Transport Decision Makers: Prepare for the Future
What is happening and what will happen to trucking capacity and costs? Here's the data you need to help plan for the coming months.
The steady fall has paused.
The "where" of the spot market: We now have spot data through the end of October 2018, eight full months into the 2018 capacity event. We also have contract data through September, seven full months. The "what" of the spot market: The graph (below) shows Truckstop.com's capacity metric, Market Demand Index (MDI). High numbers indicate tightness.
We see two things here. First, the values for each truck type have been declining since about week 22 and are also well below the peak values at the beginning of the year. The market is not nearly as tight as it was. Second, in contrast, more recent weeks have seen a flattening of the trend, only the second such flattening in this seasonalized data for 2018.
Strong levels persist but are flirting with normalcy.
The chart (below) provides a relative look at market strength. It measures percent above the average from this recovery, a relevant comparison point. We see the same declining picture as above. The key number here is the 50-percent level, roughly the point above which growth cannot be explained by simple random variation. Using that standard, the flatbed market is back in sub-50-percent "normal" territory. Using the same logic, one can also use the 200-percent level as the threshold for crisis conditions. The market has spent much of 2018 above that level, but only the reefer market is currently pushing against that standard.
Conclusion: The market is tight, but no longer critically so. Again, the decline in tightness is currently absent, but is no longer at crisis levels. It is wise to keep this in mind because the rhetoric within the industry is still quite shrill.
Things were worse last year.
The last of the three views (below) is the year-over-year (YOY) story. It shows the familiar declining, then stabilizing trend, but has a different emotional punch. That is because all but the reefer market are in negative territory. The markets are clearly less tight than one year ago. You see this same story in the spot market pricing numbers below.
This data reminds us of the importance of understanding the state of the comparison data (comps) when looking at YOY charts. In 2017, we were coming off a capacity tightness stemming from two hurricanes. The capacity numbers spiked in September and early October before receding in November and then jumping to record highs with the Electronic Logging Device (ELD) mandate late in December. Beware of YOY numbers, given the wild gyrations of the market between September of 2017 and March of 2018. Also, next year the YOY numbers will pick up after June when the comps are the declining numbers of July-September 2018.
Very tight capacity is coming back to earth—at various rates.
This capacity data sends three clear messages.
- First, it is easy to understand the dramatic events of the past year. The spot market—always the lightning rod for the truckload—got very tight early in the year and sustained much of that tightness through mid-year. As a result, prices rose rapidly, and shippers had to scramble for capacity.
- Second, results have varied by truck type. The flatbed market has led the parade in absolute terms, but has been less far above its "normal" levels. The reefer market has been the opposite. Such complexity reinforces the value of doing your statistical homework.
- Third, consistent with logic, as the metrics decline toward more accustomed levels, the rate of decline falls.
Will the leveling be sustained?
It is not clear how much longer the still significantly elevated levels will persist. My forecast is that the decline will resume once we pass the holiday rush in a retail sector thoroughly traumatized by the online marketing explosion. Note that these capacity levels have clearly been positively affected by the strong economics of 2018. Should the economy slow in 2019, as many economists fear, these metrics could easily retreat to 2015 levels.
The mother of capacity crises
The final chart in this discussion on capacity (below) presents Transport Futures' estimation of capacity utilization for the entire market. It gives us a good view of pressures on contract relationships, not represented by Truckstop.com's spot market data. This data provides a useful historical perspective with which to judge the most recent developments.
It is easiest to understand by looking at the 100 percent, the point at which the market begins feeling major stress. That is a surprisingly common occurrence as the market struggles to adjust to rapid demand swings, especially after downturns as in 2010 and 2002. Most approaches to 100 percent, however, are short-lived. It is when the market tarries in that vicinity that things get tough; see 2003-2004, 2013-2014 and 2017-2018. It is notable that the visit to the 100-percent territory has been most extreme in the latest event, a fact entirely consistent with other data sources.
But something is happening.
That visit is apparently over, however, as the market has receded to high-normal levels and is expected to fall farther in 2019, especially in the second half. So, we have a second capacity metric that shows the record tightness of the first half of 2018 and a decline since. These capacity dynamics have a major implication on pricing.
2019 Pricing Review
We are just past the peak of the most spectacular pricing event in truckload history. How long before we are back to normal?
Industry dynamics that caused the burst of price increases are past their peak. The capacity metrics that we use to gauge industry pressures on truckload pricing are all declining. Although they are still at higher than usual levels, their movement is decidedly downward. That means, in the absence of some surprising new pressure, prices should follow. Indeed, spot prices, always the first to move in response to market forces, are already clearly lower than their early July peaks.
Were I not the obsessive analyst that my DNA and environment have produced, I would simply say that 2019 spot prices will be lower than those of 2018 but will still be easily higher than average. Contract prices will be slightly up in 2019: end of story. Perhaps, however, like me, you would prefer some data to support this view and maybe even some estimates more precise than "lower" and "higher than average." Okay, you asked for it: here we go.
2019 truck prices will be hard to forecast.
As is usually true of extreme events, the prospects for pricing over the next several years are fraught with uncertainty for two reasons. The first reason is the volatility inherent in the kind of extreme event we are experiencing. It implies greater-than-normal uncertainty until the market settles back into a normal mode. Crazy things have happened over the past year. Crazy things are likely to happen again before this trip to the Twilight Zone is complete.
Second, the volatility of this episode may be due to some permanent change in market dynamics that will remain with us well into the 2020s. If so, we must factor that into our forecasts. These are big issues that demand careful consideration. Accordingly, I will look at the historical record to search for clues to this chancy 2019 forecast.
Let's tease this puzzle apart.
On the contract rate side, we have good data going back far enough to give us some significant insight. I will start the analysis with contract data going back to 1993. The first principle of forecasting is to disaggregate the forecast into its constituent parts.
To keep things simple, I see three parts to the forecast: industry or "market" conditions, fuel, and general inflation. The total numbers that we will see in the market are the product of those three sources of growth or shrinkage. Unless we understand the contribution of each force, we won't know why prices are moving. One can just straight-line some relevant historical period. I will do that in part in this analysis. But a good forecast is best a forecast of such "why's." It considers whether things might change from the trends recent data reveals.
We'll start by stripping out fuel and inflation.
So, let's start with a forecast of the market why's then layer in inflation and fuel why's. To do that we need to first factor out the fuel surcharges from the historical data. The chart above does that, revealing the fuel price crisis of 2008, the tough times between 2010 and 2015, and the recent middling experience with crude oil inflation.
Given the hype of fuel issues, it is surprising to discover that fuel inflation has accounted for only 3.3 percent of the increase in truckload contract prices since 1993. This is just another piece of evidence to show that the energy crisis is over.
Shippers have had little to complain about for a long time.
The second task is to factor out inflation, something I do here using the Consumer Price Index (CPI) as my inflation metric. One could use several others. However, the story changes little. Unlike fuel, inflation makes a big difference. It accounts for 80 percent of price increases, and that includes the increases in the past year.
This means that shippers should look elsewhere when complaining about truck pricing, at least over the long run. It follows that one must, therefore, sweat the inflation assumptions in any forecast, because it normally is much more responsible for price change than other market conditions.
But I said we would start with the market why's.
So, let's look closely at the line of data in the chart labeled Real Prices (see below). Economists apply that adjective to indicate an inflation-corrected value because most users of price data want to understand what industry conditions have done to price, not the effects of the wider economy. So, they call inflation-corrected prices "real" prices because they indicate what has really been affecting prices within their industry. In our truckload case, that says the "real" annual growth rate since 1993 has been .9 percent annually rather than the 3.2 percent annually realized in the uncorrected prices that economists call "nominal" prices.
Sure, inflation is important, but something else happened over the past two years.
Although the inflation analysis tells us most of what is influencing truckload prices over a long period, it doesn't explain the 15-percent hop in prices since early summer 2017. To enable that analysis, I have arrayed inflation and fuel-corrected prices against the underlying trend in those prices.
The artifice quickly shows us that the price at any given time may be moving at rates very different from the long-term .9 percent per annum trend. It also says that such variation is usually not sustained. The only consistent deviation from trend was the steady price decline between 1993 and 2002. Prices have fluctuated since then but largely around the long-run trend.
But the data shows rapid increases sometimes.
Prices have two facets, easily seen in the data, that could produce high 2019 values. In late 2003 and early 2004, prices jumped 20 percent in just five quarters. That rapid acceleration showed up again in late 2017 and early 2018. In both cases, the market was reacting to strong freight growth and regulatory changes.
We also see an economically derived phenomenon in the 1993 bump at the left of the chart. This tells us that there is historical precedent for what we have experienced the past two years. It is why I have been predicting such a jump for six years. However, the historical data also shows that such bumps are not permanent. Eventually, the industry gives back the increases to resume growing slowly, roughly along the straight trend line calculated on the graph. Know that I am currently a pessimist.
How long will this bump last?
If we are just concerned about 2019, the most likely result is easy to see. In the 2004 bump, high prices lasted until the economy collapsed in 2008, almost a full four years. Let's see: 2017 plus four equals 2021. No sweat for carriers for two more years. But wait a minute! We also had a small bump in contract prices in 2014, the last time of market tightness. That bump lasted only two years. 2017.3 plus two years equals 2019.3. More about this below. My point here is to emphasize the risks of 2019.
What's the second facet about high prices you mentioned?
The data also show that the market does move from one long-run growth path to another—on occasion. Between 1993 and 2003, the real price of truckload trucking was falling. Then, after the 2001 slowdown ended, the regulatory and freight stimuli jumpstarted prices onto a new upwardly moving path, one that persisted at least until last year. That path, again, is only .9 percent up per year in real terms, but it is upward not downward.
If I showed you the data going back to 1935, when our industry got started, this upward movement has great meaning, because the 1993-2003 1-percent decline was merely a continuation of a very long decline—since 1935. Moreover, the decline shown here was merely a tired finale to a long history of spectacular decline, averaging more than 4 percent for almost 60 years. So, the 2003 shift from slow decline to slow increase is historically significant in its change of direction.
Are we in the middle of a permanent upward movement?
The majority of industry commentators believe this to be true, just as they believed it to be true in 2004. While the collapse of the 2004 bump says otherwise, the presence of important changes in pricing drivers leaves open the possibility that something is happening to move prices upwards on a sustained basis.
Labor costs are rising and should continue to do so until automation is in full swing. The move to internet marketing is also lowering productivity as appointment and delivery times become tighter. Note importantly that such changes are gradual, easily overwhelmed by the bump. The latter can easily cause a 10-percent jump in real terms verses 2-3 percent in any year from a sustained trend.
How about a one-time sustained increase?
Economists like to talk about "step-function" changes, events where results suddenly and permanently change. That happened in baseball about 1920, when Babe Ruth's astounding home run output taught the major leagues the proper way to attack the newly harder baseballs.
Several possibilities could impact truckload pricing. One is regulatory change. Although the industry is already staffing up to offset the most recent losses of capacity from regulatory change, the costs increases are permanent. This happened in 2003, with the first of the big Hours of Service changes. You can see a possible effect of that in the starting and ending point of the 2004 bump. The ending point is six percentage points higher than the starting point, possibly caused by the combination of labor inflation and Hours of Service losses.
Consider though that much of the 2000-2002 dip in prices that lowered the starting point of the bump was caused by the difficult freight downturn of those years. My best guess shows cyclically adjusted start and end points, with no deviation from the long-term slow growth trend.
Another possibility is more credible.
This crisis is a very strong one and could conceivably fund a step-function change. I see two possibilities: One is a proclivity for shippers to purchase larger-capacity buffers than they have recently. The steady rises in capacity utilization on trend are evidence of declining capacity buffers—all of which cost money. I estimate an upside effect from that at three percent.
More likely is a step-function increase in driver pay, currently estimated at an average 7-8 percent. Perhaps this is the first cycle where such increases are not given back during the next down cycle. Combined, the two possibilities could theoretically add 10 percent to rates, in essence keeping the current numbers the same distance above the trend line indefinitely. That is distinct from history (2003-2009) where the majority of the bump was given back—permanently.
But history says no.
Our experience with regulation and driver shortages says that any sudden pricing increases are eventually given back, or, to some extent, spread over several years, making it part of the underlying trend increases.
This was clearly the case in the most similar historical event, that of 2004. Since this crisis has started much like the 2004 event, one must attribute most of its increases to such temporary forces. This supposition frames the fundamental question about the current event: Is it something new or just a somewhat more severe example of what we have experienced before? I vote for the latter, strongly.
The spot market says things will revert to normal.
Consider the accompanying data. Truckstop.com's MDI peaked in January at three times normal levels of 20 and almost 20 points above the 2014 event. (We have no spot data from 2004.) However, since that peak, the seasonalized data has steadily receded, now standing only about five points above normal (20).
By this measure, and similar DAT metrics, the spot market, always a leading indicator for contract markets, is moving into the realm of normal pressures, not the extreme tightness we had during the spring. Spot rates normally follow MDI capacity condition by about six months. Sure enough, six months after the January peak in MDI, spot rates have begun a steady fall and now sit about $.30/mile above normal. The current trend would have them back to normal by January.
But contract prices are still increasing.
And increasing they should be, given the lags between contract and spot prices. When will they begin to move back to normal? The 2004 example says not until 2020.1. The 2014 data chronicles a lag of half that, suggesting a 2019.1 slump, seasonally corrected. In a market that appears to be accelerating its responses, I vote for the more recent precedent, expecting a peak somewhere late this year. That would be roughly halfway between the 2004 and 2014 precedents.
We are missing one more variable: The lags make the spot and contract market forecasts different.
Armed with this data, I conclude that the spot market will finish its record year on a downward path, while the contract market will finish at or near a peak. Let's start with the spot market. As one would expect from a market determined by daily swings in market conditions, its lags are shorter.
Unfortunately, we do not have data back to 2004, being limited to viewing the market's response to the lesser 2014 pricing crisis. In that event, spot prices reverted after roughly one year. Given this event has been more extreme, my current base forecast has it reverting significantly during the second year, sometime in late 2019.
As you look at these numbers, please do not be impressed with their precision. This is a highly uncertain forecast. Think of the spot forecast as saying significant spot rate declines "sometime in 2019, probably later than earlier."
That is, however, quite different from the common view that prices will remain high indefinitely. The one indefinite factor is the 3.9-percent permanent increase to the trend line that you can see between 2018 and 2019. That is the effect of the surge capacity and driver pay issues I mentioned above. Add that to the normal .9-percent per year trend increase, and one gets a 6.5-percent permanent increase in spot prices since they took off in early 2017.
For contract prices, think 2020.
The accompanying chart (below) showing my contract price forecasts presents my belief that, although the lag between capacity and price is longer than with spot prices, it is shorter than the 2004 precedent. That's due to the 2014 precedent and my concerns about economic conditions in 2020.
Although these numbers do not reflect a recession, they do factor in slower economic and freight growth. Note that a recession, as feared by some economists, including me, would produce much lower numbers, clearly below the long-run trend, as they did in 2009.
Spot and contract prices dance differently.
The best way to look at these two segments of pricing is to consider spot prices as a flagman telling the approaching locomotive engineer what is around the next bend. The brakeman waves the spot market flag vigorously to get the engineer's attention. Thus, we see that spot prices vary by more than twice the amplitude of contract prices. They rise farther and will fall more dramatically. Now just past the peak, carriers in spot markets remain in a euphoric state. The same dynamics say that one year from now those carriers will be moaning as shippers shout for joy.
The chart (below) also shows the lead-lag behavior of the two metrics. If the brakeman is to warn an approaching train of a hidden obstruction up ahead, he has to walk well back from that obstruction to give the approaching train time to stop. In the same way, spot prices warn contract markets what is coming six to nine months ahead. So, the softening of spot prices I am predicting some time in 2019 should be a warning of a similar softening of contract prices in 2020. The same contract shippers who ignored the rise of spot prices in early 2017 should not despair when contract prices stay high in 2019. Their turn will come after the normal lags, a year later: spot prices first, contract prices next.
But what about inflation and fuel?
The graph (right) presents my outlook for inflation and fuel. The bars show the slow and steady price of inflation, a factor that is getting stronger. That is the downside of our currently strong economy. Although inflation has a yearly effect much smaller than fuel, its uniform direction (up) gives it a powerful cumulative effect, as evidenced by its historical influence on rates.
As recent results show, fuel is much more volatile in a given year, generating swings of 30 to 40 percent, even in the recent, relatively benign oil markets. However, as fuel flips from a positive to a negative, its cumulative effects are small. Note that the modest increases I show in 2019 and 2020 are bracketed by risks on both sides.
What numbers should I plug into my budget?
The final pair of graphs (above) presents this forecast in "All In" terms: my estimate of what shippers will actually pay, including fuel, inflation, and market forces. You will find these numbers more recognizable than the "Real Price" estimates published above. The real price estimates are of use mainly in figuring market rates of change. Since that is the most important task in this forecast, I used them. However, I have to translate them back into all-in numbers for you to use.
The all-in graphs combine rate/mile estimates with the YOY change calculations for the all-in rates. This combination is revealing, as it shows how the rates can remain high, while giving negative YOY numbers. This is clearly seen in the spot numbers where the rates remain well above the 2016 values, despite two years of YOY shrinkage. Note that with the contract numbers, the rate/mile values continue to climb in 2020, due to the longer lags that govern contract prices. By the end of that year, they should be falling, even though the full-year average is above 2019's. You can also see in the tabular display that all the 2019 and 2020 growth comes from inflation and fuel, save for the .1 percent in 2019. The market estimates reflect the softening capacity documented in the first section of this review.
Tell us what you have told us.
In summary then, the outlook is for prices to remain above the long-run trend through 2020, although spot prices will have regressed to near-trend by the end of 2020. Contract prices will make that approach in 2021. This is a reasonable base case forecast, derived from a careful study of historical precedent. It is clearly more likely than the more optimistic assumptions that most of the industry is still making, buoyed by the good feelings (for carriers) of the past 18 months.
I'm a pessimist. Here's what the optimists say.
Of course, history may not repeat itself and produce a major step-function upward change in prices. Again, I have built a 4-percent version of such a step function. However, some commentators see it closer to 10 percent. Combine that with a Trump-like optimistic economic forecast and one could add 5-7 percent to my base case numbers. I put such a probability of less than 20 percent—non-zero for sure, but unlikely.
In 2020, I'll be an optimist again. For now, I am concerned about a downside.
I find a downside exposure more likely than an upside, especially by the end of 2020. This recovery is very old, approaching a record for length should it continue, as is likely, in 2019. We may be approaching a natural end to this recovery, a pause while people save up for the next rush of investments and spending.
In addition, growing troubles in the global economy, combined with the worrisome trade war, could retard the U.S. economy. Should the economy weaken, or go into outright recession, history suggests a regression of prices below the long-run trend. That could produce late-2020 prices 20 percent below today's levels for spot markets and 6 percent below for contract markets. Sadly, I find this exposure more likely than the upside risk, at a probability of 30 percent or more. This is why I advise you to be cautious with your cash, despite the wonderful current conditions for carriers.
ABOUT THE AUTHOR
Transportation economist Noël Perry provides insightful analysis of freight transport within North America, with special emphasis on truckload, rail, intermodal, and domestic water markets, through Transport Futures. transportfutures.net