The slump in freight demand could continue for months more, but analysts foresee an upward trend by the end of 2008. A bad housing market is a given, so the real wild cards are consumer spending and manufacturing.
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When economists, pundits and average citizens swap pronouncements and prognostications about whether the U.S. economy will slip into a recession, most trucking executives probably wonder what these people are thinking – or drinking. As far as the trucking industry is concerned, the recession is a reality and has been for quite a while.
“Trucking has been in a recession for five quarters,” says Donald Broughton, transportation analyst for Avondale Partners, an institutional research and investment banking firm. “We should have already seen an economic recession.”
But a recession in 2008 won’t necessarily have a big impact on trucking, says Eric Starks, president of freight transportation forecasting firm FTR Associates. “Most of the pain is out of the system. When you look historically, the trucking market usually takes the hit at the front end.”
Broughton and Starks are referring to the fact that trucking typically leads the economy into a recession and then leads out of it. That’s not to say trucking causes either the recession or recovery, of course. Rather, trucking is a leading indicator. A precise explanation of why this is true is elusive, but it might have something to do with lead times in the supply chain and the relative weight of goods.
“In theory, trucking should not be a leading indicator,” says Bob Costello, vice president and chief economist of the American Trucking Associations. Because trucking hauls freight throughout the supply chain, you would expect trucking volume to coincide with economic activity, not predict it, he says.
Costello surmises that manufacturers probably order less raw material when they perceive a impending downturn in demand, and more raw material when they believe a slump is bottoming out. And because raw materials generally account for more tonnage than finished goods, these early barometers show up in trucking volume. Costello concedes, however, that there is no clear consensus on the explanation. “Sometimes the numbers are just what the numbers are.”
Regardless of why trucking leads into and out of a recession, it’s probably good news today that it does. An economic recession might be more painful for trucking than the current slump, but at least the industry would be among the first to make it through. And what about the chances for recession? A bad housing market is practically a given throughout 2008, so the critical factors will be the strength of consumer spending and manufacturing.
Starting out weak
Baseball great Yogi Berra gets credit for a saying that sums up the economist’s fate: “It’s tough to make predictions, especially about the future.”
So it is with the freight outlook for 2008. Costello explains that accurately forecasting over a long period – the next decade, perhaps – is easier than forecasting the next 12 months because peaks and valleys smooth out over time.
“The easy part is that we’re pretty sure that the economy will be fairly weak for the next two quarters,” Costello says. Blame the housing market and the related credit crunch. “The probability of a recession has definitely increased,” he says. ATA this fall adjusted its own projection upward to a 40 percent probability of recession. “Morgan Stanley says a recession is likely – more than a 50 percent probability.”
Costello adjusts projections for the Gross Domestic Product to determine the likely impact on freight. For example, GDP includes services, which don’t directly affect trucking volume. And it excludes imports, which do affect trucking. Estimates are that real GDP will be up less than 1 percent in the first quarter of 2008 and up less than 2 percent in the second quarter, Costello says. If so, freight demand would be down slightly in the first quarter and up slightly in the second. In both cases, the change likely is in the range of half a percent or less.
Meanwhile, the likelihood for significantly tighter capacity that would at least boost pricing isn’t high. “We have not seen the catastrophic rate of failures that we saw in past high-fuel periods, but they are starting to inch up,” Broughton says. Due to generally higher fuel costs, slower freight and high cash needs for renewals of licenses and insurance premiums, “the first quarter in the best of years is usually higher than usual.”
“There really is no risk of capacity tightening,” says FTR Associates’ Starks. “Where things could potentially change is the third quarter.” The firm estimates the current truck utilization rate at about 88 percent, where it had been all year. “It really started coming down in mid-2006,” Starks says. “Freight was falling off, and people were overbuying due to not seeing freight fall off and the truck pre-buy.” By comparison, utilization rates in 2005 and early 2006 were in the high 90s.
Starks’ projections for the near-term freight market are nothing to shout about. “We’re still somewhat pessimistic,” Starks says. “Freight continues to be very sluggish. It’s really just not out there yet.” He doesn’t expect any turnaround until at least the second quarter.
Consumer demand
One big wild card is consumer spending, Starks says. “The consumer is starting to pull back. There was no traditional peak season this past year. If they aren’t buying, you aren’t moving the freight.”
Consumer demand definitely is slowing, and that’s a real worry for trucking if the credit crunch and problems with the housing market lead to an economic recession, Costello says. “In the last recession, even though we got hit hard, the consumer never left the game.” So far, however, spending is a concern but not a major problem. “We haven’t seen the declines in retail and wholesale sales that we saw in the last recession,” Costello says.
Changes in total retail sales don’t present a true picture of consumer spending, Broughton warns. That’s because total retail sales include both the pass-through of higher energy costs and sales of high-priced gasoline itself. So if you look at retail sales on a unit volume rather than gross revenue basis, consumer spending looks much weaker.
“From a retailing perspective, we’re in the first consumer-led recession since 1990 and 1991,” Broughton says. Whether that translates into an overall recession depends on strength of manufacturing relative to housing and retail, he adds.
Manufacturing strength
Broughton believes manufacturing will be stronger than expected this year. “I think 2008 will be a mildly positive surprise,” he says. Broughton cites two principal factors for his prediction: A weak dollar and moves by the Federal Reserve to increase the flow of capital in the economy.
“The dollar has devalued dramatically against other major currencies, especially the Euro and pound,” Broughton says. Many companies choosing between the United States and Europe for assembly are opting for the United States due to the exchange rate.
“When this happened in 2003, you had Japanese and German firms spending hundreds of millions expanding assembly plants in the United States,” Broughton notes.
Starks agrees that so far the weak dollar has been a plus, especially for business investment. “We’re also seeing a very healthy export market,” Starks says, cautioning that it’s difficult to declare this a net benefit of a weak dollar since the volume of imports is almost twice that of exports. In the long run, however, the inflationary pressures created by a weak dollar could overwhelm the benefits for exports, Starks says.
In addition to a weaker dollar, the Federal Reserve’s response to the credit crisis by lowering interest rates and by growing money supply will help, Broughton says. “There’s usually a two- to three-quarter lag between Fed actions and an impact on truck tonnage.”
By the end of the first quarter or the beginning of the second, some of the Fed’s first actions should be seeing results, Broughton says. “By the middle of 2008, that will be the topic of conversation – how the U.S. manufacturing base will be surprisingly strong.”
Costello also acknowledges the key role of the Federal Reserve. “When the Fed cuts interest rates, they want to get ahead of the curve so that the weakness in housing and credit crunch doesn’t filter through to the rest of the economy.” As is the case with consumer spending, the manufacturing segment so far isn’t pointing clearly to a recession, Costello says, adding that weakness in the manufacturing sector was much more pronounced before the last recession.
Broughton suggests that there’s another beneficial factor related to the supply chain. “One of the effects of the proliferation of technology and the ability of people to use it has been the continued reduction in inventory-to-sales ratios,” he says. “Any uptick in end-use consumption will be felt throughout the supply chain.”
So perhaps manufacturing will be the trucking industry’s salvation in 2008. In any case, observers seem to think the situation at the end of 2008 will be better than it was at the end of 2007.
“Assuming a recession doesn’t happen – and that’s a big assumption – we think things will improve by the end of the year,” Costello says. “If the housing market and the credit crunch do lead us into a recession, trucking will feel a major brunt. But if in fact we get into a recession, I don’t hear anyone saying it will be a prolonged, awful recession.”
The view of manufacturers
From the perspective of manufacturers themselves, 2008 should be a fairly good year. According to a semiannual economic forecast from the Institute of Supply Management released last month, 62 percent of purchasing managers and supply executives expect revenues to be greater in 2008 than in 2007. The net increase expected is 6.8 percent, substantially higher than the 2.4 percent increase in revenues reported for 2007. For more information, go to www.ism.ws.
