K-Ratio Q3 Rate Outlook
Q3 RATE OUTLOOK
Glass half-full or glass half-empty? 2020 is half gone and the remaining months will either be the start of the next freight bull market or the beginning of the next recession for both the overall economy and freight, it just depends on who you ask. Hyperbole aside, it’s hard to recall a time with as much and as strong of disagreement in opinion as we find ourselves today. Markets can be interpreted as participants’ opinions expressed financially and the persistent volatility across all markets since March clearly indicates that we don’t seem near any sort of agreement. Despite the lack of consensus, or perhaps because of, we present the following facts, circumstances, points, counterpoints, and truths with uniform objectivity so the reader may reach their own conclusions but only after all relevant matters have been discussed.
Truck capacity in the form of federally registered tractors available for hire has been on a steady incline since the economy first started to emerge from the depths of the Global Financial Crisis back in 2011. Even throughout all of 2019, a year of historically low rates per mile and hundreds, if not thousands, of trucking company bankruptcies (1), the total number of trucks in the marketplace continued to grow. Apparently, it takes a global pandemic and government-mandated closures for that trend to stop. According to FMCSA registers, May 2020 saw the largest drop in for-hire tractors since July 2015 with a 1% decrease of 16,4562 (2).
This decrease is particularly notable because the assets were not absorbed by other entities, which is frequently the case as this survival of the fittest game routinely plays out in cyclical fashion inside the freight industry. Better capitalized Carriers roll these assets or contracted owner operators into their fleet while acquiring a greater share of business from the customers served by the expiring Carriers. This year, however, is a year unlike any other, and businesses typically get defensive when it comes to adding expenditures to the balance sheet during uncertain and recessive economic times. Another defensive industry during times like this are banks, which have a tendency to reduce lines of credit when companies need it most, so financing issues could cause this lack of expanding capacity to linger longer than many expect. Adding to that dynamic is the fact that certainly some of the lost contract freight that led to these insolvencies belonged to companies that may not exist any longer themselves, providing another reason for solvent Carriers to maintain fleet sizes and for lenders to shy away from asset financing.
One positive note for Carriers currently is the continued low fuel expense enjoyed by all. Much of the industry does operate on fuel surcharges from Shippers but those don’t come into play for empty miles and deadheads. The second largest line item expense after driver compensation (3) has been roughly half its cost to start 2020, and this serves almost as a subsidy for Carriers while rates per mile are depressed while providing flexibility in load selection in areas with low volume density. Should low diesel prices continue during rising RPMs, Carriers will experience a better level of margin come year end than what 2019 provided as pre-IMO 2020 fears bid diesel prices while RPMs were relatively flat.
The final weeks of Q2 have brought head-scratching volume levels even for seasonally strong June. According to FreightWaves’ Outbound Tender Volume Index, only the Covid restocking ramp-up gave us larger numbers than what this June recorded (4) . To put this in context, ending volumes for June 2020 are 23% better than last year and 17% higher than the booming 2018. The rally of 2018 was a supply driven market exacerbated by outside influence in the form of government intervention. The rally in RPMs to end June was one brought on by demand and lots of it. Obviously, the question on the mind of everyone right now, is how long can this pace last? The answer may ultimately provide the course for the remainder of 2020.
The 4th of July holiday usually marks the beginning of the dog days of summer for freight. Volumes pull back from the Memorial Day to Independence Day levels, but like we said before, this year is anything but ordinary. Though we are not in the business of modeling, any wizard in the field would admit this year has forced the release of version umpteen.0, with global doomsday now factored in. Historical comparisons for a post-Covid (maybe we’re in-Covid still?) freight economy just do not exist. What we do know is that while American manufacturing and industrial production have seemingly disappeared, the latest Durable Goods report gave us a -17.9 YoY print and that’s with the MoM reading at +15.8% (5) while the 43.9 May ISM Manufacturing PMI was the lowest number since 2009 (6), the American consumer, which accounts for 70% of US GDP, has changed its consumption tastes and returned with an appetite if we deductively remove lost non-consumer goods from current freight volumes.
Summertime vacations are no longer a thing, nor is dining out, attending sporting events, or swapping tall tales at local watering holes. While unemployment has jumped higher than anything on record, those still gainfully employed have seen their options for spending slashed. Furthermore, the types of jobs lost so far this year have been unequally distributed and tilted toward lower paying salaries (7), which means the total pool of available discretionary spending has not diminished linearly with payroll trends. Outside of finished goods, there doesn’t seem to be much else for the American consumer to purchase and this comes while the Bureau of Economic Analysis reported personal consumption expenditures were up 0.5% YoY (8) . No, that is not a misprint, the total amount of consumer spending increased.
If this trend continues, and what evidence is there against the idea as it already flies in the face of conventional wisdom, the seasonal RPM bump currently underway in freight will last longer than a season. Should these spending patterns persist, we will undoubtedly experience a sustained rally in price. Contracted freight will exceed volume estimates since this volume expansion is centered around specific industries and those providers servicing them will not be able to keep up with demand, which leads to a run through the routing guide. In years past, this might not have been so great a worry, but given the prominent tightening of the spread between spot and contract rates over the last 18 months and the recent popularity of “mini-bids”, the difference between primary and tertiary or even waterfall on the routing guide just isn’t what is used to be. Freight brokerages will eat losses on a lane for weeks to retain the customer, but they won’t do that for months and a prolonged rally in rates will bring widespread capitulation across the industry, which leads to even more spot loads and higher spot rates in a vicious, compounding manner.
In our last quarterly report, we highlighted the notion of Carrier insolvencies for those with an unbalanced blend of customer type in their freight portfolios. The primary driver behind what ultimately came true was the production halts seen across many industries, but second to that was the effect of low spot rates and minuscule spot volumes. The latter seems no longer as rates have drastically shot higher, as have national tender rejections, measured by FreightWaves at 13.5% to close June, which indicate that spot volumes are considerably greater than just a few months ago (9). This will keep many Carriers suffering from lost volumes and revenues afloat, while bringing friendlier quarterly earnings calls to those on better footing, and possibly saving countless 3PLs from more headcount reductions, or worse. These national rejections will be the key industry situation to monitor as fierce competition from the younger, digital freight brokerages like Uber and Convoy versus the established C.H. Robinson, TQL, Echo, et al. has blurred the lines between contract and spot rates and set the stage for spot rates to surpass contract rates. The resulting fallout from such an occurrence would further lead to even higher spot rates and greater spot volumes in a snowballing effect.
The U.S. economy once again takes center stage as the single most important factor on the freight marketplace and this influence is gaining. We’ve mentioned several prominent economic measures already, but moving forward, the economy will not matter as much per se, it will be the federal government’s response to the economy. As has been the theme in this report so far, the playbook here doesn’t exist. This is not the Great Depression. This is not the Global Financial Crisis. This has been everything across the world shut down immediately followed by partial re-openings and false starts. All options appear to be on the table with respect to the Federal Reserve’s fiscal stimulus.
Interest rates are nonexistent and credit facilities of all kinds continue to pop up. How much of this makes its way to the mom and pop owner-op doesn’t even matter anymore, they’ve circumvented tight lending standards with PPP loan programs. The great unknown is how far the scope of policy can go but it seems like the areas of possibility outnumber those off limits. Almost equal in uncertainty lays the time at which the dichotomy between equity markets and the economy finally reaches its breaking point. Perhaps then, and only then, will the American consumer stop spending enough to support these volumes since consumer confidence has a tendency to erode in lockstep with stock prices. Should this scenario play out, buckle up because it’s going to be a bumpy ride back down to the flat rates of 2019.
The elephant in the room here is understandably Coronavirus, specifically, a return to nationwide quarantines. We saw what that looked like the first time around, so the freight market response should be somehow smoother but still volatile. Panic buying of necessities once again would drive the market, flowing from the warehouses then to them, in the same unload then restock manner. No freight, then too much freight, back to no freight, then…?
The largest socioeconomic experiment ever known continues and brings with it seemingly permanent uncertainty. A case can be made for this next quarter to be the busiest one for freight on record and the start of the next freight market boom. On the other side of the coin, an argument for the worst quarter ever for freight volume and possibly rates can also be made, and the odds between the two are anybody’s guess. The factors for each are as such: amidst less trucks and higher volumes, every condition a bull could want for rates this quarter currently exist, but none of that matters much to a virus with no cure.
(1) https://www.wsj.com/articles/trucking-company-shutdowns-grow-as- shipping-market-cools-11567104495
(2) FreightWaves’ SONAR, 06/2020
(3) American Transportation Research Institute, 11/2019
(4) FreightWaves’ Sonar, 06/2020
(5) U.S. Census Bureau, 06/25/2020
(6) U.S. Institute for Supply Management, 06/01/2020
(7) Pew Research Center, 04/2020
(8) U.S. Department of Commerce, 06/26/2020
(9) FreightWaves’ SONAR, 06/2020