[Excerpt from The Pickett Line February 2023 Issue]
Yet while the month skewed to the boring side, relative to the wild ride we’ve been on the last couple of years, it was not entirely without drama as every new data point brings with it the potential to reinforce or contradict our expectations for what comes next. Is the US economy in for a hard landing, a soft landing, or no landing at all as a result of the Federal Reserve’s use of monetary policy tools to rein in inflation? Was the unexpectedly high Q4 2022 Class 8 Net Tractor Order print a signal or a head fake? And are contract TL linehaul rates finally going to break Y/Y deflationary this quarter as expected? We’ll cover all of that and more in this February 2023 issue of The Pickett Line – as even a slow month in the US trucking market can be utterly fascinating to the freight nerds at Pickett Research, and to the freight nerds that follow us. So let us begin.
Recall that last month, we came in like a lion with January’s hot start posting an early Q1 2023 read on US Spot Linehaul rates almost right on forecast at -22.5% Y/Y. But as rates cooled over the rest of the month, we ultimately went out like a lamb on a much weaker -27.3%. And now as we prepare to close the book on February, our revised Q1 read has cooled still further, pulling all the way back to -30.3% Y/Y vs. a forecast of -22.5% + 5% and a Q4 2022 read of -29.6% Y/Y. So… about that Q4 inflection point? Now you see it, now you don’t. With spot rates fading still lower at this point, that can only mean that enough surplus capacity remains active that can operate profitably at the rate levels the spot market is currently offering. So now the question remains as it did last month, how much lower can the market go as the race to the bottom continues and motor carriers with less competitive cost structures are ultimately forced to exit the market in enough numbers to set a floor? At this point, we estimate that we are already running below the average motor carrier operating cost per mile, so it is only a matter of time before the market churns through the population on the higher side of that average and we finally find our floor. And we continue to expect that we get there in the month ahead as we close out Q1. Though, as we stated above, the case is much weaker than it was coming into January.
But while our spot market forecast line is certainly up for debate, contract rates are running right on schedule, at least as signaled with our preliminary Q1 read on the Cass Linehaul Index. One of the more riveting storylines over recent quarters has been the battle between TL contract linehaul rates and market gravity. And while contract rates managed to stay Y/Y inflationary to close out 2022, despite a cratering spot market, we expected it was only a matter of time before they finally converged with their forecast line on the deflationary side of the chart. Has that time arrived? Before the big reveal, let’s for one last time revisit the backstory on this one for any new readers that may be following along this month. Back in early 2022, 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 below. 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 and a Q4 that registered +1.8% Y/Y, gravity clearly appeared to be taking charge and all remained directionally on track. In fact, we commented last month that “while we missed our Q4 forecast by 480 bps to the high side, we believe there is currently enough of an air pocket below our Cass line to support a downward move to -5.0% Y/Y in Q1 as projected.” Now with our preliminary Q1 2023 finally in and on the board at -6.6% Y/Y, it appears that we’ve found our air pocket and broken deflationary…with a vengeance. And given the magnitude of this initial read, it is now likely that we’ll blow past our forecasted bottom of -7.0% Y/Y in the months and quarters ahead before reversing course in the back half of the year. Gravity for the win.
Now onto the macro outlook, where conditions have deteriorated from bad to worse this month and the soft landing narrative has weakened materially. Recall that last month we reported relatively lackluster preliminary GDP, Consumption and Import results for Q4 2022. GDP came in at +1.0% Y/Y – roughly half of Q3’s +1.9%. Consumption faded lower to +1.9% Y/Y vs. Q3’s +2.2%. And Imports tanked all the way from +7.4% Y/Y in Q3 to +1.7%. Well, we got our first revision this month – with most data points moving slightly lower still. Both GDP and Consumption bumped 10 bps lower to +0.9% Y/Y and +1.8% Y/Y , respectively. Imports bumped 10 bps the other direction to revise slightly higher to +1.8% Y/Y. Beneath the aggregate Consumption line, all of the weakness came from Goods Consumption with Durables ticking lower from +1.1% Y/Y to +0.5% and Nondurables from -1.4% Y/Y to -1.7%. Services remained unchanged at +3.2% Y/Y. So while the odds of Chairman Powell and the FOMC sticking that landing don’t look great at the moment, this story is far from written. All hope is not lost. We could still get an ending reminiscent of Kerri Strug at the 1996 Olympics with Jay hobbling up to the vault injured left ankle and all…then ripping off a 9.712 and clinching the gold medal for the U.S. USA, USA, USA…
But we digress. While we remain hopeful that the Fed somehow threads the needle and we avoid a painful economic recession, we also acknowledge that hope by itself is not a strategy. And until we get some signal that the downtrend in Consumption is at least leveling off, the recession warning light remains flashing. As noted in past issues, in three of the last four recessions (1990, 2001, 2008, 2020), Consumption went Y/Y deflationary – with 2000 proving the sole exception. At Q4’s +1.8% Y/Y, we still have some ground to cover before breaking negative. But given the current trajectory and the historical correlation with Industrial Production, that appears to be exactly where we’re headed.
While deflationary Y/Y Consumption is three for four vs. recessions since 1990, Industrial Production (IP) has gone a perfect four for four. So with our initial Q1 2023 read on the board at -0.4% Y/Y vs. Q4’s +2.5%, there is real cause for concern. And with the manufacturing segment within IP coming in even weaker at -1.2% Y/Y, it would appear that the industrial slowdown is finally upon us after holding up reasonably well through most of 2022 after the COVID-driven whipsaw of 2020-21. And if historical patterns persist, which we see no reason why they shouldn’t, we should expect further weakness in IP so long as Consumption is pointed down and to the right. That said, there is precedent for deflationary Y/Y Industrial Production in the absence of an economic recession. We saw exactly that in 2015-16 where IP swooned to -3.8% Y/Y while Consumption ran flat at +2.5-3.0% Y/Y – therefore, no recession. So just because IP breached negative territory this month, that does not mean we are not doomed to an inevitable protracted slowdown. But it sure doesn’t look good. To get a repeat of 2015-16 though, should IP continue its journey south, we would have to see a stabilization in aggregate consumption at or close to current levels. Which as unlikely as that may seem, given the nature of this particular slowdown where we continue to see at least some level of Goods Consumption spending migrating to Services, we cannot rule it out altogether. Considering that Services continues to represent over 60% of total Consumption in the US, a stable to growing Service sector can do much to prop up the broader economy as Goods Consumption comes under increased pressure. But while good news for the economy as a whole, any decline in industrial activity usually means a decline in the relative demand for truckload capacity and therefore downward pressure on spot rates.
That brings us to relative inventory levels as expressed by the Inventory to Sales ratio. Whatever cautious optimism we had reason to hold coming into Q4 last year has since been dashed as the monthly prints started to break higher from the 1.33 levels we had been range-bound against for much of 2022. Last month, our revised Q4 read ticked higher to 1.34. And with December now accounted for, we close Q4 slightly higher still at 1.35 with momentum in the data set signaling more room to run higher in the months to come. Historically, the Inventory to Sales Ratio runs inverse to Industrial Production – which makes sense as bloated inventory levels diminish the need to make more stuff to restock shelves. So once we observe a local top in Inventory to Sales, we should expect a local bottom in IP – and vice versa. But until then, expect the macro outlook to remain somewhat downbeat.
With Consumption, Industrial Production, and relative inventory levels all signaling further weakness, now let’s turn our attention to our primary TL demand indicators – the Cass Shipments Index and the ATA TL Volume Index. This month, we got our first glimpse of Q1 with the preliminary January read on the Cass Shipments Index coming in at -2.3% Y/Y compared to last quarter’s -0.5%, which tracks with the slowing IP narrative. And we got our final read on Q4 ATA TL Volume to close the quarter at +1.5% Y/Y vs. last month’s revised +2.0%, so slowing on that front as well. So for the first time since late 2018, both of our TL demand indicators are running in phase with Industrial Production – which we interpret as healthy correlation. As industrial activity slows, and TL demand as evidenced by the Cass Shipments Index slows with it, the inflationary inflection point in the ATA TL Volume index signals that we are well past peak supply expansion. We now appear to be well into the process of supply rationalization, or in simpler terms, motor carrier exits. And it is only when a sufficient number of these uncompetitive, over-costed carriers is unfortunately forced to exit the market can spot TL linehaul rates finally find their deflationary floor. And this is the battle that has raged over the last several months, a battle that only gets prolonged with cheaper diesel prices and soft demand conditions. So we’ll be watching our TL demand indicators closely in the months ahead for signal confirming that that such a floor has finally been reached – or not.
Which brings us over to the supply side – where over the last few months we noted that things had just gotten 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 and December revisions cooled us off a bit, we still landed at an unusually strong +86.5 Y/Y on the quarter. 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, is that what Q4 was? If Q1 2023 proves to be another inflationary quarter, then the case gets stronger. If not, then we cue it up as a head fake. Well, with our first glimpse at Q1 now on the board, we got zero signal either way. The January read puts Q1 at an almost dead flat -0.6% Y/Y. So we’ll have to wait another month to find out if the scale gets tipped in either direction. Count on this to be one of the more dramatic storylines in the March issue.
And what makes this particular pattern noteworthy, aka ‘nutty’ (that’s the technical term)? We have remarked repeatedly in past issues that net tractor orders had up until this current cycle 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. Though we continue to believe it will likely be the former.
And speaking of unusual 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 2022 – 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 in the northeast. Fortunately, those fears proved to be unfounded as diesel instead reversed course once again to settle -15.3% lower to the current February 2023 MTD read of $4.453/gal and +10.4% Y/Y. As the oscillations continue, it is difficult to build too much conviction one way or another although momentum clearly signals further price reductions in the weeks ahead.
As noted in past issues and repeated here for any new readers, the last time we saw anything like last 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 evaporate. And as noted in recent issues, we believe we’re just about there – though recent market activity suggests we may need to grind along at these levels for some time before sufficient supply is exhausted. If diesel finds a way to continue its mid-term move materially lower in the months ahead, we could see that inflection point shift a quarter ahead to the current 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. So far at least, that appears to be the story of February. If we don’t get a bounce in the weeks ahead, then this is likely where things are headed.
Now more than halfway through this first quarter of the new year, the early signal we got last month pointing to a Q4 2022 cycle inflection point, has all but vanished – which sets us up for a more dramatic and uncertain road ahead than we anticipated. We should have known it wouldn’t be this easy given the roller coaster we have been on the last couple of years. But the potential outcomes from here are pretty binary. At this point, our US TL Spot Linehaul Index sits roughly level with the prior quarter at -30.3% Y/Y. If spot linehaul rates fade lower in March, bucking the market’s seasonal tendencies, then Q1 closes lower than Q4 which negates the otherwise suggested Q4 deflationary inflection point. In that case, Q1 2023 becomes the projected cycle bottom and the entire curve forecast shifts forward by a quarter. If spot linehaul rates instead reverse trend and turn higher in the month ahead, then Q4 2022 likely holds as this cycle’s deflationary inflection point and the current forecast holds. So, what will determine the ultimate location of our market floor? In our estimation, it is the same two wild cards that have dominated the conversation for most of the past year: TL-intensive Consumer Spending (i.e. Durable and Nondurable Goods) and Diesel prices.
1. TL-Intensive US Consumer Spending: Conditions remain tough, and are getting tougher, for the average US consumer, despite signal that peak Consumer Price Inflation (CPI) is well behind us after several months of slow yet steady sequential decline – from June’s +9.1% Y/Y to January’s +6.4% Y/Y. But while the Fed’s tightening monetary policy looks to be achieving its end, progress has been slow and most of the guidance from Powell and the gang remains hawkish overall. They have slowed the upticks to 50 bps yet continue to reiterate the expectation of higher for longer. That said, the US Consumer continues to hang in there for the most part. Retail spending came in surprisingly strong in January, however questions mount as to how long the Consumer can hold up given recent cracks in the labor market and rising household debt. But so long as Consumer spending remains steady, the probability of a soft landing for the economy remains on the table – though that probability cleared ticked lower this month. In any case, we don’t see this wild card going anywhere anytime soon.
2. Diesel Prices: As noted in recent issues, it is increasingly likely that diesel prices in the weeks and months ahead will determine our eventual bottom in TL Spot Linehaul rates – both the ultimate destination and how long it will have taken us to get there. And while prices have been on a bit of a roller coaster ride over the last few months, the recent down trend appears to be extending our time down here at the bottom of the cycle. After declining steadily from June through September, they reversed higher in October and into November. But have since reversed once again, fading 80 cents or -15.3% lower to the current $4.453/gal. Where we go from here is anyone’s guess, but we continue to believe that even with diesel at current levels, the market has already reached the point where spot market dependent motor carriers have already begun heading for the exit in increasingly large numbers – either temporarily or permanently. So, it remains only a question of the pace at which this continues in the months ahead, and that depends very much on what diesel prices do going forward. Last month we noted that “the most positive thing we [could] say after the last month of data is that conditions could be worse.” And this month, the market and the economy proved just that as just about every indicator that we track indeed got worse. But it has so far been a gradual, well-mannered decline – in many ways downright boring, even for a February. Which could prove to be a signal that the ultimate bottoming and initial recovery ahead will be every bit as orderly and without any dramatic dislocations for market participants to contend with. Only time will tell.
But it is in times like these, during periods of peak uncertainty and distress as pessimism compounds, that we especially appreciate the natural order of things that recurring cycles represent. We must endure such corrections to reset the cycle and clear the way for brighter days ahead. So whether our deflationary inflection point ultimately lands this quarter or the last, history suggests that we are indeed at the bottom. It’s just a matter of how much longer we need to grind it out down here before we make our turn and begin our journey back to Y/Y inflationary market conditions and the next US TL Linehaul Spot rate cycle. But while we’re down here, use this as an opportunity to get more resilient…to take cost out your operation…to do more with less…and to prepare for the inevitable market shift coming next year. As your performance in 2024 will be shaped by the decisions you make and the actions you take over the balance of 2023. Don’t get complacent and squander the opportunity, as both the good times and the bad times tend not to last for long in this market. Now onto March.