Two historical freight market troughs in 2011 and 2013 support the idea that rapidly contracting absolute capacity coupled with even modest economic growth should yield higher spot rates. Any macro surprise to the upside would contribute to an outsized move higher in rates.
The Passport Research team published a note on February 14 analyzing the fourth quarter financial results of 25 publicly traded transportation companies. Trucking carriers were virtually unanimous in their belief that freight markets – and, most importantly, trucking rates – will mount a significant recovery in the second half of 2020.
(To learn more about Passport Research, click here).
When management teams gave reasons for that belief, they tended to cite new regulations like the Drug and Alcohol Clearinghouse, which are supposed to accelerate the exit of trucking capacity from the industry, tighten markets and then lift rates.
This hypothesis turns on two ways of thinking about capacity: absolute capacity, or the total number of trucks available for dispatch; and relative capacity, or how well the relationship between freight demand and available capacity is balanced. In our view, it’s important to distinguish between absolute and relative capacity because, for example, the total number of trucks available for dispatch could remain constant while freight volumes decline, which would have the effect of loosening relative capacity.
The belief that trucking markets will recover in the second half of the year then depends on the idea that absolute capacity will contract enough to eventually tighten relative capacity, which will cause spot rates and then contract rates to inflate.
Measuring relative capacity is easy – the FreightWaves SONAR data platform tracks tender rejections in 135 freight markets daily, by equipment type and length of haul. When brokers and carriers reject more loads, we say that (relative) capacity is tightening; when they reject fewer loads, we say that (relative) capacity is loosening.
The trouble is in measuring absolute capacity, the total number of trucks available for dispatch. Government data sets are a starting place, but motor carrier numbers tend to proliferate endlessly, even as carriers leave the market, and fleet counts tend to lag reality. While good ballpark estimates of the size of the trucking industry exist, tracking shifts in absolute capacity up or down 1-3% – the kinds of moves that could dramatically impact relative capacity and trucking rates – is far more difficult.
The FreightWaves PASSPORT research team has been experimenting with one data set that appears to show directional moves in absolute capacity – the number of business capacity owners (BCOs), or owner-operators, working for Landstar (NASDAQ: LSTR). Specifically, we believe that the rate of quarter-on-quarter growth in Landstar BCOs indicates carrier sentiment and risk tolerance, and provides a view into absolute capacity.
Briefly put, when trucking rates are strong, carrier sentiment is bullish, and capacity is entering the market, more company drivers strike out on their own to become owner-operators and growth in Landstar’s BCO fleet accelerates. When trucking rates are soft, carrier sentiment is bearish, and capacity exits the market. Owner-operators exit the industry or become company drivers and growth in Landstar’s BCO fleet decelerates and turns negative.
The chart above tracks the quarter-on-quarter growth rate in Landstar’s BCO fleet over the past 10 years.
The BCO data indicates that carrier sentiment was most bullish in the second quarter of 2018 when the growth rate in the Landstar BCO fleet peaked higher than 2.5% quarter-on-quarter. The peak in carrier sentiment was correlated with a peak in year-over-year GDP growth of 3.5% and peaking trucking spot rates.
While quarter-on-quarter growth decelerated from there, it’s crucial to keep in mind that it remained in positive territory until the second quarter of 2019; it took almost a year from peak bullishness for capacity to begin leaving the market, according to this model. BCO growth went more deeply negative in subsequent quarters.
Based on the Landstar BCO data set, we believe that absolute capacity has been contracting for three full quarters and is still contracting in the first quarter of 2020. Remember that the 2019 contraction in absolute capacity occurred prior to the implementation of the Drug and Alcohol Clearinghouse. We don’t have a good read on the delta between Landstar’s typical onboarding protocol and the new regime of drug and alcohol testing, so the clearinghouse’s effect on Landstar’s ability to recruit and retain BCOs is unclear. In the absence of information to the contrary, it’s simplest to assume that the new regulations will make Landstar’s hiring and retention harder in proportion to the rest of the industry.
So there’s a good reason to believe that absolute capacity is contracting at a good clip, much faster than the pace during the minor industrial sector recession of 2016.
The other side of the equation is demand, or freight volumes. Commentary from multiple railroad management teams during their fourth quarter earnings calls suggested that industrial production growth may stay muted for the rest of 2020. Railroad customers are still risk-averse when it comes to capital expenditures because of trade policy uncertainty and, we should note, perhaps the presidential election in November, which may present American voters with a choice between sharply contrasting economic and fiscal policies.
Most macroeconomic forecasts call for decelerating GDP growth in 2020 that will be closer to 2% for the full year. Last month the International Monetary Fund forecast 2% U.S. economic growth for 2020. It’s beyond the scope of our current research to dispute or qualify that forecast, so we’ll accept it as a prior assumption.
The question then becomes – how did trucking spot markets perform at times when a rapid contraction in absolute capacity coincided with relatively slow economic growth?
The Landstar BCO chart points to two previous troughs comparable to the current market – the first quarter of 2011 and the first quarter of 2013.
We’ll examine the 2011 trough first. GDP growth peaked in the second quarter of 2010 at 3.2% and then decelerated, bottoming in the second quarter of 2011 at 0.9%. Meanwhile, the Cass Truckload Linehaul Index fell from 107.25 at the end of 2010 to 104.95 at the end of February 2011. The economy re-ignited, and GDP growth jumped from 1.6% in the third quarter of 2011 to 2.7% in the fourth quarter. The Cass Truckload Linehaul Index ended 2011 at 113.32.
In the second trough, GDP bottomed in the first quarter of 2013 at 1.3% before climbing steadily for three years, peaking in the fourth quarter of 2015 at 4%. Average dry van truckload spot rates were at $1.06/mile excluding fuel in January 2013, and rallied to $1.78/mile by November 2014, a 67% gain over the course of about 22 months.
The takeaway is that in the first trough, a modest economic recovery with most of the year in sub-2% growth contributed to slow but steady trucking rate inflation. In the second trough, strong economic growth contributed to rapid, unsustainable trucking rate inflation (the November 2014 rate peak was followed by a crash and not eclipsed until November 2017).
Based on current economic growth projections, it’s reasonable, in our view, to expect improvement in trucking rates in the second half of 2020. Even marginally stronger GDP growth (2.5% for example) could drive an outsized move higher in trucking spot rates, given constrained absolute capacity. Current forecasts don’t point to anything spectacular, but we believe that the risk to transportation market participants is to the upside, not the downside, as long as the macroeconomy avoids a recession.