[Excerpt from The Pickett Line July 2022 Issue]
Here we are in late July and well into the dog days of summer. As we kick off Q3 and peer into our US Truckload market crystal ball once again, what immediately comes to mind is a question that many of us with young children get a lot this time of year during long family road trips – ‘Are we there yet?’ But in this case ‘there’ is the bottom of the TL spot market cyclical trough and the Y/Y deflationary inflection point that signals our turn towards the next Y/Y inflationary leg and the beginning of the next cycle. Unfortunately, just as in that case, the answer is sadly ‘No…and you can’t ask me that again for two more quarters.’ Only kidding, our road trips are never actually that long, though they sure do feel like it sometimes. In any case, you get the point. We’re not there yet and it’s going to be quite a while before we are. But before you ask ‘has it been two quarters yet?’ which is often the very next question in the car, let’s turn our attention first to the Q2 that we just left in the rearview mirror then on to July and the road ahead. And ‘don’t make me come back there!’
So as we begin to unpack this July 2022 installment of The Pickett Line and get our first glimpse of a new quarter, let’s take a minute to look back to see where Q2 ultimately settled. In last month’s note, our US DAT Linehaul Spot Index was sitting at -12.9% Y/Y and $2.09/mi on the quarter. With June now settled, our Q2 read moved a penny lower to close at -13.3% Y/Y and $2.08/mi vs. our forecast of -10.0%. Considering that the Q1 before it closed at +17.3% Y/Y, this represented an aggregate 30.6% percentage point move lower over just one quarter. While a quarter is still a fairly long period of time, this was pretty steep by all historical measures – though right in line with our forecast. What likely made this move in the cycle so extreme was the unexpected kink higher that we observed in Q1 driven by the surge in COVID-19 Omicron infections in early January that created acute staffing shortages across critical links in the US supply chain, especially truck drivers and support personnel. And just like Wile E. Coyote out over the cliff sprinting furiously in mid-air, gravity eventually caught up with us this quarter and down towards the valley floor we went.
But while this 30.6% deflationary move lower was unusually severe, it is not entirely without historical precedent. In fact, we saw the exact opposite on the front end of this cycle when the onset of COVID-19 mitigation policies stalled the US TL Spot Linehaul cycle to close Q2 2020 flat with the Q1 before it at -2.9% Y/Y. With the next quarter closing at +27.6% Y/Y, this represented an aggregate 30.5% move higher. So we got a coiled spring to catapult us +30.5% points higher in one quarter and a temporary air pocket that, once removed, sent us hurtling -30.6% points lower in the other. Apparently, at least when it comes to the US TL Spot Linehaul Market Cycle, what COVID giveth COVID eventually taketh away. You really do have to admire the symmetry.
That said, we have observed no such reckoning in the Contract market. At least not yet. After kinking unexpectedly higher to +13.2% Y/Y in Q1, along with the Spot market index, it continued to defy gravity in Q2 to close only slightly lower at +12.9% Y/Y vs. our forecast of +3.0%. Interestingly enough, just as in the Spot market, we observed a historically steep leg higher in our Contract Index (Cass Linehaul) in this current cycle to launch us Y/Y inflationary in Q1 2021 – from -0.4% Y/Y in Q4 2020 all of the way to +8.5% Y/Y just one quarter later, an +8.9% point aggregate move. Over the last 15 years that we have been paying attention, we have never seen a one quarter move in the Cass Linehaul Index anywhere near that in terms of magnitude. So what comes next? As Contract TL rates tend to follow Spot TL rates by a quarter or two, they are virtually guaranteed to fade lower Y/Y. But for the same type of symmetry to show up here, we would need to see a comparable -8.9% point aggregate move lower this quarter…or possibly the next. If we get it here, that means a Q3 close of +4.0% Y/Y…down from Q2’s +12.9%. That would put us right in line with our adjusted (last quarter) Q3 forecast of +5.0% Y/Y. Even we would find that spookily consistent with the nature of cycles and there’s nobody more all-in on the cyclical nature of this market than the hedgehogs at Pickett Research. This certainly looks like the next dramatic storyline in this current TL market cycle Ladies and Gentlemen. In one corner of the US TL Contract Linehaul market, hailing from ‘the middle of nowhere’ (Looney Tunes fact, look it up) and wearing the…well, not wearing any trunks it appears…we have Wile E. Coyote. In the other, we have Gravity. Where’s Michael Buffer (“Let’s get ready to rumble!”) when you need him. In any case, we’ll be perched precariously on the edge of our seats until next month’s issue when we report on our first glimpse of Q3 with the July read releaed mid-August.
So with a bow now firmly tied on Q2, let’s shift gears to July and Q3. Just over halfway through this first month of the quarter, our preliminary Q3 US DAT Linehaul Spot Index sits at -19.3% Y/Y ($2.01) vs. our forecast of -17.5% – so tracking right in line. As noted last month, since our initial -17.3% Y/Y ($0.43/mi) drop in the index from March to May, we’ve been treading water for the most part – fading only $0.04 further since then. And while the answer to ‘Are we there yet?’ remains a hard ‘No’ with regard to the passage of time, as we won’t be in a position to confirm our projected Q4 deflationary inflection point of -25.0% Y/Y until the middle of January 2023 at the earliest, the $1.95/mi that this forecast represents is but a mere $0.06 lower from our current position. So from this perspective, we can instead happily respond with a ‘Yes, now please stop asking for the love of God.’ Or something to that effect. Which all goes to mean that we expect to grind it out down here at $1.90-2.00/mi over the balance of the year until enough over-costed or otherwise uncompetitive capacity is forced to exit the market, either temporarily or permanently, to counter the supply-side excesses that shaped the last two years.
As we said, we don’t get our first glimpse at our Q3 Cass Linehaul Contract Index until next month. And speaking of next month, as we’ve been anxiously commenting on in the last couple of issues, after last quarter’s resolution to the battle for post-COVID Consumer wallet-share growth with Team Services taking down Team Goods in relatively anticlimactic fashion, we couldn’t wait until our next read on Consumption and Imports was released with preliminary Q2 GDP coming up on July 28th. Will Team Goods miraculously regain consciousness and leap off the mat Hulk Hogan-style to sneak up behind Team Services, break up the victory party, and extend the match for another round? Or has America’s appetite for (and/or the means to consume) more Pelotons, patio furniture, and pickup trucks (EV or otherwise) finally run dry leaving the Services sector as the primary recipient of any discretionary dollars the US Consumer still has available to spend after surging inflation and rising interest rates? We’ll find out together in next month’s increasingly action-paced issue of The Pickett Line. Now onto the rest of the macro.
Our narrative last month centered on the notion that while there were plenty of economic headwinds out there to account for, whether it be historic levels of consumer and producer inflation, a hawkish fed hell-bent on raising interest rates in rapid fashion to slow the economy enough to tame them, and the specter of a looming economic recession that could come as a result, from our perspective things didn’t look nearly as bad as the broader media was portraying. And that goes for the US TL market as well. While Yes, we are in the depths of a Y/Y deflationary leg of the Spot Linehaul rate cycle, overall TL demand has yet to show any signs of major collapse. Material deceleration? Absolutely. Collapse? No, at least not yet. And we see that reflected in the recent earning reports of just about every publicly traded asset-based trucking company. The larger more diversified fleets with relatively more exposure to the Dedicated and Contract markets are doing just fine, Thank You. While the boom times surely won’t last for more than another quarter or two as Contract rates begin to adjust lower, we see nothing that screams ‘imminent recession’ or ‘truck-pocalypse zombie bloodbath’…though I admit I can’t help but click on those headlines too.
One of the more encouraging indicators that have kept us from getting overly pessimistic has been Industrial Production. As noted last month, we find ourselves at an interesting point in time where Consumption and Industrial Production have basically converged – with Consumption fading sequentially lower with Q1’s +4.8% Y/Y and Industrial Production holding steady with Q2’s final read of +4.6% Y/Y after fading 110bps from May’s revised Q2 read of +5.7%. While both point lower not higher, they currently sit at historically very healthy levels. And given the strong correlation of these two data series over time, Industrial Production will likely follow Consumption’s lead in the months and quarters ahead. So, if preliminary Q2 Consumption comes in materially lower next week, we should expect IP to weaken as well which likely means sequential weakness in TL demand going forward as a result. It’s just a matter of how much and for how long. That said, from where we currently sit, both indicators have a long way to go before hitting levels that are in any way comparable to the last four recessions. And until we see a material move lower, call it +250 bps, we remain cautiously optimistic.
Contrary to Consumption and Industrial Production, both Imports and relative Inventory levels continue to track higher on a Y/Y basis. As with Consumption, we’ll get our next Imports read next week with Preliminary Q2 GDP, but Q1’s +11.8% Y/Y was up from its prior quarter read of +9.6% and most of the volume data coming from the ports over the last few months has been generally constructive. And as noted last month, the Q2 Inventory to Sales ratio was finally breaking out of its 2021 range of 1.25-1.26 with its preliminary April print of 1.29. With May now baked in, we’ve gained another 10 bps and revised up to 1.30…and appear to be headed higher. And while rising relative inventory levels are consistent with past recessions, current levels remain at historically low levels. But a rising Inventory-to-Sales Ratio over time, if it goes high enough, can certainly act as a drag on Industrial Production and help trigger a recession. Though as noted last month, a silver lining could be that surplus inventory levels should also be a deflationary force as retailers mark down prices to burn through the excess, which would help the Fed in its tightrope act and keep the risk of a hard landing for the economy at bay. In any case, to get some signal as to what lies ahead for both inflation and economic activity overall, the relative change between Consumption, Imports, and the Inventory-to-Sales ratio over the next few months should be telling.
Now onto US Truckload Demand itself, as interpreted through the relative behavior our two TL demand indicators – ATA TL Volume & Cass Shipment. As you may recall, they crossed over each other in Q1, with ATA climbing higher Y/Y and Cass Shipments bending lower, thus signaling a change in TL market direction from a state of relative supply scarcity to one of relative supply surplus. At least, that is our hypothesis. In Q1, the divergence in the two measured only 70 bps. With ATA TL Volume at +1.02% Y/Y and Cass Shipments at +0.5% Y/Y. Now with Q2 Cass Shipments fully baked and a final read of -1.8% Y/Y (no change from last month) and ATA’s revised Q2 May read up slightly from +3.5% Y/Y to +3.8%, that divergence has grown to 5.6% points or 560 bps. And growing divergence implies that TL capacity is indeed exiting market at a faster rate than TL demand may be slowing. But while TL demand as measured by the Cass Shipments Index may be slowing as compared to the last two years of nosebleed Y/Y inflation, at -1.8% Y/Y we are basically treading water at a more neutral level. So despite the headlines claiming otherwise, so far least, demand has not shown any signs of falling off a cliff. Again, we may get there if Industrial Production makes a material move lower in the months ahead in response to deteriorating Consumption levels, we’re just not there yet.
Let’s move on to the first of our primary Supply indicators, US Net Class 8 Tractor Orders. Up until recently, this one was the greatest head scratcher of them all in this current cycle. We have remarked pretty 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. And the same goes for the other direction. Just like clockwork, as go Y/Y net tractor orders so goes US TL Spot linehaul rates – and vice versa. But this time around, we observed two quarters where that relationship diverged materially 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 in Q2 with Net Tractor Orders remaining deflationary on a final read of -47.4% Y/Y (up slightly from May’s Q2 revision of -48.8%) and the Q2 DAT US TL Spot Linehaul Index closing at -13.3% Y/Y. Going forward, we expect net orders to remain Y/Y deflationary for at least the next few quarters. From there, it will be interesting to see if they return to historic patterns relative to US TL Spot Linehaul Rates or if they shift to instead lead Spot Rates into the inflationary leg of the next freight cycle after leading them into this current deflationary leg by a couple of quarters.
Finally, on to retail diesel costs which as we all painfully know have exploded steadily higher all year long – from $2.68/gal in January to $5.75/gal in June. But with July’s MTD read of $5.62, we are finally getting a signal that perhaps a ceiling has been found. Sure, a 13-cent haircut from $5.75 price at the pump (-2.2%) hardly warrants a collective sigh of relief but it’s a start. And with Q2 closing at +70.7% Y/Y, July’s very preliminary Q3 read of +67.4% Y/Y reinforces that glimmer of hope that maybe, just maybe, runaway diesel inflation may finally be poised to correct lower in the months and quarters ahead. As noted last month, the last time we saw anything like this was in 2008 where diesel climbed to +66.6% Y/Y that June – in the midst of The Great Recession. During that TL Market Cycle, diesel spiked higher several quarters ahead of Spot and Contract rates. As a result, we saw an unprecedented wave of motor carrier bankruptcies as profitability was wiped out – especially for those most exposed to the spot market. The key difference this time around is that Spot and Contract rates led diesel by several quarters, which has allowed the market to absorb the diesel shock without forcing Carriers out of the market in material numbers – at least not yet. Consider that July MTD all-in National DAT Spot Van rates are -3.0% lower Y/Y while national diesel costs are up +68.4%. That only happens if there are enough Carriers out there with enough room still on their Operating Income line to continue to run profitably even after absorbing that kind of gut punch at the gas pump. So as the battle rages on, the role that diesel costs play from here will be in helping to set the market bottom where our Y/Y US DAT TL Linehaul Spot Index line ultimately inflects higher as sufficient surplus capacity has been forced to exit as their operating margins compress towards zero, or worse. If this proves to be only a temporary reprieve and diesel finds a way to run still higher from here, we likely reach a shallower bottom sooner. But should this turn into a sustained correction materially lower, then the market bottoms at a lower level than currently projected and it potentially takes us an additional quarter or two to get there.
So…are we there yet? Again, Yes and No. While we have another couple of quarters to spend down here in search of our market bottom and our Y/Y deflationary inflection point in US TL Spot Linehaul rates, we don’t believe we are too far from that eventual bottom rate-wise. And as the Supply side painfully rebalances over the balance of the year towards a temporary equilibrium point that will allow the market to finally make its turn higher towards recovery, keep in mind that the market will be much less vulnerable to inflationary shocks of any kind. This is in stark contrast to conditions during the inflationary leg of the cycle where seasonal dislocations, hurricanes, and CVSA International Roadcheck blitzes can be pretty disruptive as supply adapts and re-calibrates while in a state of relative scarcity. During the deflationary leg like the one we are in, there is plenty of surplus supply out there to absorb those shocks without spiking rates materially higher for any meaningful period of time. So regardless of what Mother Nature throws at us this hurricane season, the TL market will be much more forgiving than it was last year or the year before. We would also file the recent ruling on AB5 in California in the same category. Regardless of opinion on the bill itself (seems pretty sub-optimal and ill-advised to us), while we expect plenty of noise around protests and possibly some disruption at the ports should drayage capacity models begin to shift in any material way, there is enough surplus TL capacity out there at this moment in time to re-calibrate without materially impacting market rates in CA or anywhere else. So with the notion that there tends to be very little that can shock the US TL market during the deflationary leg of the cycle (which will make for an unusually boring TL news cycle though we’re sure they’ll figure something out to drive clicks), let’s cover our short list of wild cards to focus on in the month ahead. With the Russian invasion of Ukraine, China’s rolling COVID lockdowns, and California AB5 all coming and going (only in terms of their expected impact on the TL market), we continue to focus on US Consumer spending and Diesel costs as the only forces that are likely to move the needle. Let’s briefly elaborate:
1. TL-Intensive US Consumer Spending: The headwinds in play for the US Consumer today are numerous and only getting tougher – June’s +9.1% Y/Y print on the CPI shows no sign of an inflationary peak yet, rising household debt coupled with rising interest rates continue to eat into discretionary income, the housing and labor markets are cooling, and the increasing risk of recession is threatening either perceived or real job security and therefor the appetite to consume. That said, it’s not all doom and gloom out there. Unemployment remains historically low and as the Service sector emerges from its long slumber as COVID mitigation policies expire (knock on wood), experiences like air travel, vacations, sporting events, and concerts are finally back in the rotation as life returns to some form of pre-COVID normalcy for many. And while we have seen this compounding effect of less discretionary income and the allocation of that income to other things take Goods Consumption negative Y/Y in Q1, the jury remains out as to where we go from here. As noted, TL volume indicators remain stable and Industrial Production continues to hold up as Consumers have absorbed the headwinds and soldiered on. But how much gas is left in the tank as the Fed continues to tighten, the economy slows, and conditions likely get worse before they get better? Hopefully we get some constructive signal in next week’s preliminary read on Q2 GDP.
2. Diesel Prices: Speaking of ‘gas left in the tank’, that gives us a convenient segue to our second wild card, the rapid spike higher in diesel prices. Perhaps more than any other market force, diesel costs in the months again will determine our bottom in TL Spot Linehaul rates – both the ultimate destination and how long it takes us to get there. As noted earlier, 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. In in any case, we don’t expect it to get any easier out there anytime soon for motor carriers – especially those that are dependent on the spot market to get loaded and stay loaded.
And there you have it. As we enter our second quarter of the Y/Y deflationary leg of this current US TL Spot Linehaul rate cycle, things remain pretty sluggish out there as the market continues to grind out surplus capacity in search of our inflection point. So these very much are the dog days of summer as we mentioned at the top, both seasonally and with regard to the US TL Market Cycle. And for anyone that may be wondering where that term came from or what it means, there is no better time than the present to brush up on some phrase origin trivia. According to our friends at Wikipedia, the undisputed arbiters of crowd-sourced truth, “the dog days or dog days of summer are the hot, sultry days of summer.” Okay, check. “They were historically the period following the heliacal rising of the star system Sirius (known colloquially as the “Dog Star”), which Hellenistic astrology connected with heat, drought, sudden thunderstorms,
lethargy, fever, mad dogs, and bad luck.” Um okay, not sure about the mad dogs, but everything else checks. “They are now taken to be the hottest, most uncomfortable part of summer in the Northern Hemisphere.” So it turns out ‘the dog days of summer’ is a nod to the rising of the Dog Star system during this time of year and the implications of such according to Hellenistic astrology. Makes sense to me. While this is no doubt the most uncomfortable part of summer in the Northern Hemisphere (especially here at Pickett Research HQ in Chicagoland), this time around it also represents the most uncomfortable part of the US TL Market Cycle for many of us. But remember that as uncomfortable as things feel, this too shall pass. That is the nature of cycles, after all. And as we continue to navigate this downturn, every day that passes gets us closer to the next upturn. You just have to be alive and still in the market when we get there to benefit from it. So with that now settled, here’s to a constructive Q3 ahead. And watch out for those mad dogs.