[Excerpt from The Pickett Line May 2023 Issue]
“Houston, we have lift off” – to quote astronaut Neil Armstrong on July 16th, 1969 as Commander of the Apollo 11 mission to land humans on the moon for the first time. After spending the last two quarters on ‘inflection watch’, anticipating the Y/Y deflationary bottom of the current US TL Spot Linehaul rate cycle, we believe we have finally found what we’re looking for – a theme we’ve been lamenting since the U2-inspired November 2022 issue cleverly titled ‘Still haven’t found what we’re looking for.’ But now with May officially in the books and the second quarter of 2023 mostly baked, our projected Q1 2023 deflationary inflection point is looking like a lead pipe lock at -31.8% Y/Y relative to our current Q2 read of -19.7% – which is exactly where it sat last month as we opened the quarter, though not without some volatility along the way. And while perhaps lacking the relative global significance to justify in any way comparing to the heroic Apollo 11 crew and their historic mission, nevertheless it continues to be the first thought that comes to mind every time we examine our current cycle chart – perhaps just as it did to Armstrong when he improvised the same words as he felt his own rocket engines begin to fire. The phrase was not planned in advance for media effect or to intentionally etch something profound into the historical record. It was a simple unrehearsed declaration of fact, but one that also captured the excitement and anticipation of the moment. So with Neil Armstrong and the Apollo 11 crew as our inspiration this month, let’s begin to unpack this May 2023 issue of The Pickett Line. Up, up and away we go.
Recall that after the Q1 head fake that ultimately knocked out our preliminary Q4 2022 deflationary inflection point, last month it was all about cautious optimism that the initial Q2 read of -19.7% Y/Y would hold up. ’Okay, let’s try this again’, we said. And as stated above with much dramatic flair, we find this month that indeed it has – as we continue to sit at -19.7% Y/Y vs. a forecast of -20.0% + 5% and the prior quarter’s -31.8%. And unless the bottom completely drops out of the TL spot market in June, which we in no way expect it to, we are virtually guaranteed to close the quarter well above Q1’s -31.8% thus finally confirming our deflationary inflection point of this current US TL Spot Linehaul rate cycle. So, assuming that is what indeed comes to pass, we maintain our guidance from here which puts us Y/Y inflationary as early as Q4 – or more specifically, +5.0% Y/Y or +15.0% from current levels. Then it’s off to the races in 2024 as the spot market surges into the inflationary leg of the next rate cycle, contract routing guides fall apart, and we all get to do this dance again.
With our US TL Spot Linehaul Index running right on forecast, we got our first glimpse of the Q2 contract rate environment with the May Cass Linehaul Index coming out of the gate hot by posting a preliminary -12.3% Y/Y vs. a revised forecast of -9.0%. From here, we expect that the quarter could easily settle 3% percentage points higher or lower before Q2 is baked. Though the lower it goes, the sooner we believe contract routing guides break down given the expected trajectory of US TL Spot Linehaul rates over the balance of the year and into 2024. We noted in recent issues that 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 sense of comfort that becomes impossible to resist yet ultimately proves false in the end as unrealistic budgets are blown and service levels begin to deteriorate. So look for all of those 3-6 month bids from the last year to magically turn into 12-24 month commitments. And by early next year, we’ll look for many of them to begin to unravel as primary tender acceptance rates fade back to 2021 levels. But all is not lost if you are one of those procurement organizations that runs this playbook, usually under duress from the finance organization or executive leadership looking to manage costs lower by any means necessary through what many expect to be volatile and uncertain economic conditions over the year ahead. We just recommend that you invest in the technology required to give your team the visibility and control they need to track the performance of your spot vs. contract lanes and carrier partners in real time (at least on a daily or weekly basis), and then be in position to take decisive action if necessary. The next best thing to positioning for long-term performance is building the organizational agility to pivot and adapt before your competitors do as the landscape changes.
Now let’s get on to the macro, where much like last month we got a slightly mixed bag of data to consider but the overall implied direction of the economy and the demand for US TL capacity continues to point down and to the right – not straight down mind you, but clearly pointing in the wrong direction if you’re a fan of growth. We’ll start with the good news. One of the bigger risks coming into this month was that the surprise bounce higher we saw in the preliminary Q1 2023 GDP release for Consumption would get erased with the first revision. Recall that after five consecutive quarters of sequentially lower prints on a Y/Y basis, we sat at +1.7% Y/Y in Q4 2022. So when Q1 2023 hit the board at +2.3% Y/Y, we took that as a potential signal that the reports calling for an inevitable hard landing and US economic recession driven by an overzealous Federal Reservice slamming the brakes on an overheated economy were perhaps greatly exaggerated (hat tip to Mark Twain). But given the continued downward trajectory of Industrial Production, and the historical correlation between the two, we halfway expected the bounce to get revised away as the data settled. With our first revision now on the board, we were happy to see the preliminary read of +2.3% Y/Y stand – with the number itself actually moving slightly higher not lower. We got a little bit of movement under the hood, though hardly material with Durable Goods revising 10 bps lower to +2.6% Y/Y and Services going 10 bps higher to +3.1% Y/Y. Nondurables remained unchanged at -0.3% Y/Y. But with that slight uptick in Services, we now officially have all three components pointing up and to the right for the first time since 2021. We’ll have to see how long it lasts, but for the time being at least, this isn’t a chart pattern that typically precedes an economic recession.
Now, about that continued downward trajectory in Industrial Production. As a quick refresher for any new readers, we closed Y/Y deflationary in Q1 2023 for the first time since the Q1 2020 Covid recession – a move that almost without exception over the last 35 years has been a harbinger of recessionary economic conditions ahead. And while not off-the-charts deflationary at -0.8% Y/Y, it was a deflationary print nonetheless. Now with our preliminary Q2 read on the board, the question becomes how steep is our line and what does that imply going forward? At -1.2% Y/Y, which is where the April read pegs Q2 for the moment, we find that it’s actually looking pretty flat. Yes, we’re still pointing lower, but in the grand scheme of things, we see this as a pretty constructive signal that perhaps the bottom isn’t about to drop out of the industrial economy after all – especially given what we’re seeing in the Consumption line. At least not yet. As we know, one month hardly makes a quarter and one quarter hardly makes a pattern. But based on everything we’re seeing in these most recent data points, we believe there is a lot to be optimistic about with regard to the future direction of the economy and the freight market that powers it – even if we’re the only ones covering the space that seem to hold that view at the moment, certainly in stark contrast to the herd in the “Freight Recession” camp that has dominated the media narrative as of late.
So that was the good news. But as we noted above, we’ve got a mixed bag to unpack with the balance still pointing to further weakness in the months ahead. And while more optimistic than most, we can’t ignore the danger signs still flashing across our relative inventory and TL demand indicators. Earlier this year, one of the few ‘fleeting streaks of sunshine’ we noted was the 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 February revision taking us to 1.36, that particular ‘streak of sunshine’ had all but disappeared. And with the final March update taking us still higher to 1.37, we’re now instead left with an increasingly ominous storm cloud. 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, you can expect the macro-outlook to remain cloudy with a chance of recession. So tune in next month when we get our first glimpse at the Q2 Inventory to Sales Ratio and a revised Q2 Industrial Production read to consider and then bake into our outlook for Q3.
With Consumption continuing to point higher while Industrial Production and relative inventory levels signaling weakness, let’s shift gears to our primary TL demand indicators – the Cass Shipments Index and the ATA TL Volume Index. After settling in at -0.2% Y/Y for Q1 2023, our preliminary Q2 print on the Cass Shipments Index came in materially lower at -4.9% – the lowest read since Q3 2020. So no doubt a softer start to Q2, but well within the observed range of the last two cycle troughs in 2016 and 2019 – though the index did go on to collapse with COVID recession in early 2020. And while there are plenty of reasons to expect conditions to get worse before they get better, barring a repeat of a pandemic-induced shuttering of the US economy, we don’t expect to revisit the Q2 2020 lows of -21.4% Y/Y this time around. That said, we wouldn’t be too surprised to see a couple of prints in the -8-12% Y/Y range before we bounce higher.
Now onto our ATA TL Volume Index, which after a period of pretty extreme divergence from 2019 through mid-2022, has been running hand in hand with its sister TL demand indicator for the last few quarters. And we see that streak continue into this current quarter, with our preliminary read now on the board at -4.5% Y/Y – compared to a final Q1 2023 print of -0.3%. As both indicators fade lower at -4.5-5.0% Y/Y this quarter, we interpret this as a signal that the pace of supply-side rationalization has picked up in recent months – or in simpler terms, the rate at which unprofitable motor carrier are forced to exit the market. 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 in the months ahead as more carriers run out of options, despite increasingly cheap diesel. So, we’ll be watching our TL demand indicators especially close and looking for any evidence to confirm or contradict that such a spot market floor has finally been reached. Though that is certainly our view this month – that we hit our Y/Y bottom last quarter and found our sequential floor in May.
So, what else can we infer about the relative health of the supply side this month? As always, let’s start with Net Class 8 US Tractor Orders – where over the last few quarters we noted that things had gotten a little nutty again. Just when we thought we were back to historic cycle patterns, 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, relatively speaking, in Q4 2022. Rather than close increasingly negative Y/Y, we put up a +86.5% thus forming a pattern completely unprecedented relative to past cycles. 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. But as the subsequent quarter closed flat Y/Y and Q2 revising still lower to -18.2% Y/Y with this month’s read we’re back in line (again) with historic patterns. So we can take the ‘2-3 quarter nudge’ hypothesis back off the table and reframe
Q4 2022 as more of a one-off head fake likely driven at least somewhat by OEM’s opening up their 2023 order books as their supply chains normalized while at the same time the outlook for the US economy weakened further – though much of the supply side frothy enthusiasm from the 2020-21 boom remained. But given the weakness in most reported Q1 2023 motor carrier earnings, the relative weakness in Q1 and Q2 net order activity isn’t surprising. 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. From here, we expect the reversion to historic patterns to continue which means another couple of quarters of Y/Y deflationary Tractor Order reads before swinging Y/Y inflationary with the TL Spot Linehaul rate cycle by Q1 2024.
While Net Class 8 Tractor Orders have bounced around over the last couple of quarters, US 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 in mid-2022 after exploding steadily higher for much of the year up to that point – 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. Ultimately, those fears proved to be unfounded as diesel instead reversed course once again and it has since settled -25.2% lower to the current May 2023 MTD read of $3.930/gal and -30% Y/Y – continuing to run Y/Y deflationary for the first time since February 2021. At this point, the oscillations have mostly disappeared, and prices continue to fade steadily lower as momentum clearly signals even further price reductions are likely in the weeks ahead until that market finds a new floor.
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 almost violently 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 allowed the market to absorb the diesel shock without forcing carriers out of the market in material numbers at the same rate. So far at least, it has been a much more gradual exit. And as the battle rages on, the role that diesel prices have played has been 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 here and in recent issues, we believe this is it. We’re finally here. Going forward, diesel’s role becomes that of a pacesetter. If prices fade still lower, then the pace of exits likely continues at the current rate or possibly slows down a little. And if they instead turn higher, then the pace of exits likely picks up which would be a tailwind to TL spot rates and would accelerate the overall market recovery.
So here we are with a late Q2 2023 Spot TL Linehaul chart pattern that looks almost identical to the one we saw last month. The only difference is we have a lot more confidence at this point that it’s going to hold up through quarter close to confirm our Q1 2023 deflationary inflection point and signal that the spot market recovery has indeed begun. Like we said at the top, ‘Houston, we have liftoff.’ That said, we also want to emphasize that the US trucking market is not the US economy. They are profoundly intertwined, but are not the same thing. And it is entirely possible to experience an inflationary leg of the US TL Spot Linehaul rate cycle during a weak US economy if not an outright recession. We could easily see spot rates march higher while TL demand marches lower, driven primarily by diminishing supply. And we only need to look back to the 2007-2009 Great Recession to find an example of exactly that. As Consumption, Industrial Production, and US TL Demand all cratered through much of 2008 and early 2009, Spot TL rates were spiking to a peak of +23.0% Y/Y. Of course, the collapse in demand eventually caught up with the market and this proved to be the shortest and narrowest inflationary leg of any cycle observed since. But the point is that the cycle can very easily continue without the presence of an inflationary demand catalyst. So whether we get a soft landing, hard landing or no landing because we avoid a recession altogether won’t likely interfere with the TL spot market’s journey to Y/Y inflationary conditions in 2024. But it will no doubt help determine how high we go and how long we stay there. And while it is Goods Consumption (i.e. TL-intensive Consumer Spending) this is perhaps our most meaningful mid to long-term spot TL market catalyst, it is the movement of diesel prices in the short-term that will play the most direct role in driving spot rates over the next few months as the pace of motor carrier exits dictates the pace of the market recovery – at least from a pricing standpoint. So let’s dive into both wild cards briefly, as we now turn our focus to the month ahead of us:
1. Diesel Prices: As noted, we believe that diesel prices in the weeks and months ahead will not only help determine whether our proposed current bottom in TL Spot Linehaul rates holds up, but will also help set the pace at which spot market rates recover. 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 $1.325 or -25.0% lower to the current $3.930/gal. Where we go from here is anyone’s guess, but we continue to believe that even if diesel reaches still 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. 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 many months of slow yet steady sequential decline – from June 2022’s +9.1% Y/Y to April 2023’s +4.9% 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 a 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 (or no landing) for the economy remains on the table. In any case, while Consumption moved to the back burner relative to diesel prices in March and remains there this month, we don’t see this wild card going anywhere anytime soon.
So on the one hand, we had zero movement on the two most important developments from last week’s issue. The Q2 US Spot Linehaul Index revised dead flat to last month’s -19.7% Y/Y thus confirming (though still tentatively) our Q1 2023 deflationary inflection point at -31.8% Y/Y and signaling the turn in the market that cycle we have been eagerly anticipating since Q4 2022. And our preliminary Q1 2023 print on US Consumption held up at +2.3% Y/Y through its own first revision. Or in other words, the TL spot market appears to have found its floor and the US economy (70% of which is comprised by Consumption) is showing signs of remarkable resilience despite numerous headwinds. So nothing really changed in May. But on the other hand, the fact that nothing changed in some ways means that everything has changed – at least with regard to the conviction we can begin to build for our cycle forecast and market outlook going into the back half of the year and on to 2024. With less proverbial fog to obscure our vision as to what lies ahead in the US Truckload market, we can begin to think and act more decisively to position our respective organization for what comes next.
For motor carriers and brokers operating on the supply side of the market, that likely means keep doing what you’ve been doing over the last year – at least if that means cutting costs, getting leaner, and conditioning your teams to be able to do more with less. While we see a light at the end of the tunnel with regard to a recovery in Spot TL Linehaul rates over the next year, the market correction is almost guaranteed to be uneven – with different industries, geographies, and equipment types all evolving at their own pace. Also, as noted last month, while the rate of recovery can look pretty dramatic on our Y/Y cycle charts, the sequential development of the market rates each of us experiences will feel altogether different. For example, 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. But regardless of the ultimate pace at which the market flips Y/Y inflationary over the quarters ahead, there is zero downside in remaining disciplined and getting operationally excellent in what you do. This is no time to take your foot off the gas. And as you prepare for 2024, the months ahead will represent a welcome opportunity to refine your commercial strategy and carefully consider the shippers that you want to partner with going forward into the next cycle. As the shippers that reneged on contract awards during the current deflationary leg of the cycle or unreasonably extended payment terms simply because they could probably don’t deserve the same attention and consideration as those that chose to operate differently. So choose wisely.
And for the shippers (and brokers that operate on both sides) on the demand side of the marketplace, our guidance is similar. What is left of this current Y/Y deflationary leg of the cycle represents a tremendous opportunity 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, especially if you’re also in the hard landing camp with regard to the broader economy and also expect to be facing demand headwinds. So as we wrap up Q2 and prepare to plunge deeper into 2023, remember that next year’s winners will be determined by the actions taken over the balance of this one. Now let’s see what June has in store for us.