, there is less to spend on Durable and Nondurable goods – which we have started to see play out in the preliminary Q1 Consumption numbers. So while the US TL market enjoyed ‘perfect storm’ demand conditions through much of the pandemic, it is looking increasingly likely that as the weather turns in the months ahead, there will be an equal and opposite reckoning to contend with. To be fair, we haven’t seen anything that points to an erosion in US TL demand reflected in the Industrial Production data yet. But if Household Debt and Real Wage Growth are leading indictors for Consumption and Consumption is a leading or coincident indicator for Industrial Production, it is looking increasingly likely that a slowdown is indeed on the horizon.
2. China COVID-19 Lockdowns: As hard as it is to believe, China’s COVID-mitigation lockdowns persist. But as China continues to gradually lift its COVID restrictions in the weeks ahead (we mean it this time!) and Asia-centric global supply chains begin to restart, it remains 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 from here. And while we very well could see some version of that import surge play out this summer, we don’t believe it will have a material impact on US TL Spot or Contract rates. In fact, as the US Consumer faces more and more headwinds while the Fed works to combat runaway inflation and prevent the economy from overheating further, it is becoming increasingly likely that much of that inventory may have missed its market demand window and will end 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.
3. Russia’s Unprovoked Invasion of Ukraine: Given the inflationary effects already 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 and ongoing spike higher in diesel prices, which we have already addressed. Should diesel somehow 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 continues to play out.
So to summarize, after guiding for a steep drop in Y/Y US TL Spot Linehaul rates to break Y/Y deflationary by Q2 of this year for the last couple of quarters, here we sit at -11.7% Y/Y with 39 days left to go. From here, we expect to fade at least another 5-10% lower (at current diesel prices) before reaching our deflationary cycle inflection point around -25.0% Y/Y by Q4. Contract linehaul rates continue to hold up for another few months, but eventually follow the Spot market and break Y/Y deflationary in the back half of the year. So, while it may feel at times that this market turns on a dime, it really doesn’t. It will grind lower and lower until temporary equilibrium is reached, a floor is set, and conditions exist that are conducive to a market recovery to send rates Y/Y inflationary once again by the back half of 2023. Like we said at the top, make yourself comfortable. We’re gonna be down here for a while – at least another few quarters. Or better yet, once you’ve accounted for your relative position, exposure, and risk factors given this outlook for the balance of 2022 and are confident in your likelihood of survival, use this time to reload, rebalance, and reposition for the next inflationary leg of the cycle. If you made a bunch of bad long-term decisions last year like everyone else who over-extrapolated then-current market conditions up and to the right, shine a light on them. Don’t look away. Study them. Learn from them. Because if you stick around long enough, you’ll get another shot.
So, 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 March’s note, we will summarize them here again here for any new subscribers. Because nothing has really changed in this regard. 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, but because more attractive options for Motor Carriers or Brokers increasingly cease to exist. On-time service levels run at historic highs and the rate at which Carriers or Brokers give back previously accepted load tenders remains low. 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, we will continue to 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 further reshuffling there for organizations that don’t have 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. 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 repeated in recent months, 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 it will be the providers that can consistently run closest to their maximum weekly profit potential that will stand the best chance of survival through this downturn and position their organizations to outperform their less capable competitors as the US TL spot market surges higher Y/Y once again by late 2023.