[Excerpt from The Pickett Line January 2023 Issue]
Geez, we’re barely into the new year and we’ve already gone up and over our first major hill of the 2023 TL spot market roller coaster. We came in like a lion and it is looking like we will go out like a lamb. And while that phrase is typically used to describe the weather in March, we’re going to pull it forward a couple of months to describe the wild swing in the spot market since mid-December. And here we thought January was going to be boring. We got an up and down spot market, steadily declining contract rates, cheaper diesel (at least until last week), a decelerating economy, unexpectedly hot Class 8 Net Tractor Orders, and a potential deflationary inflection point forming to try to reconcile. So without any further ado, let’s get to work. Welcome to the new year and to the January 2023 issue of The Pickett Line where we will attempt to make some sense of it all and chart a course for the months ahead.
As the working title of last month’s issue ‘Twas the Eve of Inflection’ implied, we closed the December quarter on inflection watch – looking for signal as to whether Q4 would ultimately represent our cycle floor or if we would have to wait another quarter. With Q4 now closed at -29.6% Y/Y vs. a forecast of 25.0% + 5%, we see that we did manage to close just within the projection range. And that we also managed to set a new record for the lowest deflationary cycle read observed in the 16 years that we have been paying attention. The previous record was set during the 2019 trough at a paltry -19.0% Y/Y with the Great Recession trough of 2009 coming in third with an equally unimpressive -16.7% Y/Y. And that brings us to January and Q1 2023. Coming in like a lion with spot rates that started high and stayed high until after the first week of the new year, the mid-month read had us almost all the way to our Q1 forecast of -22.5% Y/Y – thus making Q4 2022 look like a virtual lead pipe lock for inflection point status. Enter the lamb. From there, spot TL rates have faded steadily lower – giving back just about all of the end of year holiday inflation that had accumulated. And just like that, our January and preliminary Q1 read has settled at a much more questionable -27.3% Y/Y ($1.92/mi) – again compared to Q4’s -29.6%.
So now the question becomes how much lower can the market go as the race to the bottom continues and motor carriers with less competitive cost structures are ultimately forced to exit the market in enough numbers to set a floor. We continue to believe that we are just about there, though we could easily see spot TL linehaul rates go another 10 cents lower before we get our bounce but then close the quarter somewhere in the neighborhood of $2.05/mi. If we are wrong, and the market finds a way to close below $1.86/mi for the quarter or another 3.2% lower from current levels, that just means that our deflationary leg just got a quarter longer and that we may have to wait until 2024 to see our return to Y/Y inflationary levels. That is not our forecast, but it is entirely possible. So we’ll be looking closely over the next few weeks to see where the current slide levels off – starting with the next few days as we close out January.
With the DAT US TL Spot Linehaul Index still signaling inflection, even after the recent decline in rates, let’s see where the Cass Linehaul Index – our proxy for US TL contract linehaul rates – settled in Q4. But before the big reveal, let’s revisit the backstory on this one for any new readers that may be joining the freight party this month. Our hypothesis was that while peak contract linehaul rate levels got artificially extended by a quarter or two, courtesy of the Q1 2022 COVID-19 Omicron surge, they would likely be breaking materially lower in Q3 to follow spot rates as market gravity finally took over. So much like Wile E. Coyote out over the cliff furiously sprinting in place, we would soon find ourselves tumbling to the valley floor. Or in our case, deflationary Y/Y market rate levels – though the first stop would be Q3’s forecasted close of +5.0%. While we didn’t quite get there with a final Q3 read of +7.2% Y/Y, gravity clearly appeared to be taking charge. And now with Q4’s final read of +1.8% Y/Y vs. last month’s +2.3% and a forecast of -3.0%, we remain on track forecast-wise. We’re just not free fallin’ (RIP Top Petty) as sharply as we expected – at least not yet. While we missed our Q4 forecast by 480 bps to the high side, we believe there is currently enough of an air pocket below our Cass line to support a downward move to -5.0% Y/Y in Q1 as projected. So no change in guidance there. Down to the valley floor we go. Beep Beep.
Now onto the macro outlook, where after a relatively upbeat November followed by an equally downbeat December, the January read signals more of the same with most indicators showing further deceleration. We waited an extra week to publish the January issue so we could get a look at preliminary Q4 2022 GDP, Consumption and Imports – so let’s start there. After coming in at +1.9% Y/Y in Q3, the initial Q4 GDP number cut that almost in half to +1.0%. Consumption fared slightly better, slowing to +1.9% Y/Y as compared to Q3’s +2.2%. And beneath the surface, the Consumption of Services ticked slightly lower to +3.2% Y/Y vs. +3.5% in Q3. Nondurables strengthened slightly to -1.4% Y/Y from -1.6%. And Durables Consumption correctly slightly lower to +1.1% Y/Y compared to Q3’s unexpected recovery to +2.2% from -3.7% in the prior quarter. And Imports slowed all the way from +7.4% Y/Y in Q3 to +1.7% in Q4. So all remain Y/Y inflationary but continue to edge closer and closer to negative territory. The hope is that Fed Chair Powell and team take that to heart in the next FOMC meeting and begin to moderate future interest rate decisions, as the likelihood of a soft economic landing remains in play in our opinion – but the degree of difficulty is getting higher and higher as conditions continue to deteriorate. Let’s stick that landing Jay. You got this.
The December print on Industrial Production took us 0.7% lower vs. November to take the final Q4 read from last month’s +3.0% Y/Y down to +2.5% – making this the third quarter in a row of slowing, and puts us at less than half of Q1 2022’s +5.2% Y/Y but roughly in line with pre-COVID levels. In the past we have remarked that Industrial Production and Consumption tend not to diverge for very long, and we see that indeed coming to pass here as IP’s +2.5% Y/Y closes in on Consumption’s +1.9% Y/Y after running somewhat higher over the last few quarters. To avoid recession and for Jay to stick his landing, we’re going to need to see both arrest their descents and level out in the next quarter or two. A tall order maybe, but all is not lost. Even with the pace of layoffs in the overheated tech and financial services industries ticking slightly higher in recent weeks, the labor market overall remains stable and consumer spending continues to hold up despite slowing somewhat in recent months. And where we go from here will likely depend on just how resilient the US Consumer continues to be.
Now let’s take a look at relative inventory levels. After triggering some cautious optimism last month with our preliminary Q4 read coming flat to Q3’s 1.33 and compared to Q2’s 1.30, the hope was that perhaps bloated inventories had indeed started to stabilize. If this was indeed where Inventory to Sales levels peaked and began to turn lower, that would represent a pretty constructive signal for the economy as a whole and support the whole soft landing narrative. As the last three times we got such a signal (2020, 2009, and 2001), we were at the bottom of a recession and the recovery in Industrial Production was about to begin. Unfortunately, with our revised Q4 read on the Inventory to Sales ratio ticking ever so slightly higher to 1.34, the outlook gets a little less encouraging. That said, we’ll have to wait for next month’s final revision to see where the quarter ultimately lands. As we said last month, stay tuned. This one could be our first big corny storyline for 2023.
And now let’s turn our attention to our primary TL demand indicators this month – the Cass Shipments Index and the ATA TL Volume Index. After closing Q3 with a relatively strong +3.4% Y/Y, our final Q4 read came in at a moderately weaker -0.5% vs. last month’s revised mark of +1.0 – so didn’t manage to stay Y/Y inflationary after all. And given the historical correlation between Cass Shipments and Industrial Production, a downward sloping trajectory here doesn’t inspire a lot of confidence. YTD, we’ve seen Cass Shipments move range bound between -2.0% and +4.0% Y/Y – so have now faded towards the bottom end of that range. We will continue to watch this one closely in the months ahead, as whether we break higher or lower from here will likely point the way for both Industrial Production and the broader economy.
Our ATA TL Volume Index, on the other hand, is flashing an even stronger signal for a potential inflection point with its revised Q4 read of 2.0% Y/Y vs. last month’s preliminary +3.3% Y/Y and Q3’s +5.5%. And for the first time since early 2019, both our volume indicators and Industrial Production have all somewhat converged between -0.5% and +2.5 Y/Y and are trending lower together. On the one hand, a reversal in the ATA TL Volume Index has signaled that enough surplus capacity has finally exited such that the relative increase in volume among the ATA carriers left standing has peaked and conditions are in place for a floor in spot market rates. We last saw this in Q3 2019. On the other hand, it has also in the past signaled that TL demand has peaked for everyone and conditions are in place for a lower for longer spot market rate environment – which we got in Q1 2015. So as noted last month, while we’ll have to wait and see which hand we’ll be dealt this time around, we suspect the former scenario to unfold although weaker demand conditions could certainly extend the time we spend down here in Y/Y deflation land once we eventually bounce.
Now onto the supply side – where last month we noted that things just got 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 in the quarters ahead as the US TL Spot market worked through its own excesses, we got a rocket ship of a number in October to take the preliminary Q4 read up to a remarkable +126.9% Y/Y – forming a pattern completely unprecedented relative to past cycles. And while the November and December revisions cooled us off a bit, we still landed at an unusually strong +86.5 Y/Y on the quarter. That said, given the early deflationary move in this indicator in Q4 2021 while our TL Spot index remained Y/Y inflationary, this wasn’t entirely unexpected. Back then, we suggested that unprecedented disruption in tractor OEM supply chains had created enough of a market distortion that the cycle correlations perhaps got nudged a couple of quarters out of phase. And if so, perhaps we would see Class 8 net orders go inflationary with the same 2-3 quarter head start that they led deflationary. So here we are. With Q4 closing decisively inflationary, we’ll be watching closely to see if the next read confirms the pattern or takes back below the x-axis thus signaling Q4 as simply an anomaly in the data.
So what makes this particular pattern noteworthy, aka ‘nutty’ (that’s the technical term)? We have remarked repeatedly in past issues that net tractor orders had up until this current cycle proven to be perhaps the most consistent signal over past US TL cycles. Across the last four complete cycles observed since 2007, both the US TL Spot Index and Class 8 Net Tractor Orders have flipped Y/Y deflationary in the same period (plus or minus a quarter) as the cycle transitioned from its inflationary leg. And the same goes for the other direction – again, at least until this cycle. So much for history rhyming in all seasons. But whether this phase shift will prove to be a temporary impact of the 2020-22 COVID-driven breakdown in global supply chains or something more permanent, only time will tell. Though we believe it will likely be the former.
And speaking of unusual patterns and reversals in trend, we can keep retail diesel prices on the list. To recap for anyone that hasn’t been paying attention, the price of diesel had finally started to correct lower after exploding steadily higher for much of 2022 – from $3.727/gal in January to $5.754/gal in June before retreating slightly to close September just barely under $5/gal at $4.993. This took the final read on Q3 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. Fortunately, those fears proved to be unfounded as diesel has reversed course once again to settle -13.1% lower to the current January 2023 MTD read of $4.565/gal and +22.6% Y/Y. As the oscillations continue, it is difficult to build too much conviction one way or another. After fading still lower to start the new year, we got an 8 cent/gallon increase this week. If the trajectory holds, signaling yet another reversal in trend, that will create additional pressure on an already strained supply side and could hasten our race to the bottom of the TL spot market and our ultimate cycle floor. So if it is indeed ‘so long cheap(er) diesel’, it was fun while it lasted.
As noted in past issues and repeated here for any new readers, the last time we saw anything like last year’s spike in fuel prices was in 2008 where diesel climbed to +66.6% Y/Y that June – in the throes of The Great Recession. During that particular US TL Spot Linehaul Rate Cycle, unlike this one, diesel spiked higher several quarters ahead of Spot and Contract rates. As a result, we saw an unprecedented wave of motor carrier bankruptcies as profitability was wiped out – especially for those most exposed to the spot market. The key difference this time around is that Spot and Contract rates led diesel by several quarters, which has allowed the market to absorb the diesel shock without forcing Carriers out of the market in material numbers at the same rate. So far, it has been a much more gradual exit. And as the battle rages on, the role that diesel costs play from here will be in helping to set the ultimate market bottom where our Y/Y US DAT TL Linehaul Spot Index line finally inflects higher as sufficient surplus capacity has been forced to exit as their operating margins compress towards zero, or worse. And as noted, we think we’re just about there – though we may need to grind along at these levels for some time before sufficient supply exits. If diesel finds a way to continue its mid-term move materially lower in the months ahead, we could see that inflection point shift a quarter ahead the current Q1 2023 as cheaper diesel allows the supply side to endure an even weaker spot rate environment over a longer period of time than it would otherwise. If not, then we are likely to see our deflationary inflection point confirmed for last Q4 2022 as currently projected.
So with 2022 now officially in the books and as we lean into this new year, early signal points to our cycle inflection point coming in last quarter as expected. Though if US Spot TL linehaul rates take another leg down in the months ahead, that signal disappears and we’re back in the ‘lower for longer’ camp and back to humming U2’s ‘Still Haven’t Found What [We’re] Looking For’ in search of that elusive deflationary inflection point. But while we find ourselves in a new quarter and a new year, barring any strong evidence to signal an unusually harsh winter storm season, we’re left with the same two market wild cards that have dominated the conversation for most of the past year: TL-intensive Consumer Spending (i.e. Durable and Nondurable Goods) and Diesel prices.
1. 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’s +9.1% Y/Y to December’s +6.5% Y/Y. But while the Fed’s tightening monetary policy looks to be achieving its end, Powell and the gang are only just recently signaling any interest in slowing down the pace of interest rate increases while guidance remains hawkish overall. They have slowed the upticks to 50 bps yet continue to reiterate the expectation of higher for longer until they are positive that inflation is finally under some semblance of control. That said, the US Consumer continues to hang in there for the most part. Retail spending came in light in December and continues to slow but overall Consumption levels are holding up – especially on Durables, defying all expectations. And so long as Consumer spending holds up, the probability of a soft landing for the economy remains on the table. It is fair to say that the probability ticked a little lower this month, but we’ll see what the next month brings. Suffice it to say, we don’t see this wild card going anywhere anytime soon.
2. Diesel Prices: As noted in recent issues, it is likely that diesel costs 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 costs have been on a bit of a roller coaster ride over the last few months. After declining steadily from June through September, they reversed higher in October and into November. But have since reversed once again, fading 69 cents or -13.1% lower over the last six weeks to the current $4.565/gal. Where we go from here is anyone’s guess, but with costs climbing 8 cents/gal last week and the China reopening narrative taking crude oil prices higher in recent weeks, we could be in store for yet another reversal in trend. That said, we continue to believe that even with diesel at current levels, the market has already reached the point where spot market dependent motor carriers have already begun to exit in increasingly large numbers – either temporarily or permanently. So it remains only a question of the pace at which this continues in the months ahead, and that depends very much on what diesel costs do going forward.
After the 2022 we endured, you’d think we would have earned a stable and uneventful January to regroup and steel ourselves for the 2023 ahead of us. But in like a lion and out like a lamb we went. And aside from the optimistic signal in Class 8 Net tractor orders, a resilient labor market, and inflation finally cooling off, there’s not a lot out there to be constructive about at this moment in time – across the US trucking market or the US economy as a whole. The most positive thing we can say after the last month of data is that conditions could be worse. We’re slowing down but not falling off a cliff. Though as noted in the past, this is kind of what the bottom of the cycle is supposed to feel like – where we all get the opportunity to painfully reflect on the irrational exuberance of the most recent cycle high.
Unfortunately, this time around we must also contend with an increasingly fragile US economy at the same time as the Fed walks the tightrope of raising interest rates to beat back inflation without completely torpedoing consumer spending and industrial activity. This is where compounding pessimism sets in, which will drive some market participants to take actions that prove to be sub-optimal in the long term but impossible to resist in the here and now – like exiting the market altogether because one believes it’s always going to be this bad, or taking your contract freight back out to market after awarding all of your business just two months ago on a one-year term. So it stands to reason that this is also where the market leaders will begin to reveal themselves, by the actions they take at the bottom of the trough – just as they often do at the top of the peak.
Though regardless of what strategy we choose to pursue, we have little choice but to endure what is left of the cycle lows as the market seeks to reset itself. But reset it will. As wild and unpredictable as the last few pandemic and post-pandemic years have been, the shape of the TL Spot Linehaul cycle has held up extraordinarily well in retrospect. The market didn’t materially consolidate – through technology-driven disruption, regulatory interference, or some other unnatural force. Therefore, the competitive dynamics that have ruled this increasingly fragmented market since de-regulation in the early 80s remain. And so long as that remains the case, the cycle persists. And when we’re at the bottom of that cycle, there’s only one way to go. And that sums up our forecast nicely for what 2023 likely has in store for us. You may have another quarter or two of pain to endure, if you operate on the supply side, but not another year or two. And if you operate on the demand side, there will never be a better time than right now to reset your transportation strategy for more challenging times ahead. We may not see them before the back half of the year, but they’re coming. So Happy New Year & Cheers to a successful 2023 campaign – wherever you sit in the market.