[Excerpt from The Pickett Line June 2023 Issue]
Welcome to late June 2023, where we prepare to turn the page on an eventful Q2 and begin to dig in for what has the potential to be another wild quarter ahead. You may recall that last month we turned to none other than astronaut Neil Armstrong, Commander of the 1969 Apollo 11 mission to land humans on the moon for the first time, and his heroic crew for inspiration in recognizing the significance of finally confirming the deflationary inflection point of the current US Truckload Spot Linehaul Rate Cycle. Or rather, potentially confirming that milestone as we still had a full month to go before quarter close. And after the early head fake that Q1 threw at us with regard to confirming Q4 2022 as our bottom, we couldn’t rule out something similar coming to pass yet again – as unlikely as that might have seemed given the signal strength of the revised index read. Nevertheless, “Houston, we have lift off” we declared. And with the quarter now just about baked, we find that much like the Apollo 11 spacecraft atop its powerful Saturn V rocket on that historic day, we have cleared the tower and remain headed towards the next stage of our journey. For Commander Armstrong and the Apollo crew, that meant a 100-nautical-mile-high orbit around Earth en route to the moon. For us down here on earth, that means steadily rising TL Spot Linehaul rates en route to the next Y/Y inflationary leg of a new market cycle. Though depending on what side of the market you sit, you may find yourself questioning just which of the two rides you wish you were on in the quarters ahead.
This month however, we’re going in a slightly different direction for our literary inspiration. As we indeed confirm Q1 2023 as the deflationary inflection point of the current US TL Spot Linehaul rate cycle with the supply side signaling that it’s finally been pushed to its deflationary limit, we are reminded that “even a worm will turn” – a line that the literary GOAT himself Billy Shakespeare used in Henry IV, Part 3. The expression was used by Lord Clifford, killer of Rutland, to convey the sentiment that even the meekest or most docile of creatures will retaliate or seek revenge if pushed too far. As used here, while ‘meek and docile’ are hardly terms one would use to describe asset-based motor carriers as individually they are quite the opposite as they painstakingly provide a difficult yet essential service to sustain our society and power the global economy, their lack of market leverage during the deflationary leg of the cycle makes them so collectively. But there is a limit, which when reached, will eventually trigger a reckoning. And that ‘turning of the worm’, Ladies and Gentlemen, is what we believe we observed in Q1and what drives the fundamental mechanics of the US TL Spot market to begin with. But don’t think for a minute that the supply side has exclusive rights to the worm moniker. As the cycle marches on and we break Y/Y inflationary in 2024 en route to our next spot market peak, it will be the demand side that get pushed to their own limit before finally breaking lower. And we will find that once again, “even a worm will turn.”
So with the stage set, let’s move past the rockets and worms and dive into this June 2023 issue of The Pickett Line. Recall that last month’s revised read on the Q2 US TL Spot Linehaul Index had us pegged at -19.7% Y/Y vs. Q1’s -31.8% and just about spot on (pun intended) with our spot index forecast of -20.0% + 5%. And with just a third of the quarter left to go, it was virtually certain that Q2 would close higher than Q1, thus confirming Q1 2023 as our deflationary inflection point and Y/Y bottom on the cycle. Now with June mostly behind us and our revised Q2 index read on the board at -18.8% Y/Y, while we got knocked further off our forecast with our index creeping slightly higher, we remain decidedly above Q1’s -31.8%. So with less than a week to go in the quarter, please join me in recognizing Q1 2023 as America’s new Y/Y TL Spot Linehaul rate cycle floor, and the most recent addition to a long list of esteemed deflationary inflection points that came before it – legends like Q2 2019, Q2 2016, and who could forget Q4 2012? And with Q2 now projected to close at its current position +1.0%, we look ahead to a forecast line over the balance of the year that pegs Q3 at -10.0% Y/Y and Q4 at +5.0% – which would be our first Y/Y inflationary mark since Q1 2022.
Now with a bow just about tied on the final Q2 Spot Linehaul Index read, we still have a month to go before we can do the same with our Contract (Cass) Linehaul Index. But with the May revision taking our Q2 mark from -12.3 Y/Y to a slightly lower -13.4% vs. a forecast of -9.0%, we got some signal that there is plenty of room to run still lower before finally settling. And that we should expect to see a floor closer to -15.0% Y/Y, potentially as low as -17.5%, in the next quarter or two before inflecting higher to follow TL Spot rates into the next inflationary leg of the cycle in 2024. Should this trajectory hold, we expect to see the Y/Y Spot Index cross over the Y/Y Contract Index as early as next quarter and for many contract routing guides to begin underperforming by Q1 2024.
So, what happens between now and then? As noted in recent issues, with the projected spot market cycle bottom now in, many enterprise procurement teams first look to extend the duration of their contracts to try and “lock rates in at the bottom” – which never really works over the long term but represents a short-term temptation that is difficult to resist. So look for all of those 3-6 month bids from the last couple of years to magically morph into 12-24 month commitments. But by early next year, we’ll look for many of them to begin to unravel as primary tender acceptance rates fade back to 2020-21 levels. That said, all is not lost if you are one of those procurement teams that runs this playbook, usually under duress from the finance organization or executive leadership looking to manage costs lower by any means necessary given the slowdown in economic activity across many sectors and the specter of a potential recession still looming over the US next year. You’ll just need to be especially agile as the freight market landscape shifts. To that end, if you haven’t done so already, we recommend that you invest in the technology and tools required to give your team the visibility and control they need to track the performance of your contract lanes and carrier partners on at least a weekly basis if not daily, and then be in position to take decisive action if necessary – from rebidding lanes away from underperforming vendors to leveraging more dynamic contracts. Again, the next best thing to positioning for long-term performance to begin with is building the organizational flexibility to pivot and adapt before your competitors do as the cycle marches on and the transportation marketplace evolves as a result.
Now let’s get on to the macro, where the song remains much the same as in recent months. We got yet another mixed bag of data to consider but the general outlook for the US economy and the demand for the truckload capacity that powers it remains tepid at best. While we still see no sign of impending collapse or an otherwise hard landing anytime soon, we also don’t see any obvious positive catalysts building yet that indicate a material recovery in Industrial Production in our near future. But maybe that’s the point – things could be a lot worse, yet they aren’t. Despite the numerous headwinds that remain in play, the US Consumer so far at least remains remarkably resilient and both the economy and the trucking market remain relatively stable from a historical perspective. Sure, we’re going through a deflationary leg of the Y/Y Spot and Contract rate cycles but none of the demand indicators scream ‘volume recession’ to us – though we guess that depends on what one’s definition is for ‘recession’ in this context. We are technically Y/Y negative on both volume demand indicators (more on that below), but at -4.0-4.5% we’re nowhere near the depths seen in the two most recent economic recessions in 2020 and 2008-09. In any case, we see more to be optimistic about than not, but concede that we are far from out of the woods. Though a Q2 2023 Consumption print above Q1’s +2.3% Y/Y would go a long way…as would an immediate end to the war in Ukraine which one can’t help but get a little more constructive around after recent developments in Russia. And while we take no comfort in cheering for the mercenary chief of a Kremlin-allied private militia in this skirmish, given the alternative we have little choice. Hopefully this “lesser of two evils” conundrum isn’t in any way foreshadowing our own political contest coming up here in the US in 2024.
With the final revision on Q1 2023 GDP and Consumption not due out until next week, our latest read of +2.3% Y/Y still stands. Should it hold up after this next revision, it will represent a potential welcome change in long-term trend. 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 and stayed there after the first revision, we took that as a possible signal that seemingly consensus 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 a little exaggerated. 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. That possibility remains until we get the final print, but should it stand we’ll get our next dramatic storyline for the writers at Pickett Research to nerd out on in the months ahead: ‘Consumption vs. Industrial Production – who’s telling the truth?’ It doesn’t take much to get us excited over here. Apparently, we don’t get out much.
So with the protagonist of this story, Consumption, treading water until next week’s update and a preliminary Q2 read due to print July 27th, let’s now shift gears to 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 revised Q2 read on the board, the question becomes how steep is our line and what does that imply going forward? In one of the more constructive developments this month, last month’s preliminary read of -1.2% Y/Y actually got revised slightly higher to -1.1% – so still looking pretty flat which is a positive 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, two months 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 as to where we go from here.
So much like last month where Consumption and Industrial Production both flashed ‘weak but could be worse’ signals while the Inventory to Sales ratio came in a little worse by comparison, our first glimpse at Q2 inventory levels with the April print suggests more of the same. After closing Q1at 1.37, which was 2 bps higher than Q4 2023, our preliminary Q2 read stepped another 3 bps higher at 1.40 – so no sign of a local peak just yet. 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 near-term macro-outlook to remain cloudy with a chance of recession.
With Consumption continuing to point higher while Industrial Production and relative inventory levels signaling weakness, let’s update 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, last month’s preliminary Q2 print on the Cass Shipments Index came in materially lower at -4.9% – the lowest read since Q3 2020. But on another more constructive note this month, the May revision has taken Q2 slightly higher to -4.0% Y/Y. So no doubt, still 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 in line with the COVID recession in early 2020. And while there remain plenty of reasons to expect that conditions could 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, it also wouldn’t be a shock to see a couple of prints in the -5.0-10.0% Y/Y range before we ultimately 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 Q2 read still on the board at -4.5% Y/Y – compared to a final Q1 2023 print of -0.3%. We’ll get our next revision later this month, so the same -4.5% from last month’s issue stands for now. 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 has accelerated. 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 Y/Y deflationary floor – which as we noted above, has now been confirmed to have been reached in Q1 2023. Though we’ll no doubt see more and more of these exits in the months ahead as more carriers run out of options as the market turn continues, despite increasingly cheap diesel and a stable-ish volume demand environment. But for those that are able to hang on, the worst is behind them and a more constructive Spot market rate environment is on the horizon.
And speaking of the supply side, let’s now shift our attention to 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 now revising still lower to -12.9% 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 deteriorated further – though much of the supply side’s frothy enthusiasm from the 2020-21 boom remained. But given the weakness in most reported Q1 2023 motor carrier earnings performances, the softness 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 nothing but a nothing burger. From here, we expect the reversion to historic patterns to continue which means another quarter or two of Y/Y deflationary tractor order reads before swinging Y/Y inflationary with TL Spot Linehaul rates 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 now seven month 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 -27.4% lower to the current June 2023 MTD read of $3.815/gal and -28.1% Y/Y Q2 average – so 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 – primarily driven by a weak global demand outlook and perhaps to be nudged even further should a peaceful resolution be found in Ukraine in the coming months.
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, we believe we’re finally here with the confirmation of Q1 2023 as our deflationary inflection point. 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. Should 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 back towards Y/Y inflationary conditions.
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 and the one we saw the month before that. But with the quarter now just about wrapped, we can be confident that our -18.8% Y/Y is going to stand – which sets the stage for a recovery in the Spot TL market in the months ahead and the next inflationary leg of a new cycle throughout the entirety of 2024. After setting a new rate cycle low water mark with Q1 2023’s -31.8% and crushing Q2 2019’s prior record of -19.0%, the worm has finally turned.
That said, we also want to emphasize again 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 relative 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, it 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) that is perhaps our most meaningful mid to long-term spot TL market catalyst, it remains to be 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 spot market rate recovery. So as is our custom, let’s dive into both wild cards briefly, as we now turn our focus to the new month and quarter ahead of us:
1. Diesel Prices: As noted, now that we’ve hit our Y/Y cycle bottom, we believe that diesel prices in the weeks and months ahead will help set the pace at which spot market rates recover from here. And while prices had been on a bit of a roller coaster ride over the back half of 2022, we suspect the downtrend we’ve been on year to date is prolonging our time down here at the bottom of the cycle. The lower diesel goes, the lower the market will allow 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 $1.440 or -27.4% lower to the current $3.815/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 broader economy.
2. TL-Intensive US Consumer Spending: Conditions remain tough to say the least, 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 May 2023’s +4.0% Y/Y, a whopping 90 bps lower vs. the prior month. 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 despite the pause in the most recent FOMC meeting. That said, the US Consumer continues to hang in there for the most part, as evidenced in the revised Q1 Consumption print. However, questions mount as to how long the Consumer can hold up or whether existing cracks will widen given signs of a cooling labor market, rising household debt, and tightening credit conditions. That said, so long as Consumer spending remains steady-ish, the probability of a soft landing (or no landing) for the economy remains squarely on the table. In any case, while Consumption moved to the back burner relative to diesel prices back in March and remains there this month, we don’t see this wild card going anywhere anytime soon. In fact, it will in all likelihood regain pole position at the top of the list by Q4 barring an unusually eventful Atlantic hurricane season, which technically kicked off this month and runs through the end of November. But at the moment at least, NOAA forecasters are predicting near-normal activity this year – which means 12-17 named storms (winds > 39 mph), 5-9 hurricanes (winds > 74 mph), and 1-4 major hurricanes (Category 3,4,or 5 with winds > 111 mph). Though regardless of what may come to pass, keep in mind that in a rising spot market, rates are much more vulnerable to short-term dislocations like major storms. So the risk level this year is going to much higher than in 2022 when the spot market was in free fall.
So there we have it, Ladies and Gentlemen. With Q1 2023’s -31.8% Y/Y standing up as our deflationary inflection point, we are now officially in the 4th and final quarter of the current US TL Spot Linehaul market cycle. As the remaining surplus capacity that entered the market during the Y/Y inflationary phase (1st & 2nd quarters) is shed over the next two quarters, we zoom right past a state of relative equilibrium and into a new cycle where, you guess it, we get to do this all over again from 2024 to 2026. So what does that mean with regard to the months ahead for the supply-side motor carriers, the demand-side shippers, and the both-sides brokers that make up this wildly dynamic and fragmented ~$900B market? Much as we outlined in last month’s issue, for what it’s worth, our guidance remains as follows.
For motor carriers and brokers operating on the supply side of the market, this 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 +14% increase from current levels. And we don’t expect the contract market to correct materially higher for another couple of quarters after that. But regardless of the ultimate pace at which the market flips Y/Y inflationary over the quarters ahead, there is little downside in remaining disciplined and getting operationally excellent in what you do. 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 it is the shippers that reneged on contract awards during the down cycle or unreasonably extended payment terms simply because they could that probably don’t deserve the same attention and consideration as those that chose to operate differently. So make your own choices wisely. And for 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 almost certainly 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, operating models, and vendors could create a comparative advantage – whether it be from cost, speed, or flexibility – in an inflationary TL market. Remember that next year’s winners will be determined by the actions taken over the balance of this one. So let’s make the most of it. Now onto July and Q3.