[Excerpt from The Pickett Line November 2022 Issue]
Now two thirds of the way through this final quarter of 2022 and well into this most wonderful time of the year, we continue to search for reassuring signal of our projected market cycle bottom in US TL Spot Linehaul rates. But as our index continues to revise lower, we must channel our inner Bono circa 1987’s The Joshua Tree album as we ‘still haven’t found what [we’re] looking for’. And while all remains directionally on trend with recent projections, market behavior suggests that we still have some room to go before we hit bottom and get our deflationary inflection point to signal the beginning of a recovery in spot rates. In fact, it now seems quite possible that we will ultimately have to wait another quarter altogether given the current trajectory and the Q1 2022 kink in the cycle that we are comping against Y/Y. We’re not prepared to make that call yet but will consider a revision in the 2023-25 forecast in next month’s issue if current conditions persist. So settle in and get comfortable as we unpack the last four weeks of market data in this November 2022 issue of The Pickett Line – and find out exactly what makes us think we may have to wait another quarter before we get our deflationary inflection point of this current US TL Spot Linehaul Rate cycle.
Let’s start with our DAT US TL Spot Linehaul Index. With Q3 closed at -21.7% Y/Y vs. a forecast of -17.5%, our revised Q4 read now sits at -30.8% Y/Y ($1.80) vs. last month’s -27.7% ($1.88) and a forecast of -25.0%. So while we continue to operate at rate levels consistent with past cycle bottoms, the market continues to signal that we’re not quite there yet as we slowly grind still lower. Like we said, we still haven’t found what we’re looking for. But we just may in the month ahead as we reconcile a number of inflationary catalysts, including stubbornly inflationary diesel prices, normal seasonal volatility, and the threat of disruptive winter weather. If we close the year without any of these making a material dent in US TL market conditions, there will likely be a strong argument to shift our Spot market forecast forward by a quarter. But as is often the case, we’ll have to wait to find out. So stay tuned for the December issue where we expect to have much of this resolved.
Now on to the Cass Linehaul Index, our proxy for the Contract TL market, where the race to find its own deflationary bottom continues. 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%. While we didn’t quite get there with a final Q3 close of +7.2% Y/Y, gravity clearly appears to be taking charge. And our preliminary Q4 read of +3.0% Y/Y vs. a forecast of -3.0% signals that we remain directionally in line with expectations. And while we still have another 600 bps to go to hit the target, we believe it is entirely possible – if not probable – that we’ll get there once November and December are accounted for. So continue to look out below.
Now, onto the macro picture, where the relative likelihood of a painful economic recession appears to have come down at least somewhat as compared to the media narrative last month. This time last month, it seemed like a lead pipe lock that 2023 would be a disaster as the Federal Reserve appeared more than willing to drive the US economy off a cliff if that’s what it took to rein in runaway inflation (picturing the final scene in Thelma & Louise, except with Jay Powell and Janet Yellen in the place of Geena Davis and Susan Sarandon). Now however, it would seem that the rumors of the death of US Consumers’ appetite to spend seem to have been greatly exaggerated – at least for now. With the preliminary read on Q3 Consumption now on the board at +2.0% Y/Y, we only saw a slight decline as compared to Q2’s +2.4% and remain roughly in line with pre-COVID levels. Though the bigger surprise was in the relative performance of the primary components of said Consumption – Services (61% of total) vs. Nondurable Goods (23%) vs. Durables (16%). While all expectations pointed to a rapid decline in Durable goods consumption, we instead got a relatively sharp recovery higher from -3.7% Y/Y in Q2 to +2.2%. Though both Services and Nondurables continued to slide lower – from +4.8% to +3.2% and -1.1% to -1.9%, respectively. So much for the material reallocation of spend from Goods to Services that was anticipated in this post-COVID market environment.
And given this observed resilience in Goods consumption, it should come as little surprise that Industrial Production continues to hold up as well. After closing Q2 at +4.4% Y/Y and Q3 at +4.0%, our preliminary Q4 read with October hit the board at +3.0%. Down slightly, but hardly showing any indication of falling off a cliff – though we’ll have to wait and see what the rest of Q4 brings before we get any more optimistic. So with positive signals from Consumption and Industrial Production, what say Inventories? Recall that last month the August revision took the Inventory to Sales Ratio up materially from 1.31 to 1.33, which tends to signal ‘no bueno’ for future industrial activity and the economy as a whole. With September now in, that is where we are going to close the quarter – at 1.33. So conditions didn’t improve, but they didn’t appear to get any worse either. But as inventory levels continue to flash ‘danger’ across many segments of the retail and consumer goods sectors this holiday season, there is a strong argument that we should expect things to get at least a little bit worse before they get better with this particular macro indicator. So enjoy those holiday sales while they last.
With solid Consumption and Industrial Production, a recovery in Durable Goods spending, and stable relative inventory levels, what’s the problem? Why all the concern about potentially shifting the Spot TL Linehaul Cycle forecast forward by a quarter? Well, while the downward slope of both Consumption and IP remain somewhat leveled, they continue to point lower nonetheless. And unfortunately, this mostly backward looking Q3 strength wasn’t reflected in our primary TL demand indicators this month – most directly in Cass Shipments. After closing Q3 with a relatively strong +3.4% Y/Y, our preliminary Q4 read came in at a somewhat weaker +1.9% – still positive, but much less constructive to the ‘up and to the right’ demand narrative that tends to power at least part of the recovery in TL spot rates off of a cycle bottom. But as noted in the past, one month hardly makes a quarter. So we’ll be watching this one closely over the next couple of months for clearer signal. Now onto our other demand indicator – the ATA TL Volume index. After revising higher to +4.8% Y/Y last month, the September update took Q3 higher still to close at +5.5% – the highest level observed since Q4 2017. And as the ATA TL Volume Index accelerates higher, it suggests that despite the relative increase in Y/Y demand observed over the last couple of quarters, carriers of all shapes and sizes (though mostly smaller) continue to exit the market at a rapid clip. While this is precisely what needs to happen to put in a market bottom – the continued march higher just signals that we might not be there yet. Again, all suggest that a market floor is indeed forming, it’s just a matter of whether we get it this Q4 as projected or get extended to Q1 2023.
Now onto the supply side – where things just got nutty again. We noted last month that 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. This took the Q3 read almost all of the way to positive territory to close at -7.5% Y/Y. With all eyes on October to see whether September’s number was an anomaly or a signal, we got another rocket ship of a read to put the preliminary Q4 mark at a remarkable +126.9% Y/Y – forming a pattern completely unprecedented relative to past cycles. Though given the early deflationary move in this indicator in Q4 2021 while our TL Spot index remained Y/Y inflationary, this wasn’t entirely unexpected. Back then, we suggested that unprecedented disruption in tractor OEM supply chains had created enough of a market distortion that the cycle correlations perhaps got nudged a couple of quarters out of phase. And that if so, perhaps we would see Class 8 net orders go inflationary with the same 2-3 quarter head start that they led deflationary. So here we are, if this preliminary Q4 read holds up.
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 – again, at least until this cycle. So as we ponder the implications for this particular cycle, we must also consider whether this phase shift will prove to be temporary impact of the 2020-22 COVID-driven breakdown in global supply chains or something more permanent. Only time will tell.
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 again reversed to march +7% (+$0.33/gal) higher over the past 7 weeks to hit $5.323/gal for November MTD and a revised Q4 print of +43.6% Y/Y – though we have seen some recent relief in a 20 cents/gal slide lower over the past few weeks. 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. 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 just about there. If diesel somehow finds a way to move materially lower in the months ahead, we could see that inflection point shift a quarter ahead to Q1 2023 as cheaper diesel allows the supply side to endure an even weaker spot rate environment over a longer period of time than it would otherwise. If not, then we likely see our deflationary inflection come in this quarter as projected and at roughly current levels, if not slightly higher.
So after a September to remember followed by a mediocre October, market volatility and uncertainty were back in November – with the threat of a US railroad labor strike on and off of the table (again), unusually strong Class 8 tractor orders, rapidly deteriorating contract rates, and another baby step lower in our DAT US TL Linehaul Spot index. But as noted at the top, we still haven’t found the market bottom we’ve been looking for. Which just means that the December ahead will that much more interesting as we look to tie a bow on an incredibly challenging 2022 and prepare for whatever the next year has in store. And while we were really looking forward to adding the threat of that US railroad strike to our shortlist of market wild cards for the month ahead, the government thankfully intervened in rare bipartisan form with legislation signed by President Biden December 2nd to block it – just seven days prior to the expiration of the previously tentative agreement. So with nothing else rearing its potentially disruptive head and the Atlantic hurricane season officially wrapping up, we’re left with the same two that we’ve been fixated on most of this year: 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 October’s +7.7% Y/Y. And while the Fed’s tightening monetary policy looks to be achieving its end, Powell and the gang are only just recently signaling any interest in slowing down the pace of interest rate increases before they consider easing off the brakes. Though the most recent employment numbers coming in much stronger than expected doesn’t make it any easier on them.
As asset prices continue to 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 – especially on Durables, defying all expectations. In fact, both Black Friday and Cyber Monday set new spending records. So it would indeed appear that rumors of the imminent death of consumer spending have been greatly exaggerated. And as long as Consumer spending holds up, the probability of a soft economic landing remains high. Given all that is at stake, 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 ahead will determine our eventual bottom in TL Spot Linehaul rates – both the ultimate destination and how long it takes us to get there. And costs have been on a bit of a roller coaster ride for most of the quarter. After declining steadily from June through September, they reversed higher in October and into November. But have since reversed once again, fading almost 20 cents lower over the last few weeks to the current $5.141/gal. Where we go from here is anyone’s guess. That said, 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.
So there we have it, Ladies and Gentlemen. We still haven’t found what we’re looking for, but don’t believe we’ll have to wait much longer. And just as we noted last month, we remain optimistic as to what awaits us in 2023, perhaps irrationally so considering all of 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, and bear markets across most global asset classes. Despite this backdrop however, industrial activity persists and along with it the demand for US truckload capacity. And whether we ultimately find our deflationary inflection point this quarter as currently projected or the next, the spot market will almost certainly turn to lead us Y/Y inflationary once again in the back half of 2023 to kick off the next cycle. And it is with this observation that we’d like to bookend the November issue of The Pickett Line with. There was a time when the squad at Pickett Research thought the inevitability of the US TL Market cycle was a depressing topic – why can’t the market govern itself with more long-term discipline to avoid this painful volatility altogether? Why does history have to repeat itself (or at least rhyme) every three or four years? But in uncertain times like this, we have come to find a sense of comfort in that inevitability. Despite how dark the road ahead may appear, we know from experience that the trucking industry endures. And with it, the entire US economy. And it is this sheer, perhaps even stubborn, endurance that gives us great confidence that the year ahead will be a heck of a lot better than the one behind us – especially for the supply side. So chins up, we’re almost there. Happy Holidays!