[Excerpt from The Pickett Line July 2023 Issue]
Well, here we are Ladies and Gentlemen. We’ve made the turn – on both the calendar and the truckload market cycle – and are now well into the back half of what has been a painfully grinding 2023 for most folks that operate on the supply side of the market. But with Q2 now in the rearview mirror, and with it our Q1 2023 deflationary inflection point now officially confirmed, we can finally start to get a little more constructive on the path ahead. And as market conditions start to heat up a bit relative to recent months, it is only fitting that July 2023 is set to be the world’s hottest month on record – so perhaps an omen for what lies ahead for us as we climb out of the deflationary trough to kick off our 6th US TL Spot Linehaul rate cycle since 2006. Yikes! That makes for 18 years of observed cycles for the freight nerds over here at Pickett Research. But time sure flies when you’re having fun…or whatever version of fun consists of experiencing recurring cycles of terror and relief every three or four years.
So, with temperatures soaring across much of the country, so much so that people in Arizona and Nevada are suffering 3rd-degree burns simply from falling on the ground, the theme this month is all about keeping our cool. While our bounce off the Y/Y cycle floor in Q1 certainly serves as a constructive long-term signal for the direction of US TL Spot Linehaul rates, there is plenty that can happen along the way to drive rates lower on a short-term basis. We don’t see too many of those potential catalysts lurking around the corner at this moment, but that doesn’t mean they’re not there. That means for all of you supply-siders counting on the strong 2024 spot market rate environment that this particular research publication is predicting, just remember that the path that leads us there may not be a linear one. So, let’s stay nice and cool. Let’s hold off on the high-fives and fireworks celebrations – or any material long-term investment decisions that hinge on 2023-24 spot market conditions – until we get a few more months of data points behind us first. That will only help maintain conviction through the inevitable short-term market fluctuations that await us along the way. Or in other words, it will help us keep our cool. Now with that as the backdrop, let’s all find a nice cool place to kick back and relax as we dive into this July 2023 issue of The Pickett Line. We would recommend heading to a chilly movie theatre for the three hour Oppenheimer movie for this, but the light from your laptop/phone/ipad or head lamp (if you prefer the printed version of TPL) while you’re reading might not be well received by fellow moviegoers. So if you go this route, it may be best to avoid any potential confrontation by sitting in the back row. Of course, Barbie is also an option but only gets you an hour and 54 minutes of chill time. But you be you.
As we noted last month, with June just about in the bag and our Q2 US TL Spot Linehaul Index on the board at -18.8% Y/Y vs. Q1’s -31.8% and our Q2 forecast of -20.0% + 5%, it was virtually guaranteed that our Q1 deflationary inflection point would hold. And now with June and Q2 officially closed at that same -18.8% index read, that guarantee stands and Q1 remains crowned as America’s latest Y/Y TL Spot Linehaul rate cycle floor. So, onto Q3 where our forecast remains -10.0% + 5%. As expected given normal seasonality, we entered July with a head of steam coming off of End of Month and End of Quarter June momentum and right into July 4th holiday weekend capacity challenges – with the holiday itself falling on a Tuesday this year making things perhaps a little choppier than usual. From there, the Spot market has corrected roughly back to mid-June levels. As a result, we saw a lot of movement in our Spot index over the course of the month – though it now rests at -12.3% Y/Y, again vs. a forecast of -10.0% so directionally in line with expectation. And as is often the case, the next few weeks will be especially interesting with the longer-term cycle forces signaling rates should go higher while current momentum continues to point slightly lower. Like we said, at the top the path to a sustained TL spot market rate recovery may not be linear.
And with our final June read now accounted for, we can also tie a bow on our Q2 Contract (Cass) Linehaul Index which closed all the way down at -13.9% Y/Y vs. last month’s -12.3% and a forecast of -9.0% – so running well below guidance. As noted last month, given current momentum, it is reasonable to now expect that we’ll 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. And should this trajectory hold, we expect to see the Y/Y Spot Index cross over the Y/Y Contract Index as early as this quarter and for many contract routing guides to begin springing leaks by late Q1 2024.
What happens between now and then? As noted in recent issues and summarized again here for any new subscribers, with the projected spot market cycle bottom now in, many enterprise procurement teams will 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 yet represents a temptation that is often difficult to resist. That means look for all of those quarterly 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 – especially given the slowdown in economic activity across many sectors and the potential for recession in the US at some point 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, and then be in position to take decisive action if necessary – from rebidding lanes away from underperforming vendors to leveraging more dynamic contracts that adjust more frequently based on market indices or benchmarks. If you’re unable to position for long-term performance to begin with, the next best thing is building the organizational flexibility to pivot and adapt before your competitors do as the economy evolves and the freight cycle marches on.
Now on to the macro, where July represents one of those special four months of the year where we get our first glimpse at last quarter’s GDP report, which includes data on Consumption, Imports, and a bunch of other stuff. And given the dramatic narrative we wove last month around ‘Consumption vs. Industrial Production: Which is telling the truth?’, we’d better start there. After what has felt like an endless stream of months producing a mixed bag of economic data to try to decipher, this one is skewed much more to the positive side of the ledger. Recall that last month, our latest read on Q1 2023 Consumption sat at +2.3% Y/Y with a final revision due the following week. And we noted that should it hold up after this next revision, it would represent a potential welcome change in long-term trend. 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.
But with Q1 now settled, we have our change in trend. In fact, we revised slightly higher to close at +2.4% Y/Y. And with preliminary Q2 2023 now on the board at a flattish +2.3%, we’ve even more positive signal that our reversal higher – therefore skirting any version of a US economic recession – may have some legs. And while a flattish consecutive read is hardly a decisive move higher, it’s certainly more constructive than the alternative. But just as with Q1, we’ll have to see where the subsequent revisions take us before overreacting one way or the other. Remember, we must stay cool. Though if we look beneath the headline number at our three core components, we see even more reason to be optimistic. After finding their own local bottoms in recent quarters, both Durable and Nondurable goods consumption took another step higher in Q2 with Durables up to +3.4% Y/Y from +2.6% and Nondurables back on the inflationary side of the axis for the first time since Q1 2022 at +0.5% Y/Y from -0.4%. Services, despite the ongoing reallocation of consumer spending narrative, instead moved lower to +2.6% Y/Y from +3.3%. So clearly more good news than bad this month with regard to the demand outlook for the US trucking market and the strength of the economy as a whole.
With the protagonist of our story, Consumption, making its case that US Consumers remain resilient and that the current relative weakness in Industrial Production is unlikely to last, let’s check in with our villain – Industrial Production itself. After closing Q1 at -0.8% Y/Y and our first deflationary print since Q1 2021, last month’s revision took Q2 ever so slightly higher to -1.2% Y/Y from -1.1% – which we took as a potential signal that IP was ready to make the turn and begin to converge back towards our Consumption line. But with this month’s update taking us back in the other direction to close Q2 at -1.4% Y/Y, we see that we’re not done treading water down here in the -1-2% range just yet. But the change in slope as compared to the relative freefall we experienced through 2022 remains constructive with regard to the probability of a recovery in the quarters ahead, especially taking into account the recent arrest in the decline in Consumption we got over that same 2022 period.
As a quick refresher for any new readers this month, as noted above 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 final Q2 read on the board, the question becomes how steep is our line and what does that imply going forward? Again, even at a slightly weaker -1.4%, we’re 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. In fact, we could see some version of the exact opposite over the back half of 2023 and into 2024. But as we all know, one quarter hardly makes a pattern. And while we continue to believe there is a lot to be optimistic about as to where we go from here, we need to see a few more months of data before getting too much conviction one way or another. Until then and in line with this month’s them, we keep our cool.
As our dramatic ‘Consumption vs. Industrial Production: Which is telling the truth?’ storyline remains unresolved for yet another month with Consumption looking a little better and IP looking a little worse, let’s see if our Inventory to Sales Ratio indicator gave us any clues this month. Though it is important to note that this is one of our more delayed economic data points with regard to its release so this month we get the May read to bake into the April number that gave us our first glimpse at Q2 last month. Recall that last month, we saw a pretty negative move with the ratio moving three bps higher to 1.40 from the prior quarter’s 1.37 that poured a little bit of cold water on our ‘weak but could be worse’ signals from Consumption and IP. But with this month’s revision holding Q2 flat at 1.40, that ‘weak but cold be worse’ narrative now applies here too. We still have no sign of a local peak, but it’s not moving any higher either…at least for now. 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, the near-term macro-outlook remains cloudy at best.
So with Consumption, Industrial Production and relative inventory levels all currently treading water for the most part, let’s turn 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 April 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 June read has revised the final Q2 print slightly higher to -4.2% Y/Y. No doubt, still a softer Q2 than the quarter before it, 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 it is reasonable 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 see anything close to the Q2 2020 lows of -21.4% Y/Y this time around. We’ll get our first glimpse at Q3 in a couple of weeks, so stay tuned for the August issue to find out whether we got a bounce higher or another leg lower with this particular indicator.
Now on to 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 revising slightly higher to -3.6% Y/Y from last month’s -4.5%. As both indicators fade lower at –3.5-4.5% Y/Y this quarter, we interpret this as a signal that the pace of supply-side rationalization has indeed 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 finally find their Y/Y deflationary floor and can mount a recovery – which as we noted above, has now been confirmed to have been reached in Q1 2023. 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. But for those that are able to hang on, the worst is most likely behind them and a more constructive Spot market rate environment lies ahead.
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 closing at still lower to -8.0% Y/Y and the lowest count since Q2 2020 with this month’s read we’re back in line 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 had 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 and Q2 2023 motor carrier earnings performances, the softness in Q1 and Q2 net order activity isn’t surprising. 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, up until this month US retail diesel costs had settled into a sustained seven-month Nov ’22 to Jun ’23 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 had since settled -27.7% in June 2023 at $3.802/gal and a Q2 average of -28.1% Y/Y – so continuing to run Y/Y deflationary for the first time since February 2021. But just when we were starting get bored, July signaled a potential reverse in trend in coming months with a MTD read 2 cents higher than June at $3.821 and a preliminary Q3 print of -26.0%. Should this inflationary trend pick up any steam, it would only hasten the exit of over-costed capacity and therefore accelerate our journey to the next Y/Y inflationary leg of the next cycle. Suffice it to say, we’ll be watching closely as the quarter develops.
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 and exits as profitability was 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. And so far at least, it has been a much more gradual exit. 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, which July could be signaling, 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 in early Q3 2023 Spot TL Linehaul chart pattern that so far at least continues to track closely with our most recent Q1 2023 revision that pushed our deflationary inflection point forward a quarter from Q4 2022. And with Q2’s close at -18.8% Y/Y, Q1’s -31.8% Y/Y mark is confirmed as our cycle bottom which sets the stage for a recovery in the Spot TL market through the end of the year and into 2024. Now roughly a third of the way into Q3, our current index read of -12.3% Y/Y vs. a forecast of -10.0% is tracking in that direction as well. But with July likely to close two cents lower than June’s $1.73, we are reminded that the recovery is not likely to be linear in nature. We could very easily see down weeks and months yet remain on track with our longer-term cycle projections. In that regard, the month ahead will be especially interesting as we’ll find out whether the market takes us further off our Q3 forecast line before snapping back in September or begins to firm up after recent softness and bends the index in the completely opposite direction. Will the impact of the Yellow Corp. bankruptcy in progress prove to be an inflationary catalyst for the truckload spot market? Will the resumption of student loan payments on September 1st after more than three years of COVID-19 forbearance materially dent goods consumption in a way that we haven’t seen up this point in the recovery? Will record high temperatures somehow collude with the Atlantic hurricane season to generate a market-moving weather event? Only time will tell, so we’ll all have to patiently wait until the August issue to find out. But with regard to that last one, after many months with TL-intensive Goods Consumption and Retail diesel costs trading positions on the monthly wild card leader board, we’re finally adding a third to the mix as the rate of extreme weather events picks up in many parts of the country. So let’s dive in as we shift our gaze to the road ahead of us and what could be an unusually eventful August.
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 only prolonged 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 $1.45 or -27.7% lower to June’s $3.802. But with July’s two cent bump higher to $3.821 and increasingly bullish crude oil forecasts through the end of the year, it’s quite possible we have found our local bottom and diesel prices are poised to run higher from here. And if that happens, we should expect more over-costed spot market dependent carriers to exit at a quicker pace and for spot TL rates to accelerate higher at a greater clip as a result.
2. TL-Intensive US Consumer Spending: Conditions remain tough to say the least 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 June 2023’s +3.0% Y/Y, a whopping 100 bps lower from May which was a whopping 90 bps lower from April. 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 with the most recent 25bp raise this month following last month’s pause. That said, the US Consumer continues to hang in there for the most part, as evidenced in the preliminary Q2 GDP & Consumption print – especially with regard to TL-intensive goods consumption. However, questions remain as to how long the Consumer can hold up or whether existing cracks will widen given signs of a slowly but steadily cooling labor market, rising household debt, tightening credit conditions, and the resumption of student loan payments coming up in September. 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.
3. Atlantic Hurricane Season (Jun-Nov): And returning to the podium after an extended hiatus with other market forces running the show, we welcome back the Atlantic Hurricane Season as a potentially market-moving wild card in the month ahead. As we prepare to enter our third month of this year’s season, experts remain mixed on their outlook. 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). Meanwhile, Colorado State University predicts an above average season with 18 named storms to make landfall with nine hurricanes, four of which they predict will become major hurricanes. Both prediction models are based on decades of historical data and take into account conditions that include sea surface temperatures, sea level pressures, vertical wind shear levels, and El Niño – which thanks to Chris Farley (RIP) in one his most underrated Saturday Night Live skits of all time (look it up), we know is Spanish for “The Niño”.
The last market-moving storm we got while in the deflationary leg of the cycle was Hurricane Matthew in Q3 2016 along the SE US Atlantic coast, which accelerated the recovery in spot linehaul rates into Q4 that year but then set up a relative stall in the trend line in Q1 2017 before breaking Y/Y inflationary a quarter later. So that’s what we’ll be looking for should we get a storm of sufficient magnitude, duration and geography (think Gulf Coast not Florida) to distort the balance of US truckload supply vs. demand enough to move spot rates higher for an extended period of time. Though regardless of what may ultimately come to pass on this one, just 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 logically going to be much higher than in 2022 when the spot market was in a virtual free fall.
So with our deflationary inflection point in for Q1 and the first leg of Q3 confirming the direction of the market recovery, we are entering territory that we haven’t navigated since late 2019 as that cycle came to an end, thus setting up the one we’re currently in the process of wrapping up. What does that mean for supply-siders and demand-siders alike over the balance of the year?
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 and a half – at least if that means cutting costs, getting leaner, and conditioning your teams to be able to do more with less. While we absolutely see the light at the end of the tunnel with 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 Spot rates go on to close Y/Y inflationary by Q4 this year as projected, that only represents a +10-15% 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 pursuing operational excellence 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 choose wisely as those that navigate the cycle most successfully over the long run tend to be the ones with the most durable long-term commercial relationships with partners that have earned their trust through the ups and the downs.
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, if necessary. 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 capacity partners 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 don’t squander this opportunity just because you’re beating your 2023 freight budget and service levels are at an all-time high. Now on to August and the next leg of Q3. Everyone stay cool out there. We’ll be at the movie theatre if you need us.