[Excerpt from The Pickett Line April 2023 Issue]
Okay, let’s try this again. As we look back on this first month of the second quarter of the second year of the deflationary leg of this fifth observed US TL Spot Linehaul rate cycle since 2007, in the immortal words of the great Yogi Berra, “it’s like déjà vu all over again” compared to last quarter. Coming into 2023, we were looking for signal to confirm the projected Q4 2022 deflationary inflection point at -29.6% Y/Y. And in our January issue, we reported just that as our preliminary Q1 2023 index came in at -27.3% – not the strongest of signals, but signal nonetheless. But alas, it was not to be. Spot TL linehaul rates turned over and faded lower in February and March to close the quarter at -31.8% Y/Y and take out Q4’s proposed cycle bottom. Which means Q1 becomes our new candidate for deflationary inflection point and our forward market forecast curves get pushed out by a quarter.
So here we are in Q2, again looking to confirm the last quarter as our cycle bottom. But this time around, our signal is much stronger with our preliminary Q2 TL Spot Linehaul Index coming in at -19.7% Y/Y. And while spot market rates continue to fade lower this month, we think this early signal has a much better chance of holding up this time around and we’ll finally get our confirmation that the cycle has turned and the road to recovery has begun. But for that to happen, we’ll need to see evidence that the spot market has finally found a sequential floor over the balance of the quarter – which only happens when enough of the supply side capitulates and exits as the all-in TL spot market rate per mile falls below their fleet cost per mile to operate. So how low will we go and how long will it take to get there? We’ll look to answer both of those questions in this April 2023 issue of The Pickett Line, where we dissect the most recent updates to our macro and market indicators then dust off the old crystal ball to try and see what comes next. Let’s get to work.
As we get our first glimpse at Q2, let’s briefly look back at the final read on the Q1 we just tied a bow on. In last month’s issue, we reported a revised Q1 2023 US Spot TL Index read of -31.4% Y/Y vs. a forecast of -22.5% and 180 bps under Q4’s mark of -29.6% Y/Y. With the final few days of March now baked in, our final print now sits at a slightly lower -31.8% Y/Y and 220 bps under our projected Q4 deflationary inflection point. Recall that last month we noted for Q2 ‘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.’ And with our initial Q2 print now on the board at -19.7% Y/Y and -7.2% Q/Q, this is exactly what is so far unfolding. But as with the last quarter, we’ll have to see where the next couple of months take us before knowing anything for sure – whether we have indeed found the point of maximum pain that the market can endure before breaking or not.
And while we’ll have to wait until next month to get our first look at Q2 2023 contract rates, we got our final revision of the Q1 Cass Linehaul Index to consider as we closed the quarter at -7.1% Y/Y vs. a forecast of -7.5% – so right on track. From here, as we noted last month ‘we now expect to hit -9.0% Y/Y by Q4 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.’ What usually happens during this phase of the Contract TL rate cycle is that procurement teams first look to extend the duration of their contracts to try and ‘lock rates in at the bottom’ – which never really works but creates a false sense of comfort (and budget) that becomes impossible to resist. So look for all of those 3-6 month bids from last year to magically turn into 12-24 month commitments. And by this time next year, we’ll look for all of them to begin to unravel as primary tender acceptance rates erode back to 2021levels. But that will be a problem to solve for another fiscal year and another budget cycle, at least for those without the will or the organizational support to take a longer-term view with their transportation planning and procurement strategies.
As we shift gears to the macro, while we’ve gotten intermittent flashes of optimism across one indicator or another in recent months, the overall direction has remained decisively down and to the right. And at this point, it seems that a majority of market pundits are calling for an unavoidable economic recession in the US as the combination of high inflation, still rising interest rates, and now tightening credit conditions triggered by a string of high-profile bank failures takes its toll on consumer spending. Though just when the storm clouds couldn’t appear much darker, here comes a preliminary Q1 2023 GDP and Consumption print to part the skies to make way for just a sliver of sunshine. So now we must wonder whether the reports of the death of the US Consumer have been greatly exaggerated (hat tip to Mark Twain) after all – at least at this moment in time. From the Q2 2021 COVID spike in Y/Y Consumption at +16.2%, we saw steady deceleration for six consecutive quarters – all the way down to +1.7% Y/Y in Q4 2022. And given the weakness in the rest of the macro indicators that we track, it became increasingly logical to expect the negative trajectory to hold – to breach the x-axis in the couple of quarters and go Y/Y deflationary as the economy plunges into recession. But with our preliminary Q1 read coming in at +2.3% Y/Y, we instead got a potential reversal in trend – again as compared to last quarter’s +1.7%.
But was this unexpected relative strength driven by the much heralded reallocation of Goods consumption to Services? Not so much, says the data. The bounce came entirely from Goods as the consumption of Durables improved by 210 bps to +2.7% Y/Y and Nondurables by 130 bps to -0.3% Y/Y. Services consumption held flat at +3.0% Y/Y. Not too shabby Ladies and Gentlemen. We interpret this as signal that the Consumer and the economy are proving more resilient than the media has given them credit for. But in the spirit of ‘here we go again…’, we’ll have to wait for the next couple of Q1 revisions and the Q2 numbers to reveal themselves before we get too excited about a recovery in progress. That said, as noted in the past there is no more important macro-indicator that we track to represent the underlying strength of the US economy and its likely direction than Consumption. So this is no doubt an interesting development and one that we will continue to pay very close attention to – starting with Consumption’s relationship with Industrial Production (IP).
Recall that Industrial Production tends to track Consumption pretty closely, so any sustained reversal in trend in one should be reflected by the other. And with Q1 2023 IP running Y/Y deflationary for the first time since the COVID recession, with a revised read last month of -0.7%, we noted that as an ominous signal for what might lie ahead. And while our final Q1 revision didn’t take us any higher, closing flat at -0.7% Y/Y, it didn’t take us any lower either. So where we open Q2 will be especially interesting to the extent that it could help confirm or contradict the strength we saw in Q1 Consumption. We noted last month that ‘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.’ But if Consumption is no longer pointed in that direction, we have reason to hope that perhaps IP may follow suit in the months and quarters ahead – and the most anticipated recession in US history fails to materialize.
But just as our Consumption signal flashes green, here comes a revised Q1 2023 Inventory to Sales ratio to curb our economic enthusiasm. One of the few ‘fleeting streaks of sunshine’ we noted last month came in a preliminary Q1 print of 1.34 that, when compared to Q4 2022’s 1.35, suggested that perhaps the relative inventory surplus that had developed during latter stages of the COVID recession and recovery had reached its peak and was beginning to normalize and recalibrate to post-COVID demand patterns. But with the most recent revision taking us to 1.36, that particular ‘streak of sunshine’ has all but disappeared. Recall 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 finally do observe a local top in the Inventory to Sales Ratio, we should expect to see a local bottom in IP – and vice versa. But until then, expect the macro-outlook to remain pretty gloomy.
Now, as Consumption points higher while Industrial Production and relative inventory levels bend lower, let’s shift gears to our primary TL demand indicators – the Cass Shipments Index and the ATA TL Volume Index. With our final Q1 2023 read on the board at -0.2% Y/Y, we saw a slight improvement to last month’s -0.4% and last quarter’s -0.5%. So we remain flat while signaling some positive momentum – much weaker as compared to the runaway demand conditions we experienced in 2021 but hardly anything that resembles a “freight recession”, a term we heard more than a few times in Q1 earnings calls from the larger publicly traded asset-based motor carriers to explain their underperformance – and from the mainstream freight media platforms that parrot them. Seems an easy enough excuse to point to, so we should expect to hear it repeated for another couple of quarters as the large operators will increasingly struggle as the TL market cycle finally catches up to them as contract and dedicated rates reset lower. So to summarize, it’s a “driver shortage” during the inflationary leg and a “freight recession” during the deflationary leg, but each is just another way of saying there’s too much or too little demand relative to supply or vice versa. In any case, we look forward to getting our first glimpse at Q2 in next month’s issue to see where it points us next – driver shortage or freight recession? Stay tuned to find out.
We also got our final read on the Q1 2023 ATA TL Volume Index, which flipped Y/Y negative for the first time since Q1 2021 to close at -0.3% vs. our preliminary January read of +0.2% and last quarter’s +1.7% – maintaining the downward trajectory it has been on since peaking at +5.5% Y/Y in Q3 2022. So with Cass trending ever so slightly higher to -0.2% Y/Y and ATA bending lower and lower to -0.3% Y/Y, Q1 technically represents the crossover in these two indicators that has signaled a Spot TL market shift in the quarters ahead – from Y/Y deflationary to Y/Y inflationary in this case. As industrial activity remains flat 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 indeed 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 that spot TL linehaul rates can finally find their deflationary floor. We’ll no doubt see more and more of these over the next few months as Carriers run out of options, despite increasingly cheap diesel. So, we’ll be watching our TL demand indicators closely in the months ahead for evidence that that such a spot market floor has finally been reached – or not. We’re clearly not there yet.
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 for the quarter. At the time, we noted that this wasn’t entirely unexpected. Back then, we suggested that the 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? With the final Q1 2023 print on the board at -1.7% Y/Y and decidedly deflationary, it doesn’t look like it. We’ll have to see what Q2 brings, but with net orders now back on the negative side of the x-axis and aligned with more regular historical patterns, Q4 2022 is looking like a one-off head fake likely driven at least somewhat by OEM’s un-constraining their 2023 order books as their supply chains normalized while the outlook for the US economy weakened further – yet much supply side enthusiasm remained (i.e. those open orders weren’t cancelled, at least not yet). But given the weakness in reported Q1 2023 Motor Carrier earnings, the relative weakness in Q1 net order activity isn’t surprising and we should expect more of the same in Q2. So in altogether underwhelming form, the ‘signal vs. head fake’ narrative around Q4 2022 US Net Class 8 Tractor Orders has been resolved – and it unfortunately proved to be anything but dramatic. On to the next storyline.
While Net Tractor Orders have bounced around over the last couple of quarters, retail diesel costs have settled into a sustained downtrend after spiking through much of 2022 on Russia’s unprovoked invasion of Ukraine. To recap diesel’s wild ride 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 2022 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 -22.0% lower to the current April 2023 MTD read of $4.099/gal and -20% Y/Y – continuing to run Y/Y deflationary for the first time since February 2021. And at this point, the oscillations have mostly disappeared, and prices continue to fade steadily lower as 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 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 in earlier issues that ‘if diesel finds a way to continue its mid-term move materially lower in the months ahead, we could see our cycle 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.’ 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 2023 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 expect that it will given more normalized year-over-year comps now that the Q1 2022 Omicron kink no longer factors.
So with an early Q2 Spot TL Linehaul chart pattern that looks eerily similar to the one we saw in early Q1, we have every reason to remain suspicious that our proposed deflationary inflection point will hold up – especially as DAT Spot linehaul rates continue to fade lower sequentially. But given the constructive signals in both the macro with Consumption signaling unexpected strength, especially with regard to Durable and Nondurable Goods, and market indicators like our two TL Demand indexes, we also have reason to be confident that this time around it will. It is just a matter of how much lower all-in TL Spot rates will need go before enough of the supply side finally taps out. As it stands, we believe that market rates are already running lower than the average motor carrier operating cost per mile according to the American Transportation Research Institute (ATRI) – forcing many to run at a net loss, alive operationally but dead financially. So it is just a matter of time before market conditions force those zombie carriers to the sidelines and a floor is reached. But how much time? How long will we have to wait before the zombies exit and we reach a spot market floor? While we realize we must sound like a broken record by now, we are focused on the same two wild cards that have dominated the conversation for most of the past year: Diesel Prices and TL-intensive Consumer Spending (i.e. Durable and Nondurable Goods) – in that order. We’ll dive into both but first a public service announcement to explain that last sentence:
PSA: Records were how we listened to music before CDs, MP3s, and now Spotify for any Gen Z readers out there. When the vinyl they are made from got scratched, or the record broke, the same section would often repeat. Hence, a broken record repeats. And so do we on this particular topic.
We now return to the regularly scheduled program…
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 had been on a bit of a roller coaster ride over the back half of 2022, the downtrend we’ve been on year to date 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 -22.0% lower to the current $4.099/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 begun heading for the exit in increasingly large numbers. 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 March 2023’s +5.0% Y/Y. But while the Fed’s tightening monetary policy is well on its way to achieving its end, progress has been slow and most of the guidance from Powell and the gang remains hawkish overall – almost resolute in their willingness to plunge to economy into a painful recession if that’s what it takes to rein in runaway inflation once and for all. At least they have slowed the upticks to 25 bps and have begun to signal that the end of this tightening cycle may be near. That said, the US Consumer continues to hang in there for the most part, as evidenced in the preliminary Q1 Consumption print. However, questions mount as to how long the Consumer can hold up or whether existing cracks will widen given signals of cooling labor market, rising household debt, and tightening credit conditions as the US banking system comes under increasing duress. That said, so long as Consumer spending remains steady-ish, the probability of a soft landing for the economy remains on the table. In any case, while Consumption moved to the back burner relative to diesel prices last month and remains there this month, we don’t see this wild card going anywhere anytime soon.
Talk about an action-packed month. We got to tie an official bow on a ‘now you see it, now you don’t‘ Q1 with regard to our much anticipated deflationary inflection point and US TL Spot Linehaul market cycle bottom. Despite early signal otherwise, Q4 2022 was not to be and Q1 2023 now represents the next eligible candidate. While the early signal is much stronger this time around, we know from experience that just about anything can happen in this market from one month to the next – and we have two more to go before we can draw any conclusions on the quarter. That said, the Contract market rolls along right on schedule and we expect to see a cyclical bottom later this year before turning Y/Y inflationary once again in mid-2024 to chase the Spot market higher. So what is one to do between now and then?
If one is on the Supply side, most likely all of the same things you’ve been doing over the last year – get leaner, get more efficient, and condition your organization to be able to do more with less. While even if Q1 represents the bottom of the cycle and Spot rates go on to close Y/Y inflationary by Q4 this year as projected, that only represents a +15% increase from current levels. And we don’t expect the Contract market to correct materially higher for a few quarters after that. So there is no doubt a light at the end of the tunnel, but while we are confident it’s not another train headed right for us, we remain in a pretty long tunnel. So stay focused and stay disciplined on getting operationally excellent in what you do. This is no time to take your foot off the gas. And as the focus extends beyond simply surviving 2023 and preparing for the inflationary leg of the new cycle that awaits us in 2024, choose your commercial partners (i.e. Customers) carefully. As the Shippers that reneged on contract awards during the down cycle or unreasonably extended payment terms simply because they could probably don’t deserve the same attention as those that chose to operate differently. Because, make no mistake, those were all choices.
And for the Demand side of the marketplace, what is left of this current Y/Y deflationary leg of the cycle represents your best chance to recalibrate your transportation strategy for the Y/Y inflationary leg that is looming ahead. The race to the bottom of the TL market that you are currently enjoying is no doubt masking weaknesses and deficiencies that will take a toll in 2024 if left unaddressed. So now is the time to examine your current and projected freight flows to understand where alternative modes and operating models could create a comparative advantage – whether it be cost, speed, or flexibility – in an inflationary TL market. Where could Intermodal play a role? What is your LTL vs. Shared Truckload (STL) vs FTL strategy? Will your private or dedicated fleet strategy hold up as the market shifts? How strong are your core carrier relationships? What are you doing to keep them that way over the next 12-18 months? As we know, everything gets easier for the Demand side in a down market. But it will be those that used their time down here on Easy Street most productively to re-calibrate their networks for the tougher times ahead that ultimately outperform their more complacent and less disciplined competitors. So as we plunge deeper into Q2, now is the perfect time to question which one you are – as next year’s winners will be determined by the decisions made and the actions taken in the quarters ahead. Now on to May. Good luck out there.