Economic Update

ECONOMIC UPDATE

The More Things Change, The More They Stay the Same

DONALD BROUGHTON

Managing Partner, Broughton Capital LLC

We live in extraordinary times. The single greatest book on economics, “The Wealth of Nations” by Adam Smith, was written 245

years ago, but the basic principles outlined

in it remain true today. Concepts such as free markets being the most efficient allocator of scarce resources, and the power of the Invisible Hand (i.e., markets incentivize individuals, acting in their own best interest, to produce what is best for everyone).

How marketplaces work, and how market participants behave, has not

changed. What has changed is the speed and efficiency of markets. Never before have markets reacted and adjusted as quickly as they do today. As more sophisticated technology is used by buyers and sellers of all sizes, significant increases in information about supply and demand have become available to everyone. Adjustments such as increases/ decreases in price that used to take weeks or months, now happen daily or even hourly. Just as this is true for those of us in the trucking industry, it is also true for the producers of the products that need to be shipped. The net result is that at times markets seem more volatile. Choosing any marketplace factor, and conducting a simple comparison of the amount it changes from the top of a market cycle to the bottom of a market cycle, suggests that the magnitude of swings today is fairly consistent with the magnitude of swings that happened 5, 10, or 20 years ago. But, the speed at which the market can swing has never been faster. As the use of technology and the capabilities of that technology continue to grow, so will the speed at which markets react. Those who continue to adopt new technologies and position themselves to quickly adapt to changing marketplace conditions will thrive; those who do not, will not survive.

There is one factor in the trucking market which is an exception to the con-

cepts we have just summarized. It won’t last long, but the correction will produce a marketplace shift that will catch many by surprise. Throughout 2021, spot pricing was higher than contract pricing in all modes of trucking and shippers struggled to find enough trucks to move their loads. As a result, in the most recent shipping contract bid cycle, a record number of shippers insisted on committed capacity. They agreed to much higher contract pricing, but only if a minimum number of trucks would be provided on a routine / regular ongoing basis. It made sense for the shippers, many of whom had extraordinary difficulties finding enough trucks to move their loads in ‘21. It made sense for large carriers, who were able to secure large rate increases as well as a minimum guarantee of load volume. This shifted loads out of the spot market into the contract market, and spot pricing fell back below contract pricing where it normally is. Then when the rate of demand growth slowed, spot pricing fell even further. Normally as the discount (the amount spot pricing is less than contract pricing) increases, the incentive for shippers to shift loads, away from contract and into spot, increases. The larger the discount the larger the shift of

loads. This continues until eventually the shift of loads becomes large enough to support pricing in the spot market and the discount stops growing and begins to narrow. This time, because so many shippers had guaranteed volume in order to guarantee capacity, they could not shift loads out of contract into spot no matter how large the discount. All three modes of truckload have seen the discount of spot pricing to contract pricing reach new record highs, on both a nominal and percentage basis. As contracts are rebid in the new year, we expect shippers will abandon the committed capacity provisions in their contracts. Loads that are currently locked into being first offered to contract carriers, will be freed and many of them will quickly shift into the spot market. Spot rates will rise and the discount of spot to contract will narrow to more normalized levels.

WHAT ELSE IS COMING IN 2023?

Dry Van - demand will continue to be driven by consumer spending and new household formation. While the rate of growth in consumer spending has slowed, it had to slow from the frenetic pace it reached, it will continue to grow in 2023 as consumer income continues to grow. As demand for labor continues to exceed the supply of workers, wages and consumer income will continue to grow. New household formation has also slowed. Similar to consumer spending, it had reached a frenetic pace (housing starts hit levels not seen since 2006, before the 2008 housing crash) that was impossible to maintain. Higher mortgage rates are putting pressure on new household formation right now, but inflation will trend lower throughout 2023 and as it does mortgage rates will decline and new household formation will reaccelerate.

Purchasing a new house is only the first step for a young couple. Almost a decade of spending follows the house purchase, as they make the house their home. Young couples don’t buy houses because mort-

gage rates are low; they buy them because they need a place for their growing family to live.

In the first year after buying a new home, consumers are >2 times more likely to buy a new car.

Although it has retreated from the ultra-high levels it reached earlier this year, it is still above 50 and still at levels which should support pricing increases in the months to come.

Reefer - Although any incremental demand from medical supplies is already fading, an entirely new driver of incremental demand has been created.

Not just pizza and Chinese food anymore – over the last year many restaurants failed, but those that survived are thriving. Consumer buying habits have been completely retrained. Diners of all ages have learned how to order breakfast, lunch and dinner on their phone. Delivery services such as Door Dash and Grub Hub are booming. In areas where restaurants have fully reopened, many of them are back to pre-Covid (not socially distanced) maximum capacity for in-house dining, yet their receipts from takeout are still exceeding the receipts from dine-in. Since most restaurants do not serve any processed food, they use far more fresh / frozen food stuffs than most households. Since they also tend to make larger serving sizes the amount of food stuffs they consume is magnified even further. We believe the vast preponderance of this shift in purchasing behavior is permanent. If it is, it not only magnifies demand, but in a similar fashion to the e-commerce demand for local drivers, Door Dash and Grub Hub compete for available labor, offering regular home time without the need for a CDL or a drug test. Most Reefer fleets will be unable to grow and will struggle to keep their current fleets seated.

Our favorite measurement of the equilibrium, between capacity and demand, is signaling more strong pricing power ahead for Reefer.

Although it has retreated from the ultra-high levels it reached earlier this year, it is still above 50 and still at levels which should support pricing increases in the months to come.

Flatbed – demand will continue to be driven by the construction and automotive industries, with significant waves of additional demand being added by the oil & gas exploration, manufacturing and agricultural industries.

The rally in WTI crude oil prices, to levels that materially exceed the cost of production via fracking in all the major fields, has already driven rig count dramatically higher. Just as e-commerce and food delivery govern the addition of capacity in Dry Van and Reefer, Oil & Gas Exploration will offer alternative high paying employment to potential drivers for the Flatbed industry.

Summary - the economy continues to rebound more vigorously than most people appreciate, and it will continue to grow faster for a longer period than anyone predicts. The drivers of demand in each segment are also offering employment alternatives to drivers, thwarting the ability of each mode to add capacity. The combination of sustainable demand and constrained capacity should extend the length of this period of prosperity for the entire trucking industry. Fasten your seat belts because it is going to be an incredible ride!

With current oil prices, the oil rig count, already 3.6X the August 2020 low, could more than double again from current levels. Current concerns, after Russia invaded Ukraine, have driven oil and natural gas prices even higher. In the last twelve months, the oil rig count has increased by more than 40%, and the natural gas rig count has increased by more than 50%.

Donald Broughton

It is our long-held belief, backed up by years of experience and tons of data, that the most reliable and earliest indicator of economic conditions is the trucking industry. Long before the wizards of Wall Street, or those big brains with PHDs in economics, become aware of a trend, the men and women of the trucking industry know. Not only do you know whether the consumer economy or the industrial economy is getting better or getting worse, based on the volume of loads and the rates being paid, but you know about specific companies (i.e., Wal-Mart may be sticklers about appointment times but they get me unloaded quickly; K-Mart is very disorganized, take forever to unload me, I can’t understand how they stay in business). Our ongoing mission with this column will be to: highlight trends in other parts of the freight market that you might not be aware of, but could end up affecting you; as well as trying to explain what we believe are the reasons behind the trends you are experiencing in trucking.

After spending over two decades as one of Wall Street’s top Analysts and one of its leading Market Strategists, Donald Broughton founded Broughton Capital in 2017. Broughton is notorious as a hard-hitting forensic accountant, using Sell ratings more often than any other analyst. He is highly regarded for translating goods flow data into economic forecasts that have proven to be highly prophetic. Additionally, Broughton is convinced that most individuals know much more about the economy than they realize and believes that economists are only boring because they are lazy or choose to be.