[Excerpt from The Pickett Line March 2023 Issue]
Well, now we know how Michael Corleone must have felt in that scene in Godfather 3 where he laments that “just when I thought was out, they pull me back in!” Though in our case, we are talking about the 3rd quarter floor-seeking leg of the US TL Spot market rate cycle as opposed to the Italian mafia. But if you’re an asset-based motor carrier or freight broker that is dependent on the spot market to make a living right now, we’re not sure which is more menacing. After pegging Q4 2022 as the Y/Y deflationary inflection point signaling the bottom of the spot market cycle for the past several quarters, it now appears that the market itself has other ideas – as we took another material leg down in spot rates this month bringing our revised Q1 2023 read below Q4’s -29.6% Y/Y. So just when we thought we’d hit bottom and could begin rallying around an inevitable recovery back to Y/Y inflationary market conditions by Q3 this year, we now find that we’re now going to be down here a bit longer. The recovery remains inevitable, we’re just going to have to wait another quarter for it as cheaper diesel continues to prolong the supply-side reckoning that must occur before the market is able to inflect higher.
So, the good news is that as fuel gets cheaper, motor carriers in the spot market see operating profits expand which allows them to continue operating. The bad news is that as fuel gets cheaper and operating profits expand, more carriers are able and willing to accept lower and lower spot freight rates thus putting more pressure on operating profits – for them and everyone else. And it is only when enough of the market can no longer operate profitably at current spot market freight rates that we finally find our cycle floor. As market rates have continued to slide over the last two months, we can only marvel at the resilience of the supply side that is clearly on display – which of course can’t last for much longer given cost structures that, aside from diesel fuel only recently, remain stubbornly inflationary compared to pre-COVID levels. So how low can we go? And what does the macro data have to say about all of this? We’ll address all that and more in this March 2023 issue of The Pickett Line. So, let’s dive in (…though not in a “Luca Brasi sleeps with the fishes” kind of diving in if there are any Mafioso reading this and offending by our liberal use of Godfather references in this issue. We mean no disrespect.)
After opening January like a lion with an initial Q1 2023 read running right on forecast at -22.5% Y/Y, we closed February like a lamb with our DAT US TL Linehaul Spot Index fading all the way back down to -30.3% – just below our Q4 2022 mark of -29.6% and proposed deflationary inflection point of this current cycle. ‘Ruh-roh’, we said. Though, even then we expected at least some sequential market compression in March as over-costed carriers continued to exit the market which could take spot rates just high enough for the quarter to close above -29.6% Y/Y thus confirming our Q4 2022 inflection point. It didn’t happen. Spot market rates instead faded in the other direction to drive our revised Q1 2023 slightly lower to -31.4%, which takes out Q4 and now stands as our projected market bottom of the current rate cycle. And with the quarter just about wrapped up, this is likely where we will close plus or minus a couple of basis points. So as the Q1 dust begins to settle down here almost 10 percentage points below our forecast of -22.5% Y/Y, we are pushing our cycle forecast line forward by a quarter – which we outlined last month as the most likely outcome should Q1 close lower than the quarter before it. For this new trajectory to unfold, we now expect US Spot TL Linehaul rates to fade another 5-10% lower from here to close at -20.0% Y/Y before marching higher over the balance of the year to close Y/Y inflationary at +5.0% in Q4.
With the downward revision in our spot market forecast line to reflect a more likely lower for longer scenario, we must also reconsider the path forward for contract linehaul rates. Last month, we got our first official Y/Y deflationary read on the Cass Linehaul index with a preliminary Q1 2023 read of -6.6% Y/Y vs. a forecast of -5.0%. We remarked then that “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.” And with the February revision now in at -6.8%, we continue to believe we have more room to run lower before hitting bottom. So, in the spirit of lower for longer, we are revising our Q1 forecast to -7.5% Y/Y and now expect to hit -9.0% by Q4, at latest, before making a turn to follow spot rates higher once again – though we don’t expect to see our first Y/Y inflationary mark before Q2 2024. And with the proverbial valley floor now quickly closing in on us, we can finally close the book on the corny Wile E. Coyote vs. Gravity storyline we have been using to describe the behavior of contract rates over much of the past year. But fear not, the writers at Pickett Research are confident they’ll come up with something just as corny to help put the return trip off the market floor to set up the next cycle into context for us. So, stay tuned for that.
Now onto the macro outlook, where last month we noted that conditions had deteriorated from bad to worse with just about every market indicator that we track ticking lower in February. As if that wasn’t enough to make one downright depressed about where we go from here, we got a Twitter-induced run on the bank – Silicon Valley Bank to be specific – this month to add to the mounting stress on the US economy, which kicked off similar though perhaps less-dramatic runs on a number of other regional and community banks. Thankfully, the swift response of the federal reserve and the FDIC, in addition to the US banking system as a whole, appears to have stabilized the situation…for now. Then, just as there was a sigh of relief that the potential contagion was at least contained to the US, Credit Suisse said ‘Hold my beer’ (or whatever the Swiss equivalent is…hot cocoa?) as its rapid collapse just a few days later triggered a forced sale to UBS. And as we speak, recent concerns about Deutsche Bank continue to send shudders through the global financial markets. But while the hits keep coming on the black swan front, the rest of macro this month showed some fleeting streaks of sunshine between the storm clouds.
While we got our first flashing yellow recession indicator last month with our first Y/Y deflationary read on Industrial Production since Q4 2020 with a preliminary mark of -0.4%, it didn’t get much worse this month with the February revision coming in only slightly weaker at -0.7% Y/Y. Recall that 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 revised Q1 2023 read now on the board at -0.7% Y/Y vs. Q4’s +2.5%, while only slightly weaker than last month’s initial read of -0.4% Y/Y there is real cause for concern. And with the manufacturing segment within IP coming in even weaker at a revised -1.3% Y/Y also slightly worse than last month’s -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. Though while the Y/Y print deteriorated a bit, the sequential M/M comparison actually improved slightly – which if that proves to be signal vs. noise, could suggest a more constructive path ahead.
So Yes, we are technically deflationary. Yes, that historically only happens when we’re in or headed towards an economic recession. And Yes, the relative Y/Y downdraft in Industrial Production over each of the last four NBER recessions (1991, 2001, 2008, and 2020) has been increasingly severe – from -2.5% to -5.3% to -14.6% to -14.9%. But we don’t appear to be in a free fall just yet and it remains entirely possible that we could buck the trend this time around or avoid a recession altogether given the resiliency of the labor market.
But 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 quarter, that does not mean we are doomed to suffer 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 meaningful decline in industrial activity usually means a decline in the relative demand for truckload capacity, and therefore more downward pressure on spot rates all else equal.
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 that we had been range-bound against for much of 2022. Last month, we reported a final Q4 2022 of 1.35 noting that ‘momentum in the data set signaling more room to run higher in the months to come’. But with our preliminary Q1 2023 now on the board with January’s 1.34, we are seeing signal for the opposite – which would represent one of those fleeting streaks of sunshine we mentioned if the pattern holds. Remember that 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 pretty downbeat. Whether this preliminary Q1 read becomes early signal for just such a top or simply a head fake remains to be seen, but we sure are looking forward to finding out over the next couple of months as the macroeconomic landscape continues to gyrate and evolve.
With Consumption, Industrial Production, and relative inventory levels all signaling further weakness, let’s now turn our attention to our primary TL demand indicators – the Cass Shipments Index and the ATA TL Volume Index. This month, we got our second glimpse of Q1 with the revised February read on the Cass Shipments Index coming in at a materially stronger -0.4% Y/Y as compared to last quarter’s -2.3%. So count that as another fleeting ray of sunshine, though we continue to track lower and in line with the slowing Industrial Production narrative. In fact, both indicators are literally right on top of each other at this point at -0.4% and -0.7% Y/Y, respectively. We also got our first glimpse at Q1 ATA TL Volume with our preliminary January read of +0.2% Y/Y vs. last quarter’s +1.5%, so we continue to bend lower on that front as well. And for the first time since late 2018, both of our TL demand indicators are running in phase with Industrial Production – which we interpret as a return to healthy correlation. As industrial activity slows and TL capacity demand with it, as evidenced by the Cass Shipments Index, the Q3 2022 inflationary inflection point in the ATA TL Volume index signals that we are well past peak supply expansion. And 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. We got a few more of these this month, with regional truck fleets folding in North Carolina and Florida, and saw the first merger of large national carriers with the acquisition of US Xpress by Knight Swift that we have seen since…well, the acquisition of Swift by Knight to form Knight Swift. This is the battle that has raged over the last several months, a battle that only gets prolonged as increasingly lower diesel prices and soft demand conditions persist. So, we’ll be watching our TL demand indicators closely in the months ahead for signal confirming that that such a spot market 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 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 through 2022-23 as the US TL Spot market worked through its own excesses, we got a rocket ship of a number in October 2022 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. Now with our first Q1 revision on the board at a slightly higher and officially Y/Y inflationary +2.5% compared to last month’s -0.6%, we got a weak but arguably more decisive signal for the former. But we’ll have to wait another month to find out for sure as to which side of the axis we ultimately land. Signal or head fake? We can count on this to be one of the more dramatic storylines in the April issue.
So, for the benefit of any new readers this month, what makes this particular pattern noteworthy, aka ‘nutty’ (that’s the technical term)? We have remarked 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 – though perhaps not for much longer as we continue as a more sustained downtrend continues. 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 2022 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 -19.4% lower to the current March 2023 MTD read of $4.238/gal and -17%.0 Y/Y – the first Y/Y deflationary read since February 2021. At this point, as the oscillations have mostly disappeared and prices fade steadily lower, momentum clearly signals further price reductions are likely 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. We noted last month that ‘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.’ And that ‘if we don’t get a bounce in the weeks ahead, then this is likely where things are headed.’ Well, no such bounce materialized so here we are. With Q1 now officially settling slightly lower than Q4 2022, it has become our new candidate for this cycle’s deflationary inflection point. Whether it holds up as we work our way through Q2 remains to be seen, but we are pretty confident that it will given the year-over-year comps now that the Q1 2022 Omicron kink is behind us.
Now this first quarter of the new year just about in the bag, the early signal we got in January pointing to a Q4 2022 cycle inflection point, has vanished – now you see it, now you don’t. We should have known it wouldn’t be this easy given the roller coaster we have been on the last couple of years. Spot linehaul rates indeed faded lower in March, bucking the market’s seasonal tendencies, which have taken our Q1 close lower than Q4, thus negating our projected Q4 deflationary inflection point. Q1 2023 now becomes the projected cycle bottom and the entire curve forecast shifts forward by a quarter. But whether this forecast holds or we’ll have to do all of this again next quarter will depend entirely on how low the supply side can go in the months ahead before we finally find our floor. And given we believe we are already operating below the market’s average operating cost per mile, we can only assume that it can’t be much further. The supply side can only bend for so long. Eventually, it is absolutely going to break. So, what will determine the ultimate location of our market’s breaking point? 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. Though this month, we are flipping the order and moving Diesel prices into the pole position.
1. Diesel Prices: As we continue to note, 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 six months, the more recent extended downtrend appears to be prolonging our time down here at the bottom of the cycle. The lower diesel goes, the lower the market allows Spot linehaul rates to go. After declining steadily from June through September 2022, diesel reversed higher in October and into November. But then reversed once again, fading almost a dollar or -19.4% lower to the current $4.238/gal. Where we go from here is anyone’s guess, but we continue to believe that even with diesel increasingly lower 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 – even more so than what happens with the economy.
2. 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 2022’s +9.1% Y/Y to February 2023’s +6.0% 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 – though hopefully recent tremors from both the banking system and the commercial real estate market have given them reason for pause. At least they have slowed the upticks to 25 bps and have begun to signal that the end of this tightening cycle is near. That said, the US Consumer continues to hang in there for the most part, though cracks are forming with February retail spending slowing -0.4% M/M. However, questions mount as to how long the Consumer can hold up or whether those cracks widen given signals of cooling labor market and rising household debt. That said, so long as Consumer spending remains steady-ish, the probability of a soft landing for the economy remains on the table – though that probability cleared ticked lower in recent months. In any case, while Consumption has moved to the back burner relative to diesel prices this month, we don’t see this wild card going anywhere anytime soon.
So there you have it. Just when we thought we had found the bottom of the cycle and turned the corner, the market has pulled us still lower. And with our expected deflationary inflection point now shifting forward by a quarter to the Q1 that we just wrapped up, our entire forward market curve shifts with it – which means we are likely looking at Q4 of this year before we get our first inflationary Y/Y quarter. And while this means a little more pain and suffering for the supply side before we get our recovery, the playbook remains the same. Use the extended time that we’re down here to take cost out of your operations and learn to do more with less. Get lean. Get resilient. So when we experience our inevitable market shift higher going into next year with a new cycle, you will be positioned to take maximum advantage of it. Then it becomes all about staying disciplined and staying lean through the next inflationary leg because what goes up must eventually come down again. So let’s remember what down feels like, and what we’ve learned, as we work our way through the next couple of quarters and into the recovery – and use those learnings to position for the entirety of the next 3-4 year US Spot TL Linehaul rate cycle, not just the ride up. You and your organization will be better for it.