K-Ratio Q4 Rate Outlook
Q4 Rate Outlook
We’ll spare you the references, metaphors, and analogies that call out the unique year 2020 has been so far; it’s been the anomaly, we all know that. Also commonly accepted is the fact that spot rates are at historic levels never before seen after spending much of Q2 at lows never witnessed prior. What is up for debate is just how long this current environment of elevated rates per mile can and will last, as well as the seemingly excess volume behind it. The word “seemingly” is deliberately used here as the level of freight demand has become its own contentiously argued topic across the industry. With the context of this situation now stated and in the spirit of election season, we present the reader with the necessary useful information required to place yourself firmly into either the bull or bear registry. Choose wisely, because this final quarter of 2020 will bring feast or famine to many balance sheets, and nobody likes a flip-flopper.
Perhaps the only metric desired more than true volume amounts is the number of trucks available on the open market, and while the search is constant, greater emphasis is found in markets of increasing rates like ours today. Unfortunately for the industry, the best attempt continues to be FMCSA data on trucks registered for hire. The main point of contention with this metric is that trucks can fall off the grid much faster and with great frequency than the federal register can note, however, given that rates have exploded since bottoming out in May, it seems very unlikely that many trucks would leave the market. Building on that assumption, the latest reading presented 10,764 more trucks than the May low. This is obviously not nearly enough to meet current demand levels as it’s roughly the same amount as seen in November 2019, a time when spot rates were $.50-60 lower than present levels.
Why the depressed truck levels despite a robust spot market and a firming contract market? Doubt. Indecision. Tight lending environment. Hesitation from the large public carriers to grow capital expenditures in the face of extreme economic uncertainty. Want proof? Class 8 truck orders, while up from the shockingly low April number of 3,678, are just 17,680 or what we saw at the end of 2019, a historically oversupplied marketplace. Even worse, current 3-year-old used truck prices are down 16% YoY while spot rates are up $.82/mile.
Regardless of size, from the individual owner-operators up to the fleets of several thousand, nobody is adding capacity at anywhere close to what’s required by current demand levels let alone typical tractor replacement rates (20-25,000 per month). Unless Q4 demand falls sharply, the equilibrium is tilted and the upward pressure on rates will persist.
There are several choices for freight demand out there: Cass, ATA, FreightWaves, DAT. Each has its merits yet each has its detractions. Invoices, tonnage, tenders, loads to trucks, none are perfect but all provide value. The common denominator across all is that volume is up, though to what degree and compared to when is where the math breaks down. The end result of the equation, however, is undoubtedly higher prices. Given that we know the supply of trucks is relatively inelastic (trucks cannot simply appear overnight, it takes time to bring on additional capacity), one could grab a napkin and back into a figure that makes sense based off the delta in spot rates. Subjectivity aside, the folks at FreightWaves’ Passport Research came up with a new twist on the Outbound Tender Volume Index (OTVI), a measure of loads tendered to providers, and the Outbound Tender Rejection Index (OTRI), a measure of loads rejected by providers. Since both metrics are based on load tenders, some of which could be particular loads tendered and rejected several times, and indexed to the same March 1, 2018 date, they multiplied OTVI by the inverse of OTRI to create an Accepted Tender Volume Index. This number has increased 16% YoY, a number much more palatable for a total volume taste than the 51% increase in the OTVI.
Since RPMs are determined not only by absolute supply and demand on a macro level but also by the micro conditions inside of each region and market, the disruptive nature of this rally’s type of freight would allow a 10-20% increase in volume to result in the 38% YoY increase in spot rates. The National Longhaul Outbound Tender Volume Index is up 63% YoY but using the same logic as above to reverse engineer the Longhaul Accepted Tender Index gives us an 83% YoY increase. This is the type of freight that dislocates capacity while exacerbating the problem brought on by its shortfall. Unlike earlier this year when local runs and shorthauls were the driver of rates during the initial Covid restocking phase, longhauls move trucks further away from where they’re needed most, and this less than ideal mode of transportation only becomes common when warranted by high end-user demand. That demand can be found in the last reading for Retail Sales, which make up an estimated 25% of US consumer spending and came in at 2.6% YoY, which is further complicated by an Inventory to Sales Ratio at its lowest print since 2014. Not only are we trying to get the goods to the consumer, we’re trying to restock the warehouses, as well. All of this as we’re on the cusp of the traditional freight holiday season push.
We know that consumer spending on services is down along with travel and leisure. We know that food and grocery spending is up as more Americans opt to stay home. Both of those fit within a bleak employment backdrop. With 8.4% of the workforce out of a job and 100% of the nation living in a restricted Covid world, what does Christmas spending look like?
Without question, the single greatest effect on spot rates moving forward will be contract rates. In an odd and perhaps cruel (think 3PLs) twist, the rapid and prolonged rise in spot rates has created a nightmare for Shippers that can only result in a mass repricing of contract business. Aside from the financial implications, the operational bandwidth for a Shipper to deal with national load rejections above 20% for longer than 60 days is beyond limited. This opens the door to mini-bids, earlier than usual RFPs, and the tired freight practice of rate negotiation.
Routing guides are trashed. A freight brokerage will sit on a negative margin lane for a while. It’s a numbers game and as long as the valleys outweigh the peaks on average, profits persist. When your committed contract business gets booked at spot rates and spot rates on hundreds of lanes are 50-100% higher since June, now the business is given back or it’s the end of your business. Even the well-capitalized and hyper-digitized brokerages have their loss limits. This rising wave of renegotiated contract rates in a counterseasonal time across the entire country, establishes a new floor to spot rates and creates an inflationary effect for lanes or brokerages not quite yet underwater with their own business. As more and more business gets repriced higher and higher, 3PLs must compete for capacity against new, higher-priced contract loads across the entire supply-chain.
This is how a marketplace can see volumes and rejections moderate while spot rates remain firm and still move higher. Markets have a certain level of homeostasis to them. We are clearly out of balance right now but the ongoing rise in contract rates will lead to a new resting level. That level, however, might be much higher than most are willing to accept.
Q4 freight means holiday season and even this year that holds true. Despite the uncertainty of consumer spending this year, all indications are that retailers are doing everything they can to ensure inventories are well-stocked this season. Container imports to the Port of LA during the month of August hit a new record high, 6.5% better than October 2018 during the notorious tariff pull-forward, and preliminary numbers for September indicate another new record on top of that. Consecutive months of historic cargo volume means all of that freight needs to go somewhere, and the options for moving that freight are confined to OTR as rail lines are short on capacity and long on price. Outbound LA rail rates are up 124% YoY, outbound container volume sits at record highs, and a recent AJOT report claims outbound LA is fully booked to Midwest destinations. Should this trend continue, and the recent surge in import containers suggests it will, the LA will continue to act as a sponge that soaks up capacity from the entire West Coast, placing greater inflationary pressure on rates everywhere.
The final destination of all of that cargo is ultimate question. Will it move beyond the warehouses and distribution centers? That answer will come from the US consumer and its spending behavior this quarter. The greatest influence on that behavior tends to be the general health of the economy, inaccurately surmised from US equity performance. Going on 28 straight weeks of greater than 800,000 initial jobless claims, at some point this will begin to outweigh the increased spending on goods coming from those still gainfully employed.
Once again, the great unknown here is Coronavirus. Another surge in infection rates could force mass closures, removing any chance for brick and motor retailers and possibly severely damaging the psyche of the US consumer, while undoubtedly slamming equity markets. It’s likely too late in the year for any possible global shutdown to affect international trade but that doesn’t bode well for consumer sentiment either. Shockingly, or perhaps not so much these days, an almost equal influence to COVID-19 could be the US Election. Capital markets love stability and this election season has provided none of that. A presidential change brings about fiscal policy questions that gives Wall St. a certain uneasiness but the greater risk here is from a transfer of power, or more specifically, the potential delay of that transfer of power. That instability would seem to come almost immediately following the November results, early enough in the holiday season to dampen any freight volume festivities.
A slight piggyback to the current political grumblings is the US-China relationship both now and in the future. A significant portion of the ongoing import influx could be attributed to a genuine fear of trade war escalations should we see a second term president. That aspect could result of a large share of today’s imported goods resting in warehouses rather than under the tree come December, which would provide a quick reversal to the bullish rate setup.
Lockdowns, masks, remote workplaces, no vaccine, and a new president. Re-openings, no masks, back in the office, a vaccine in 30 days, and re-election. Possibility A and Possibility B are not political, but rather the stark contrasts between combinations of best/worst outcomes of stability and instability as perceived by capital markets. Some combination of the two is probably ideal but unlikely. Regardless of the result after November 3rd, some semblance of national unity would be a welcomed sight, and not just for the markets.
 ACT Research, 09/2020  Truckstop, 09/2020  US Department of Commerce, 09/2020  DAT Trendlines, 09/2020  Port of LA Signal Platform, 09/2020  DATiQ FreightWaves SONAR, AJOT, 09/2020  US Department of Labor, 09/2020