[Excerpt from The Pickett Line December 2022 Issue]
‘Twas the eve of inflection, and all through the market
Not a Carrier felt optimistic. Thought they might as well park it.
Costs remain high, while rates remain low.
Cheaper diesel sure helps, but only softens the blow.
How long must we wait, before this market finds a floor?
This feels strangely familiar, like it’s happened before.
So let’s look backward in time, to see where we’ve been.
And use that as context to assess the position we’re in.
Then into the future, we’ll peer once more.
To consider just what does the next year have in store.
Will the cycle repeat? Is there reason for doubt?
The December issue is here, so let’s unpack and find out.
And with that as our walk-up music, welcome to the December 2022 of The Pickett Line – our twelfth and final episode of what has been a wild year in freight. We noted last year that we still hadn’t found strong enough signal to claim this Q4 as the market floor and deflationary inflection point that we’d been looking for (thanks to U2 for the literary inspiration). And that it remained entirely possible that we would have to wait yet another quarter before we hit rock bottom in Q1. Now with another month of market data on the board to consider, we find little to change that outlook one way or the other. While most of the macro updates were relatively downbeat, thus signaling further weakness ahead in overall demand, they were by no means apocalyptic. And our supply side indicators remain a mixed bag – Class 8 Net Tractor orders remain surprisingly strong, which tends to be a bullish forward spot rate signal, and the cost of diesel continues to slide lower, which tends to be the opposite. Yet through all of this, our Q4 2022 spot linehaul rates barely moved – nudged a mere 2 cents higher. So while we certainly may see conditions arise next quarter that would delay our cycle inflection point by a quarter, we see no compelling argument in the data on the board today to materially shift our 2023-25 forecast. Though we did take down the Q1 and Q3 2023 forecasts slightly as we now believe the bounce will be slightly more subdued than previously charted.
So let’s get to it then, starting with our DAT US TL Spot Linehaul Index. Recall that we closed Q3 at -21.7% Y/Y vs. forecast of -17.5%, therefore running lower by 420 bps. Coming in at -30.8% Y/Y last month (1.80), our revised Q4 read now sits at -30.0% even (1.82) – compared to a forecast of -25.0%. So our gap to estimate expanded only slightly by 80 bps, and we now sit at the outer edge of where we typically guide on a given quarter (i.e. + 5% pts). We also believe that with less than two weeks of the quarter to go and the market distortions we typically see around the Christmas and New Year’s holidays, it is more likely that Spot linehaul rates drift higher from here, not lower. So it is entirely possible that that we get another cent or two on the final quarter’s read to close the gap by a few bps, which would make the holidays shine just a little bit brighter for the forecasting team here at Pickett Research.
Now what says Cass? Are we still free fallin’ (nod to the late great Tom Petty)? With the Cass Linehaul Index serving as our proxy for the US Contract TL market, we have been tracking its correction lower as it follows the spot market by a few quarters. And for any new readers this month, the backstory on this 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 read of +7.2% Y/Y, gravity clearly appears to be taking charge. And with Q4’s revised read of +2.3% Y/Y vs. last month’s +3.0% and a forecast of -3.0%, we’re still fallin’, just not as freely as we projected. Now with only one month left to go, we may get close to 0.0% but not likely all of the way to our -3.0% Y/Y target. That said, we have left our 2023-25 Cass Linehaul forecast unchanged, starting with the Q1 2023 forecast of -5.0% Y/Y. So look for the plunge lower to continue.
In shifting to the macro outlook, just last month we noted that ‘the relative likelihood of a painful economic recession appears to have come down at least somewhat as compared to the media narrative last month.’ Well, it looks like we took a step backwards in December. Despite the continued decline in consumer and producer inflation, coming along slowly but surely, Fed Chair Jay Powell’s remarks at the most recent FOMC meeting (after taking interest rates up another 50 bps) put ice on whatever optimistic market sentiment has begun to take shape around the risk of recession in 2023. So here we are looking right back into the abyss. Thanks Jay. But to be fair, the most recent macroeconomic indicators that we track showed almost universal weakness compared to the prior month. Not off the cliff weakness, but weakness nonetheless.
The November print on Industrial Production declined 0.2% vs. October, but not enough to move the revised Q4 read of +3.0% Y/Y off of last month’s initial mark. So here we sit at +3.0% – on a descending trajectory no doubt, but still at a relatively health level historically. And where it goes from here will be mostly determined by overall Consumption levels, though most directly by Goods consumption which above all odds, showed surprising strength in the revised Q3 numbers. Sure that was last quarter, and the potential for the market to talk itself into recession has really only just begun in earnest – where employers fearing for the future lay off employees to cut costs and reduce risk, which then drives employees fearful for losing their jobs to cut back on spending to reduce risk, which then generates exactly the drawdown in economic activity that fearful employers were afraid of, which only emboldens them to continue…making it all worse. Behold, the negative reinforcing feedback loop (aka death spiral). So far at least, it seems most of the layoff activity has been focused mostly in the tech and financial services industries, where firms are finding themselves overstaffed after bulking up to support the surge in demand over the previous two years. I guess the US trucking industry isn’t the only one susceptible to episodic periods of “overdoing it”. In any case, it is quite possible that most of the damage is indeed contained within a small number of industries rather than spreading across the broader labor market. As it stands, employment numbers remain stable and a +3.0% Y/Y Q4 Industrial Production read is encouraging.
Another sign of cautious optimism can be found in the first read on the Q4 Inventory to Sales ratio with the October print. With our final Q3 number coming in at 1.33, flat with the prior month’s revised read and compared to Q2’s 1.30, the hope was that perhaps bloated inventories had indeed started to stabilize. Now with our first Q4 read on the board at the same 1.33, that hope persists. If this is indeed where Inventory to Sales peaks and begins to turn lower, that would represent a pretty constructive signal for the economy as a whole and support the whole soft landing narrative. As the last three times we got such a signal (2020, 2009, and 2001), we were at the bottom of a recession and the recovery in Industrial Production was about to begin. This could be that, or this could be a temporary pause in a continued march higher which would signal something else altogether. That said, what’s on the board now is encouraging but we’ll have to wait to see what comes next before building further conviction one way or the other. So stay tuned, this one could be our first big corny storyline for 2023.
Now let’s turn our attention to our primary TL demand indicators this month – the Cass Shipments Index and the ATA TL Volume Index. After closing Q3 with a relatively strong +3.4% Y/Y, our revised Q4 read came in at a moderately weaker +1.0% vs. last month’s preliminary mark of +1.9 – still positive, but much less constructive than last quarter. And given the historical correlation between Cass Shipments and Industrial Production, a downward sloping trajectory here doesn’t inspire a lot of confidence. YTD, we’ve seen Cass Shipments move range bound between -2.0% and +4.0% Y/Y – and are now sitting right at the midpoint of that range. We will continue to watch this one closely in the months ahead, as whether we break higher or lower from here will likely point the way for both Industrial Production and the broader economy.
Our ATA TL Volume Index, on the other hand, showed signal of a potential inflection point with its preliminary Q4 read of +3.3% Y/Y vs. Q3’s +5.5%. And for the first time since early 2019, both our volume indicators and Industrial Production have all somewhat converged at +1-3% Y/Y and are trending lower. On one hand, a reversal in the ATA TL Volume Index has signaled that enough surplus capacity has finally exited such that the relative increase in volume among the ATA carriers left standing has peaked and conditions are in place for a floor in spot market rates. We last saw this in Q3 2019. On the other hand, it has also in the past signaled that TL demand has peaked for everyone and conditions are in place for a lower for longer spot market rate environment – which we got in Q1 2015. While we’ll have to wait and see which hand we’ll be dealt this time around, we suspect the former scenario to unfold although weaker demand conditions could certainly extend the time we spend down here in Y/Y deflation land once we eventually bounce.
Now onto the supply side – where last month we noted that things just got nutty again. 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 October to take the preliminary Q4 read up to a remarkable +126.9% Y/Y – forming a pattern completely unprecedented relative to past cycles. And while the November revision cooled us off slightly, we are still triple digits higher at +101.1% Y/Y – so still nutty. That said, 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 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 revised Q4 read holds up and remains elevated into early 2023.
What makes this particular pattern noteworthy, aka ‘nutty’? 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 much for history rhyming in all seasons. But whether this phase shift will prove to be a temporary impact of the 2020-22 COVID-driven breakdown in global supply chains or something more permanent, only time will tell.
And speaking of nutty patterns and reversals in trend, we can keep retail diesel prices on 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 reversed once again to jump +5.0% (+$0.26/gal) higher through November to close at $5.255 on fears of a US diesel shortage driven by diminished refinery capacity. Fortunately however, for all of us, those fears failed to materialize as diesel has reversed course once again to settle -7.5% lower M/M at the current December MTD read of $4.861/gal. As the oscillations continue, in the near term at least, the trajectory appears to point lower in the coming months – welcome relief to a supply-side that that remains under immense cost pressure, however long it may last.
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, we think we’re just about there. If diesel finds a way to continue its 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 are likely to see our deflationary inflection point come in this quarter as projected and at roughly current levels, if not slightly higher.
So on this (projected) eve of inflection as we prepare to tie a holiday bow on the month, the quarter, and the year, we find ourselves with little more conviction than we had last month as to whether we have found our market floor yet or not. In fact, we got mixed signals both in the macro as well as the TL Demand micro. But without any compelling evidence to shift our forecast curve altogether, guidance stands – for now. Whether it stands next month will likely be driven by the same two market wild cards that have dominated the conversation for most of the year:
1. TL-intensive Consumer Spending (i.e. Durable and Nondurable Goods) and Diesel costs.TL-Intensive US Consumer Spending: Conditions remain tough for the average US consumer, despite signal that peak Consumer Price Inflation (CPI) is likely behind us after several months of slow yet steady sequential decline – from June’s +9.1% Y/Y to November’s +7.1% Y/Y. But 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 while guidance remains hawkish overall. They have slowed the upticks to 50 bps yet continue to reiterate the expectation of higher for longer until they are positive that inflation is finally under some semblance of control. That said, the US Consumer continues to hang in there for the most part. Retail spending remains subdued but steady and overall Consumption levels are holding up – especially on Durables, defying all expectations. And so long as Consumer spending holds up, the probability of a soft landing for the economy remains high. Suffice it to say, we expect this one to remain 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 40 cents lower over the last few weeks to the current $4.861/gal. Where we go from here is anyone’s guess, but it appears more likely to be lower still. 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.
So here we stand, after a year that was in many was just as volatile and challenging as the one before it. We found out once again that what goes up, almost certainly comes down – perhaps violently so like in the US TL Spot market or painfully slow like with US inflation. And while we close down 2022 still not having found what we’ve been looking for with regard to this cycle’s deflationary inflection point, such an event can only be confirmed in retrospect anyway. So if this Q4 was indeed the low point Y/Y this time around, we won’t really know until next quarter. And if not, that just means you’ll have to put up with our corny Bono references for another three months. But rest assured, unless something has fundamentally changed with regard to the competitive dynamics that drive this market, the cycle persists – which means we should expect to see our market floor confirmed any quarter now. So, hang in there if you are on the wrong side of this. The bottoms are where pessimism compounds, and where bad long-term decisions are made – just like at the peaks, except for very different seasons as in that case it is euphoria that obscures the view ahead. And for those that are on the right side of this, our only advice is don’t get too comfortable. For there is no better time than this to begin positioning for the next inflationary leg of the cycle coming in late 2023 when we all get to ride this roller coaster once again. But in the meantime, enjoy the holidays and Cheers to a healthy, safe, and prosperous new year!