A Turning Point?

 In Market Conditions

Or a Move to New Levels of Tightness?

Those of you familiar with The Perry Rule of Three may be looking with alarm at the latest Truckstop.com Market Demand Index (MDI) numbers for dry van. We have now experienced four consecutive weeks of elevated numbers. The change has been coincident with the normal spring safety enforcement period, suggesting a strong enforcement effect. While there is likely some fire to go with that smoke,we need to look more carefully before concluding that the market has moved to a new and more dramatic level of tightness.

In evaluating this data, one must first understand that the MDI is an intrinsically volatile metric. As such it may be a useful early warning indicator. However, one must take the absolute value of any reading with a grain of salt. For instance, the current reading of 60 does not mean that the market is three times tighter than the recovery average of 20, or 50% tighter than the 40s values of early spring. It just means that the market is tight, very tight! The MDI is best understood as a capacity pressure index.

With the indicator warning us that something is underway, it is wiser to consult the rate statistics for deeper market insight. Rates are an actual absolute measure of market conditions.The Truckstop.com numbers do show upward movement since week 17 but limit dramatic movement to just the last week. Moreover, the previous two weeks before the latest week showed no movement at all. According to The Perry Rule of Three, one must conclude that prices are quite high, almost fifty cents per mile above a year ago. They are not, however, moving farther upward in a convincing fashion. Yes, last week’s reading tells us to keep watching – but that is all – until more evidence comes in.

Note importantly that this picture gives us strong hints about the seasonal behavior of the dry van market. The up and down movement of the red Recovery Average values is a good approximation of dry van seasonal rate variation. Accordingly, one can justifiably suggest that most of the 2018 movement in rates has been seasonal. The 2017 lines showed strong movement above such seasonal variations, but the 2018 bars have remained roughly the same distance above the red line all year. So, the recent upward movement in the 2018 data may be simply the normal upward movement of a spring market. If so, we can expect prices to begin falling in short order – as they normally do in July and early August.

Before closing the book on the latest spot data, one analytical step remains. The above data use raw prices, including fuel, although not including broker margins of about 40 cents per mile. Because we know the size of average fuel surcharges, we can subtract that to find how much other market forces have changed rates. Since Week 26 of 2017, fuel surcharges are up about 10 cents per mile, leaving the remaining 38 cents to market forces. Since the beginning of the year, however, surcharges are unchanged, assigning the 29-cent rise to capacity-oriented market forces. All that remains is to “seasonalize” the 2018 numbers to get the single best underlying market force indicator. This chart does that and shows a very interesting pattern. The “capacity crisis” of this sustainable event—resulting in such high rates—clearly peaked in January, not now. Again, the actual numbers, which do show a current peak, include the normal, strong, seasonal increases leading to July Fourth. Happens every year. Looking at the last six months, the seasonalized numbers fell in the early weeks after the marketplace realized that the world hadn’t ended on December 18 with the original mandate. They then rose gradually, in anticipation of the Week 13 (April 1) beginning of enforcement. They fell some more when that crisis passed without a big effect. In May, though, a gradual upward movement began in the absence of some ELD change, suggesting that the strong freight growth of the second quarter of 2018 was tightening the market. One concludes that we continue to feel the effects of that trend, even if not from the dramatic move evident in the latest week’s data.

As we look forward, then, we should expect one thing and look diligently for another. The expected thing is the normal 26 cent per mile drop in spot rates that occurs in July and early August. Working to offset that is the gradual upward underlying movement in rates that could reduce this big drop by 5 cents or so. Should the dramatic move of last week continue, then more is possible. The most likely case would be year-end rates 15 cents below current levels, assuming continued strong freight growth. Should the economy cool, then the pessimistic warnings I have been shouting all year will align with reality sooner than later.

That is the spot rate story, always the leading indicator of trucking pricing. What of contract rate increases that cover the majority of truck moves? After rising only modestly for much of 2017, contract rates, shown in the graph at right of van numbers, have taken off in 2018 – and apparently have not peaked yet. As usual, the size of the increase is much less than with spot rates. However, such double-digit increases have occurred only one other time since 2000: in 2004, the other great capacity event.

Will these increases get larger, and how much longer will the big numbers prevail? In thinking about that, keep in mind that contract rate increases have little inherent seasonality because they usually run for a year or more. Moreover, these YOY metrics eliminate whatever little seasonality is in the data. This means contract rates will not be subject to the summer reduction in rates that we’ll soon be seeing in the spot numbers. Without seasonality, then, we will only see the effects of underlying market pressures and the confusing matter of contract rate “aging.” Aging is a word that security analysts use when analyzing such phenomena. The concept recognizes that the contract rates applicable in July of 2018 are the weighted average of rates negotiated between August of 2017 and the present. Since rate increases negotiated in 2017 were much lower than in 2018, one would expect that the weighted average would trend down. To get the double-digit increases we see now, the most recent increases must be high indeed, well above the averages displayed. However, one must recognize that carriers can, and have been, walking from many of their contracts, forcing carriers to pay surcharges or renegotiate. There is no data to help us understand how much of such renegotiation is occurring, nor do we know how much of the reporting included some spot moves. All we can do is assume that the YOY increases in the latest month’s new contracts is somewhat higher than what we see here.

Despite this uncertainty, we have useable data on contract rate increases going back many years.That data allows us to compare the current event to the two previous capacity crises that are most comparable to this one, the events of 2004 and 2014. The next chart compares the three events, displaying them in months from the start of each event. The patterns are strikingly similar, differing mainly in the magnitude of the increases. The 2004 event is in the same ballpark as this one, while the 2014 event affected contract prices much less. (It did have powerful spot effects.) The data shows that we are at an important departure point. My view of the 2018 event as a powerful, but still temporary, event says that contract rate increases will soon begin to moderate, as they did at roughly this timing in 2004 and 2014. Part of that is the matter of comparison years. Now we are beginning to compare current rates with rates that rose a year ago, as compared to earlier this year when the year-ago rates continued to fall. Part of that is the adjustment of the market to its stresses, building up capacity at increasing rates. It is very reasonable, therefore, to expect this event to follow the historical precedent in a gradual retreat from the current YOY rate increases. Note importantly that the 2004-2005 retreat was very gradual, still showing 7% increases a full year later, eighteen months after the underlying capacity pressures started to recede. Part of that slowness was the aging phenomenon, and part of it was the natural lag in market responses. Truckers remained bold, and shippers remained wary of shortages well beyond the facts of the market. This means that carrier margins will stay strong well into 2019, even as capacity utilization moves back toward normal levels.

There is another view of this event—sometimes called “the new normal” —that postulates a sustained capacity crisis, just like shortages of land that keep waterfront real estate prices high. While I thoroughly discount that view with respect to trucking, markets do adjust; the chart above does suggest that this event could surge a while longer. I do feel that this event is worse than the 2004 shortage, which is testimony to the elimination of surge capacity and the slowly growing challenge of hiring drivers. If so, we could easily get two or three months of continued contract pricing acceleration and a slower, flatter retreat from the current peak. That scenario would sustain double-digit increases through the end of the year and keep us above 5% for most of 2019. That is what the 2004 data suggests. If so, the direction of events after, say, September will be clear (downward), but rates will easily stay high enough to sustain contract carrier profits into late 2019 with the reflected stress on shipper budgets. Again, that is roughly what happened in 2004-2005. The difference here is that stress levels are somewhat higher even if the pattern is repeated. It not a “new normal.” it’s just a “tougher normal.”

Note in closing that the spot data in this analysis comes exclusively from Truckstop.com’s revolutionary databases, while the contract data comes from a mix of sources, including ATA, DAT, Cass, Truckloadrate.com and the Federal Government. The means of combining those disparate sources into a single, useable index resides within Transport Futures. For more on Truckstop.com’s information, go to https://Truckstop.com.

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