Correction, not recession - Economic fundamentals fine, but uncertainty comes with a cost
Indianapolis. Why do fleets buy trucks and trailers? FTR Chairman and CEO Eric Starks routinely opens his presentations with that basic question and, given his standing as a go-to source for market analysis, he makes lots of presentations. So it’s not unusual for many in the audience to respond in unison like grade schoolers: “To move freight.”
Of course, what FTR clients really want to know is what the freight outlook will mean for truck and trailer sales in the coming year or two. The annual FTR Transportation Conference is organized not only to provide those essential forecasts, but—over three days and dozens of sessions—to explain exactly where the numbers come from, and how changes in economic trends and indicators might move the forecasts up or down.
“There’s so much, when we talk about what’s happening outside in the marketplace, that doesn’t have an impact on the freight markets,” Starks said. “Now, that doesn’t mean that they don’t have some short-term consequences on the equipment market but, ultimately, if you have zero amount of freight, do you need trucks? No, you don’t.”
Jack Kleinhenz, CEO and chief economist for Kleinhenz & Associates—and who also serves as chief economist for the National Retail Federation—opened this year’s main session with his take on the overall economy.
He likened forecasting to putting together a jigsaw puzzle and suggested that—unlike the economic puzzle leading up to and during the Great Recession—the pieces are “pretty well known” today.
He prefaced his detailed analysis by noting “an incredible number of weeks recently,” and he referred to “a lot of noise coming from tweets, geopolitical events, the yield curve and talk of recession, Fed moves, trade wars, Brexit.”
“One might say there really isn’t any precedent for the amount of uncertainty right now. There’s a lot of moving parts, which has created a lot of volatility. The data is moving around a lot—so what does it all mean?” Kleinhenz said. “I contend that we do not necessarily see a recession that’s imminent. I think we have a tariff-induced slowdown.”
While the probability of a recession may be elevated, the economy has yet to reach a point “where we need to be concerned,” he noted.
He detailed a series of indicators—including employment numbers, inflation prices, interest rates, consumer confidence and demographics—to supports several key themes:
US economic growth remains respectable but for the trade war.
• The economic expansion has set a record for longevity, with no near-term signs of coming to end.
• Although real growth is slowing, substantial momentum remains supported by consumer spending.
• The risk of more trade tensions seems to be rising, and “consumers are in the crosshairs.”
• Housing expansion has slowed, but lower mortgage rates and improving demographics should provide some boost over coming quarters.
• The Fed is “on a wait and see” and will be a near-term positive to ensure that the expansion continues to move forward.
• The two-year federal budget deal passed in August will also support near-term growth.
“The expansion continues, although it’s slowing. I’m relatively optimistic about the economy,” Kleinhenz said. “Consumer and domestic demand is solid. We’ve certainly seen swings in the market, and we’re going to continue to see swings in consumer sentiment relative to the market and how uncertainty plays out.
“The US economy remains resilient. Overall, macro conditions are not signaling a recession—it’s more a slowdown—and the risk to the expansion exists around the uncertainty that’s out there.”
Freight trends
Starks echoed the concern over uncertainty but pointed out that forecasts wouldn’t be of much value if FTR waited for clarity about the marketplace.
“We’re in the here and now—so let’s assess where we are,” Starks said.
In building out FTR’s equipment demand model, Starks begins with the broader economy (with a focus on manufacturing), calculates the freight that will be generated, then factors in equipment productivity and utilization to come up with an estimate for the demand and capacity that drive rates—which, in turn, drive equipment orders.
“Manufacturing is the lifeblood of what’s happening within this space. When we talk about the economy from a transportation perspective, we want to know what’s happening within the goods sector,” Starks said. “If goods are getting generated, that means freight is happening.”
The FTR analysis of the goods sector, excluding inventories, has growth dipping below 2% for the third quarter this year before climbing back above 2% to end the year. The goods sector will grow steadily in 2020, albeit slowly, approaching 3% through the second half. Industrial production, which fell off in the first two quarters this year, likewise will rise slowly in 2020, though at a less than 2% rate, according to FTR.
Similarly, the Institute of Supply Management (ISM) Manufacturing Purchasing Managers Index (PMI) has been steadily declining since August 2018 and has only recently slipped below 50%. A reading above 50% indicates that the manufacturing economy is generally expanding; below 50% indicates that it is generally contracting. But, with readings currently in the high 40s, the index still reflects GDP growth, but at low levels. The current ISM trend aligns closely with the 2014-2015 trend, Starks pointed out.
“We are viewing things as of now as kind of a market correction rather than a conditional recession,” Starks said.
But Don Ake, vice-president, commercial vehicles, for FTR, voiced some concern regarding the ISM’s recent sharp downturn.
“When you get into the details of the ISM, the factors that are the weakest have to do with trade,” Ake said. “In my mind it would have gone down anyway, but it wouldn’t have gone down as sharply without the trade war—which means we need to get that settled soon. We need to pull out of this decrease and get back near our forecast, which would be right at the 50 line.”
Business activity, as reflected in core capital goods orders, likewise indicate that business activity “is hitting the pause button.”
“The reason why we like to look at orders is because if they’re ordering it today, then they’re going to take delivery of it tomorrow—that’s freight in the system,” Starks said. “When we look at this uncertainty that’s out there—there’s a lot on political uncertainty, and there’s trade—those are the two big issues right now.
“When you’re a business decision maker, you’re trying to decide: What should I be doing? And when that uncertainty enters, you say, ‘I’m not doing anything.’ That’s exactly what we’re seeing within this data. It’s basically saying, ‘I’m not going to increase my spending. I’m not going to decrease my spending. I’m holding pat.’ This can only continue for so long before it starts to have some type of an impact on the broader economy.”
The business inventory-to-sales ratio has also climbed throughout 2019, reaching levels last seen during the Great Recession, Starks explained.
“There is something fundamentally different happening now, and we believe that the e-commerce is driving a lot of this that’s happening with omni channel,” Starks said. “Somebody says ‘I want to be able to get it when I want it, how I want it, and I want to order it in any way, shape, or form.’ That tells us you need more inventory in the system. All and all, I’m not overly concerned with having more inventory.”
The risk, he continued, is again a purchasing pullback related to uncertainty—which means the inventory piles up, new goods are not being produced and there’s a reduction in freight.
So, reflecting the slow growth in the freight economy, the FTR Truck Loadings Index forecast calls for downturn in the fourth quarter to be followed by a slight rebound in early 2020 that then flattens.
“For many of you, when we talk about what’s happening with the economy, what’s happening in the marketplace, there’s this sense that the market is in a downward spiral. That’s not what’s happening,” Starks said. “We’re seeing a normalization within the market. It’s getting back to what we would expect it to be—because last year was so, so crazy. We’re not going to be hitting any home runs off of this one, but we’ll continue to see freight growth.”
Anecdotally, Starks recalled a couple of recent drives between Chicago and Indianapolis.
“The amount of trucks on the road is phenomenal,” he concluded. “The difference between when we went through the Great Recession and where we are now is fundamentally different; and how many trucks are on the road compared to this point last year—it felt the same.
“This market continues to be relatively healthy.”
