If you’re familiar with the Perry Rule of Three, you may be looking at the latest Truckstop.com Market Demand Index (MDI) numbers for dry van with alarm. We’ve now had four consecutive weeks of elevated numbers. The change has coincided 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 carefully before concluding that the market has moved to a new and more dramatic level of tightness.
Evaluating the data
In evaluating this data, it’s important to 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 doesn’t mean the market is three times tighter than the recovery average of 20, or 50% tighter than the 40’s values of the early spring. It just means the market is tight — very tight! The MDI is best understood as a capacity pressure index.
Rates and market conditions
Since we’ve been warned by this indicator that something is underway, it’s wise 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 showed no movement at all. According to the Perry Rule of Three, we can conclude that prices are quite high — by almost 50 cents per mile compared to a year ago. However, prices are not moving farther upward in a convincing fashion. Last week’s reading tells us to keep watching, but that’s all until more evidence comes in.
This picture provides strong hints about the seasonal behavior of the market. The up and down movement of the red Recovery Average values is a good approximation of dry van seasonal rate variation. Accordingly, we can propose that most of the 2018 movement in rates has been seasonal. The 2017 lines show strong movement above such seasonal variations, but the 2018 bars have remained roughly the same distance above the red line all year. The recent upward movement of the 2018 data may simply be the normal upward movement of a spring market. If so, we can expect prices to begin falling in short order, like they normally do, in July and early August.
Spot data and fuel surcharges
Before closing the book on the latest spot data, one analytical step remains. The above data uses raw prices including fuel, but doesn’t include brokers margins of about 40 cents per mile. Since we know the size of average fuel surcharges, we can subtract it to see 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 increase 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” that sustainable event that has produced such high rates clearly peaked in January, not now. Again, the actual numbers, that do show a current peak, include the normal strong seasonal increases leading up to July 4. This 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 Dec. 18 with the original mandate. They then rose gradually in anticipation of Week 13 (April 1) at the beginning of enforcement. They fell some more when that crisis passed without a big effect. But in May, a gradual upward movement began in the absence of some ELD change suggesting that the strong freight growth of 2018’s second quarter was tightening the market. We can conclude that we’re still feeling the effects of that trend, even if not the dramatic move evident in last week’s data.
What to expect
As we look forward, we should expect one thing while looking 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 that big drop by 5 cents or so. If the dramatic move of last week is sustained, then more rate changes are possible. The likely case would be year-end rates 15 cents below current levels, assuming continued strong freight growth. If the economy cools, then the pessimistic warnings I have been shouting all year will align with reality sooner rather than later. The spot rate story is always the leading indicator of trucking pricing. What about contract rate increases that cover the majority of truck moves?
Contract rate increases
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 have apparently 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, the other great capacity event in 2004.
Will these increases get larger? And how much longer will the big numbers prevail? Keep in mind that contract rate increases have little inherent seasonality because they usually run for a year or more. Moreover, these year-over-year (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 be seeing soon in the spot numbers. Without seasonality, we will only be looking at the effect 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 2017 and the present. Since rate increases negotiated in 2017 were much lower than 2018, we can expect the weighted average would be pulled down. To get the double-digit increases we see now, the most recent increases must be high, well above the averages displayed. However, know 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 renegotiation is occurring, nor how much of the reporting included some spot moves. All we can do is assume the YOY increases in last month’s new contracts is somewhat higher than what we see here.
Comparing 2004 and 2014 to the present
Despite this uncertainty, we have many years of useable data on contract rate increases that allows us to compare the current event to the two previous capacity crises most comparable to this one — the events of 2004 and 2014. The next chart compares these three events displayed in months from the start of each one. The patterns are strikingly similar differing primarily by 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 (though 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 at this time in 2004 and 2014. Part of that is the matter of comparison years. Now we are beginning to compare current rates with rates that were rising a year ago, as compared to earlier this year when the year-ago rates were still falling. Part of that is the adjustment of the market to its stresses, building up capacity at increasing rates. Therefore it’s reasonable to expect this event to follow the historical precedent in a gradual retreat from the current YOY rate increases. It’s important to note that the 2004-2005 retreat was very gradual, still showing 7% increases a full year later, 18 months after the underlying capacity pressures started to recede. Part of that slowness is the aging phenomenon, and part of it is the natural lag in market responses. Carriers 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 is moving back to 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 keeps waterfront real estate prices high. While I discount that view with respect to trucking (markets do adjust), the chart above suggests this event could surge for a while longer. I do feel this event is worse than the 2004 shortage, testimony to the elimination of surge capacity and the slowly growing challenge of hiring drivers. If so, we could easily get 2-3 months of continued contract pricing acceleration, and a slower, flatter retreat from the current peak. The 2004 data suggests that scenario would sustain double-digit increases through the end of the year and keep us above 5% for most of 2019. If so, the direction of events after September, let’s say, will be clear (downward), but rates will easily stay high enough to sustain contract carrier profits into late 2019 with the reflected stress on shippers’ 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’s not a “new normal,” it’s just a “tougher normal.”
In closing, the spot data in this analysis comes exclusively from Truckstop.com’s revolutionary data bases, 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, usable index resides within Transport Futures. For more from Truckstop.com, visit Truckstop.com. For more information on Transport Futures insights, visit TransportFutures.net.
About Noël Perry: Joining Truckstop.com in June of 2017 as Chief Economist, Noël Perry is the rare economistic to specialize in transportation. Starting on a loading dock in 1968, he has followed his life’s interest in senior research positions at Cummins Engine, CSX and Schneider National. He has been in private practice since 2008, working with clients in four modes and the shipper community. He is frequently quoted in the national logistics media and heard on the speaking circuit.