[Excerpt from The Pickett Line October 2022 Issue]
While we have plenty to cover as we get our first glimpse of Q4 data points, as with any first month of a new quarter, we must first look back at where the dust settled with Q3. In last month’s issue, with but a week left to go, our Q3 DAT US TL Spot Linehaul Index sat at -21.7% Y/Y ($1.95) vs. a forecast of -17.5% ($2.05). And with that week now behind us and the quarter officially wrapped, that is exactly where it closed. So we find ourselves running 420 bps below our forecast line, just within our target range of 500 bps and directionally right on track. Now the question becomes ‘what happens from here?’ Will we find our market bottom this quarter where we form our deflationary inflection point and begin our journey back towards Y/Y inflation land in 2023 as projected? Or does the market have other plans? With most of October now in the rearview mirror, we are beginning to find out. So let’s get on with it.
Given the trajectory of our DAT US TL Spot Linehaul Index as we closed out September, we expected that Q4 would likely open a little soft, posting under our -25.0% Y/Y ($1.95) forecast – call it $1.85-$1.90 – before revising slightly higher in November and December. And so far in October, that is exactly what we are seeing with our preliminary Q4 read coming in at -27.7% Y/Y ($1.88). So for all of the readers that have been following along patiently while on the edge of their seats over the last several months wondering ‘are we there yet?’ At long last, we believe we are. We believe that the market is finally forming a bottom at which excess supply is exiting the market at a rapid enough rate to stem further declines in spot market rates. Should this continue to play out, this quarter will represent the deflationary inflection point of this current rate cycle, which began in Q2 2020 and is projected to end in Q3 2023. And given how long we often have to wait between cycle inflection points, typically 6-8 quarters, the freight nerds and writers at Pickett Research like to celebrate the occasion – with excessive puns and especially corny story lines. Yeah, we’re a wild bunch over here. Though we’ll try to tone it down a bit this time, given the tepid response to our February 2021 issue titled “From Election to Insurrection to Inflection: A Reflection on the Complexion of the Market’s New Direction”. Crickets. In any case, know that this is a special time in the US TL Spot Market Rate cycle, which makes this particular holiday season all the more festive. So hug a truck driver the next chance you get, though we recommend asking permission first. The same goes for dispatchers, demand planners, forklift operators, logistics coordinators, and procurement managers. Nobody deserves one more given the year we’ve had, on top of the one we had before it.
Now with the spot market covered and the spirit of goodwill in the air, let’s check in on our much-hyped battle between contract linehaul rates and gravity. For any new readers this month, the backstory on this one goes as follows: our hypothesis was that while peak contract linehaul rate levels got artificially extended by a quarter or two, courtesy of the Q1 2022 COVID-19 Omicron surge, they would likely be breaking materially lower in Q3 to follow spot rates as market gravity finally took over. So much like Wile E. Coyote out over the cliff furiously sprinting in place, we would soon find ourselves tumbling to the valley floor. Or in our case, deflationary Y/Y market rate levels – though the first stop would be Q3’s forecasted close of +5.0%. Through last month, with the revised Q3 Cass Linehaul Index showing +8.3% Y/Y, we had already fallen 460 bps from Q2’s +12.9% but remained well above forecast. With September now accounted for and a final Q3 read of +7.2% Y/Y, we came up 220 bps short. That said, given the slope of the correction so far and the magnitude of the divergence to the spot market, we continue to expect that contract rates as represented by the Cass Linehaul Index will break Y/Y deflationary in Q4 and maintain current guidance at -3.0% Y/Y. So gravity remains ahead on points but has yet to deliver the decisive knockout that we had speculated coming into Q3. Though to close the current 720 bp gap and go Y/Y deflationary this quarter as projected, that is exactly what will need to happen. You better refill that popcorn ladies and gentlemen, this one is going at least another round.
Now onto the macro picture, where the relative likelihood of a recession continues to revise higher almost daily across most financial and mainstream media outlets. Has it already started? Is it coming in 2023? We continue to maintain a much more constructive outlook, which the most recent data has only helped reinforce. While we patiently wait for the next Consumption and Import data points to publish with the preliminary Q3 GDP report on October 27th, we did get a revision to Q2 this month that took Consumption from +1.9% Y/Y up a very material 50 bps to +2.4% and back to pre-COVID levels of 2018. Which will make the Q3 number that we’ll soon find out all the more interesting. As noted in past issues, as we ponder the likelihood of a US recession in our near future, aside from the direction of Consumption overall, the number one pattern we look at is the relationship between Consumption and Industrial Production. While the current direction of Consumption remains troubling (i.e. pointed lower), at +2.4% Y/Y we are well above levels observed in each of the last four recessions. And while the current divergence in Consumption and Industrial Production is a cause for concern, whether it proves to be a signal for a much more dramatic slowdown in industrial activity will be dictated by how it resolves itself in the quarters ahead. But for this month at least, the data resolved itself in a positive direction. In addition to the 50 bp revision higher for Q2 Consumption, Q3 Industrial Production revised slightly higher to close at +4.2% Y/Y vs. last month’s +3.9%. So which data point is ultimately telling the truth about the US economy? Will Consumption continue to pull higher to meet Industrial Production at +4-5%, implying that IP is the better read and a soft landing may indeed be in our future? Or will IP break down to follow Consumption lower as the US consumer finally succumbs to the pressure of historic inflation and rapidly rising interest rates? Stay tuned for the November issue of The Pickett Line where we’ll find out.
However, it wasn’t all ‘glass half-full’ on the macro front this month. We got an August update to the Q3 Inventory to Sales ratio that took us from a relatively tame 1.31 all the way up to 1.33. While 2 bps hardly feels material, it was a relatively big move to observe in a single month. We commented last month that ‘if July’s read holds, that would imply that perhaps the reports of system-wide inventory gluts may be somewhat exaggerated or perhaps contained mostly within the retail sector. And at 1.31, that leaves us on the low end of the historical scale, looking back over 30+ years. Perhaps this is just a pause in an otherwise inflationary pattern and the quarter closes much higher once August and September are accounted for. But if not, and surplus inventory conditions are not as dire as the headlines suggest, that would create additional support for Industrial Production in the months ahead as the two lines tend to run inverse to each other.’ The August revision suggests the former as inventory surpluses spread beyond the retail sector alone and finally begin to show up in the broader macro data. And while this could be seen as a positive development in the interest of stabilizing supply chains and bringing down inflation in the short-term, the impact on industrial activity and the economy at large is decidedly negative over the medium to long-term. In any case, add this one to our list of dramatic storylines for the months ahead. How much inventory is too much, given the crosscurrents currently in play?
So we got bullish Consumption and Industrial Production updates this month to square with a bearish Inventory to Sales revision. What say our TL demand indicators – ATA TL Volume & Cass Shipments? After closing Q2 at +4.0% Y/Y and opening Q3 flat at the same +4.0%, our ATA TL Volume Index revised somewhat higher to +4.8% Y/Y with the August read. And after posting +3.4% Y/Y last month, up materially from Q3’s initial read at -1.4%, the Q3 Cass Shipments Index closed flat at +3.4% holding onto its sequential gain. So what does this all mean? For now at least, it implies for one that TL volume demand is actually up Y/Y as opposed to down as much of the recent media narrative would suggest. And second, as the ATA TL Volume Index accelerates higher, it suggests that despite the relative increase in Y/Y demand, smaller carriers are exiting the market at an even faster clip – which is a pattern that is consistent with a market bottom in TL spot rates, if not a required condition. Should this pattern continue, it will be a bullish signal for a continued recovery in spot rates and confirmation that despite the bevy of black swan events since 2020, the shape of the US TL market cycle persists – just like it has for the last 15+ years.
Now onto the supply side. Just when we thought we were back to historic cycle patterns with US Net Class 8 Tractor Orders, which meant depressed order activity in the quarters ahead as the US TL Spot market worked through its own excesses, we got a rocket ship of a number in September. At a preliminary 53,700 net orders for North America – of which we estimate 37,500 were for the US market, we set a monthly record according to ACT Research. We have remarked repeatedly 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. At least until Q4 2021 and Q1 2022 that is, where Net Tractor Orders broke Y/Y deflationary while TL Spot rates remained stubbornly Y/Y inflationary. That break in historical norms was however resolved in Q2 2022 when TL Spot rates collapsed Y/Y deflationary as well. And with last month’s revised Q3 2022 read on Class 8 Net Tractor Orders on the board at -48.2%, all remained in line. But with the September read revising Q3 higher to close at a barely deflationary -7.5% Y/Y, historical norms are back up for discussion. Will September’s strength prove to be an anomaly? Or will Class 8 Net Tractor Orders lead Spot TL Linehaul rates higher in the quarters ahead just like they led lower coming into 2022 – contrary to past cycles? We’ll find out soon enough.
And speaking of reversals in trend this month, we can add retail diesel prices to the list. To recap for anyone that hasn’t been paying attention, the price of diesel had finally started to correct lower after exploding steadily higher for much of the year – from $3.727/gal in January to $5.754/gal in June before retreating slightly to close September just barely under $5/gal at $4.993. This took the final read on Q3 to +53.8% Y/Y after peaking at +70.7% in Q2. Unfortunately however, diesel has again reversed to march 10% (+$0.50/gal) higher over the past 3 weeks to hit $5.133/gal for October MTD and a preliminary Q4 print of +40.0% Y/Y. So just when it looked like conditions were finally trending more favorably for the supply side, diesel prices signal ‘not so fast’. So it was no real surprise to see fuel prices overtake the driver shortage as the top issue of concern expressed by motor carriers in the American Transportation Research Institute’s 2022 Top Industry Issues survey – the first time fuel price concerns even made the top 10 list since 2013.
As noted in past issues and repeated here for any new readers, the last time we saw anything like this year’s spike in fuel prices was in 2008 where diesel climbed to +66.6% Y/Y that June – in the throes of The Great Recession. During that particular US TL Spot Linehaul Rate Cycle, unlike this one, 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 the same rate. So far, it has been a much more gradual exit this time around. And as the battle rages on, the role that diesel costs play from here will be in helping to set the ultimate market bottom where our Y/Y US DAT TL Linehaul Spot Index line finally inflects higher as sufficient surplus capacity has been forced to exit as their operating margins compress towards zero, or worse. And as noted above, we think we’re there. However, if diesel somehow finds a way to move materially lower in the months ahead, we could see that inflection point this quarter come in at a lower level as cheaper diesel allows the supply side to endure an even weaker spot rate environment than it would otherwise. If not, and current trends persist, then we expect to see our deflationary inflection come in at roughly current levels if not slightly higher.
So while relatively low levels of short-term TL market volatility combined with a stable to improving economy and stock market made for a mediocre October, at least compared to last month, we had plenty of action in our leading demand and supply indicators that kept us busy at Pickett Research as we kicked off Inflection Quarter 2022 – and look forward to a much less mediocre November and December as those signals all resolve. And while we do, with storm risk increasingly off the table as the Atlantic hurricane season wraps up November 30th and a Spot TL market cycle bottom absorbing any potential dislocations as it did with Ian, we will continue to focus on the same two market force wild cards that we have been over the last few months: TL-intensive Consumer Spending (i.e. Durable and Nondurable Goods) and Diesel costs.
1. TL-Intensive US Consumer Spending: Conditions remain tough for the average US consumer, despite signal that peak Consumer Price Inflation (CPI) may be behind us after several months of slow yet steady sequential decline – from June’s +9.1% Y/Y to September’s +8.2% Y/Y. But while the Fed’s tightening monetary policy looks to be achieving its end, until labor markets weaken much more substantially, Powell and the gang aren’t signaling anything other than full speed ahead on interest rates to the suggested terminal level of 4.6% before they consider easing off the brakes.
So as asset prices correct lower along with both nominal and real wage growth, all while the cost of debt service rises with interest rates, it would be only logical to expect consumer spending to slow down materially as a result. And that very well may come to pass, but so far at least, we aren’t seeing that reflected in the macro. Retail spending remains firm and overall Consumption levels are holding up – including Durable and Nondurable goods even as spending on Services increases. And as goes the US consumer, so goes the US economy – especially US Industrial Production and therefore overall US TL capacity demand. We expect this one to be at the top of the wild card list for the foreseeable future.
2. Diesel Prices: As noted in recent issues, it is likely that diesel costs in the months again will determine our eventual bottom in TL Spot Linehaul rates – both the ultimate destination and how long it takes us to get there. With last month’s cost relief proving only temporary in nature as prices move 10% higher in recent weeks, the breakeven point for motor carriers rises with it and we likely see our deflationary inflection point sooner, i.e. this quarter as forecasted. But should they fade lower, perhaps in conjunction with a slowing US economy, we get the opposite effect and Spot Linehaul rates get more room to run lower for longer. We continue to believe that with diesel at current levels, the market has already reached the point where spot market dependent motor carriers have already begun to exit in large numbers – either temporarily or permanently. So it becomes only a question of the pace at which this continues in the months ahead, and that depends very much on what diesel costs do going forward – perhaps even more so than what happens in the broader economy.
As we leave our mediocre October in the rearview mirror and shift our gaze to the road ahead, despite all the headwinds still in play – a fragile US economy, a slowing labor market, monetary tightening, Russia’s ongoing invasion and occupation of Ukraine, US tensions with China, or bear markets across most global asset classes – we can’t help but look forward with optimism. Maybe it’s the solace we take in finally (we believe) finding a floor in the US TL Spot Linehaul rate cycle, marking the point where a sustained recovery can finally begin. Or maybe it’s the constructive signals we see in the macro picture while the probability of a painful recession in 2023 is characterized as practically a foregone conclusion in the financial and mainstream media. Or maybe it’s just that doctored pumpkin spice latte doing its thing. Whatever the case may be, we certainly see plenty of constructive signals out there that remind us that the sky is not falling and that better times are indeed ahead – for both the US trucking market and the broader US economy. So Cheers to closing out October on a high note and to positioning for what is likely to be a much more eventful remainder of 2022.