The Epic Battle of Bull and Bear – The double-edged sword of rapid truckload rate increases

Within our services in the Chainalytics Freight Market Intelligence Consortium (FMIC), we process well over $60B in shipment transactions per year for the primary purpose of benchmarking rates and understanding market trends as transactions flow daily into our organization. At FMIC, this information provides us with a very unique perspective given the current market conditions, and I can tell you not a week goes by without multiple requests for a forecast – Every major shipper wants to know what rates are going to do in 2019 and beyond. After 2017-2018, can anyone blame them?

Given current conditions, my advice is to budget as high as your CFO can tolerate for North American truckload expense. Our spot budget risk is showing a 3-4% 2018 cost impact over contract projections for route guide failure. Contract rates would likely come in at a high single digits should the spot climate exist into 2019.

However, a word of caution to the carrier community: do not get too bullish about my opinions. No single individual controls the market. And expectations on rate gains – regardless of the source – have nothing to do with actually paying more in rates because it will not happen unless it has to…

Let me explain…

Over the course of the last 20 years, we have witnessed only a handful of extreme swings in economic business cycles impacting truck rates (2004, 2009, 2014 and 2017), and this one is different on a number of dimensions. Before we discuss differences, we need to establish the 4 fundamental phases of the business cycle:

  • Recovery – Post-trough rates that reduce year over year (YoY) cost for buyers and are less abundant
  • Accelerated Growth – Pre-peak rates that significantly increase YoY cost and are increasing in frequency
  • Slowing Growth – Post-peak rates that increase YoY cost and are decreasing in frequency  
  • Recession – Pre-trough rates that offer abundant and significant cost savings opportunities

Basic stuff, right? However an error in judgement stems from assuming all cycles are the same.

Here are some key comparisons between the current cycle to the most recent peak in 2014:

  • Duration – 2014 accelerated growth was over in one year, while 2017’s accelerated growth is now into its second year with no definitive peak in sight (August 2018 shows potential but so did Q1 2018).
  • Severity – in 2014, Spot Premiums moved 28% over contract rates in 18 months with a much more delayed impact on contract rates, and in 2017 Spot Premiums moved 35% in only 11 months concurrently as contract rates increased +10% with no delay relative to the spot increases.

What this means is that not only are spot premiums significantly elevated, but on a rapidly increasing base of contract rates! This effect makes budget targets impossible to hit. So with that in mind, let’s talk further about spot.

Spot market “tail,” wagging the contract rate “dog”

It is no secret spot rates are indicative of failing route guides. Why do they fail?  Demand or supply? It is somewhat irrelevant as to the source of the issue, the impact is the same – increased spot volumes means higher contract rates for shippers. There is a direct, measurable relationship between the outcome of contract negotiations and the rise and fall of the spot market.

You can think of the spot market as an arbitrary maximum price driven by route guide failures and out of cycle rate changes that set the tone of all new negotiations – when rates increase consistently across the country as they have now (vs. seasonality by latitudes driven by produce) – rapid comprehensive increases represent the initial stages of economic expansion.

What our data reveals is that the influence of spot rate premiums exist regardless of past contract increases. If you took a 10% increase in last year’s bid, the only hope for holding flat or decreasing rates is a falling spot market. If spot remains elevated to +30%, it will continue to drive your contract rates up as a shipper. So how can spot premiums help identify peaks and troughs in the business cycle?

Spot rate premiums roughly at or below 5% reflect troughs, aggressive growth cycles roughly begin when spot rates exceed 20% over contract rates. In the last year (Sept. 2017 to Sept. 2018), we have witnessed 15 weeks of spot premiums over 40%, and a whopping 47 weeks over 20%.  The point here is that regardless of how much contract rate increase you have sustained in 2018, the spot market dominates the price of new contracts. And as long as the spot premiums exist, negotiations will favor stronger pricing in the carrier community. However a rapid downward change in spot rate premiums yield far easier negotiations for shippers – they change rapidly within weeks.

Sell-side hubris in extreme conditions…

Why should carriers curb their enthusiasm? Well, shippers have been in a tough spot. And in periods of extreme accelerated growth (both in severity and duration), these individuals have been through what can be described as a “career event” unlike any experience in the last 10 years.  

…Leads to buy-side hubris in softening conditions

The imminent slowing growth phase will be markedly different than the same phase in 2015.  Shippers maintained greater bid cycle discipline in 2015 because the accelerated growth phase was less extreme and somewhat more related to supply constraints (snow, rail congestion) vs. structural economic expansion. In short, 2015 was a more traditional retraction. We have yet to witness the post-peak phase for the current cycle and believe it will be far different this time because individuals will be highly incentivized to aggressively prove their value to their shareholders. Fresh memories of aggressive out-of-cycle rate increases driven by the carrier community only solidify the case for immediate action. Many shippers I have spoken with regret their prior discipline in sticking to annual bids – it bought them zero benefit in the current environment. This is a new development and should be noted that the coming game for many will be played on a different field, with different rules.

What to watch

FMIC is always good start, but if are you looking for free information, GDP seems to be tracking well in this cycle, and will likely be a harbinger of post-peak demand changes. However, I don’t trust GDP in the long-term because it can lack consistency. I also like the PMI Composite Index. It shows a strong correlation to spot and contract changes – values in the high 50s and 60s are indicative of high performing economy – and it is much more consistent in the long-term. Both can be found on the Federal Reserve website (FRED) among many other key indicators.

Peaks and troughs in fact yield insights to a slow moving cycle many months in advance

I also periodically review past information and the archived questions I receive from our customers regarding future expectations in an attempt to answer the question: How can we use the past to see the future? The most interesting time for me was 2016 Q3. With the looming election, a slightly oversized capacity profile, and shippers easily hitting budgets, one has to ask, “What, if anything, could have helped shippers prepare for 2018?” That is a tough question to answer, but one fact was clear. The bottom that was 2016Q2 was easily identified, there was no direction but up, yet many shippers were in fact pressured for continued reductions as if rates were infinitely compressible. Rates, in fact, operate like a spring in a mousetrap. You can lever it back, but at some point, with the right trigger, it will snap back somewhat painfully.

In closing

If you are a shipper: The spot market is not showing any signs of serious abating…yet. There is August relaxation, but premiums are still elevated. If we can establish a peak by end of year, it will signal an easier 2019. If you can use this information to get a little reprieve for 2019 budgeting, a correction on rates may offer easier budget targets. I thinking planning for the worst case is a better strategy because this cycle is simply different than previous cycles. Preparing for the worst does not mean it will materialize!

If you are a carrier, you are well aware that our economy will get a bigger fleet due the extreme accelerated growth cycle currently present, it is just a question of when. While most of you have no incentive (or ability) to rapidly expand your fleets with increased labor, it will happen. 2018 has been a great year indeed but our economy can’t grow aggressively without your investment in people and equipment. It can’t come soon enough.

For all, forged partnerships are only meaningful in times of duress, don’t misuse your partnerships, or they too can become mousetraps. I have seen examples when both sides fail the partnership equation, and contrary to procurement creed, long-term relationships really do matter in this business and we definitely see that in the data!

Matt Harding is vice president of Chainalytics’ Freight Market Intelligence Consortium (FMIC). Chainalytics’ FMIC provides strategic freight market intelligence, benchmarking and comparative analysis to its members in a private forum.

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