Macroeconomic Monday® Special Edition - Watch the Debt

I have read two major books recently on the economy - one old and one new. Both appear to be seminal books on what drives economic booms, busts and panics.  The two books are:  1) The Makers and The Takers: The Rise of Finance and The Fall of American Business by Rana Foroohar. 2) Manias, Panics and Crashes: A History of Financial Crises by Robert Z. Aliber.

The theme of both books is excess debt plays a huge role in the build up to any recession (or worse, depression).  The cycle goes something like this:

1. Recovery begins through stimulus or some other external event (think war spending).
2. The cycle takes off and should become self sustaining (Although we never saw that this cycle)
3. Eventually it starts losing steam. In order to keep it going, we need to incur higher and higher amounts of debt. 
4. In order to keep the higher debt going,  we have to allow sub-prime to participate. Not only does debt go up but debt quality goes down. 
5. Eventually, defaults begin.
6. People begin hoarding cash and spending less as they fear the economic downturn.  This causes  more defaults as layoffs begin. The downward spiral begins. 
7. Voila!  Recession or worse and then we start all over again. 

This has been the case for hundreds of years (despite people wanting to go back to the "good old days",  hard depressions are less harsh now and certainly less frequent).  As we see freight volumes going down and with that, freight rates going down, I have to ask, are we starting to see this cycle in its later stages?  Certainly, we are at the tail end of an expansion but what does the debt data tell us?  

In this and subsequent editions of Macroeconomic Monday® I am going to attempt to explain where I think we are.  Today, we will look at three topics:  The overall debt (Household) in the nation, the makeup of that debt and finally the quality of auto loans.

The graph the the left depicts the issue at hand.  As you can see from this chart our overall household debt is almost at pre-recession levels. Two other key points are clear from this chart:

1. The debt level relative to 2003 is incredibly high.
   
2. The amount of debt due to student loans has grown exponentially (yes, this is a big problem - student loans cannot be discharged in bankruptcy and do not have physical assets behind them).

Mortgage debt is still inflated and the very interesting part of this chart is the growth of auto loans. The key part to this, as explained in the graph below, is more and more auto loans are made to the sub-prime sector of the economy. 

This graph shows more detail on the auto sub-prime loans (When you see your friend get that new BMW, you have to wonder where the money came from).  You can see that auto sub-prime really telegraphed the previous recession and then people clamped down on their borrowing to right their personal balance sheets.

However, really since about 2011 this has changed and the sub-prime borrowing started taking off again. This was almost fully due to automobile companies needing to keep the "post recession party" going.  

So, our first lesson is pretty clear, and stark.  Personal debt is growing and total debt is almost at the pre-recession levels. For one of the biggest and riskiest categories (auto loans), sub-prime debt is increasing. Finally, student debt, which stops or delays household formation, is clearly at unsustainable levels.

Following our guidance in the two books I mentioned above, this is the "brake" on the economy which never lets the flywheel turn on its own.  It is also why markets go into turmoil every time Janet Yellen even remotely mentions increasing interest rates. This brake is why freight volumes are down, we have over capacity in transportation and rates are starting to plummet.  If people do not buy, companies do not make and therefore freight capacity exceeds volumes and rates go down. It is that simple. 

So, the next time someone says to you "things will get better next year", remember the debt story. They cannot get better when more and more money is going to pay interest on debt incurred for items already purchased.  And, of course, this is why you are seeing negative interest rates as central banks realize that is the only way to fight this.  But, more on that next time.  

Another Year of Dashed Hopes for Trucking

Well, another year starts off with the "this is the year for trucking" story and it is starting to look like it is another year where it is going to fizzle.  I am traveling a lot this week so it will be tough to get into the details here.

Having said that there are clearly two big data points.  As the Wall Street Journal pointed out in an article titled "Trucking Stocks Tumble on Downgrade, Pricing Outlook", the bid season has not gone well for truckers.  This generally means there is excess capacity and that is driving lower prices.  An interesting quote (which blows apart the "shipper of choice" boloney over the last few years) is the following from a Stifel report lead authored by John Larkin:

"Many shippers have effectively elected to toss to the wayside any talk of partnerships, relationships, cooperation, collaboration, etc.,” the report read. “Shippers are under enormous pressure to cut transportation costs and seem not to be satisfied with the massive fuel surcharge reductions racked up over the past year and a half.”

If you don't believe that then use the trucking companies' actions to tell you what they think.  FTR reports Class 8 Orders at Lowest Level since 2012.  Having worked in the trucking sector I know as soon as the trucking executives see a prolonged slowdown the first thing they do is cancel truck orders.

Back to the future....

Class VIII Orders source:  FTR

Don't Be Fooled Again..

For those who read my last post and are not sure it is true, I refer you back to the post from November 7th, 2013 titled:  "The Fear Trade Picks Up Steam... Don't Be Fooled".   Same story from the carriers and the "analysts" (who mostly are just talking their book) just years ago. 

And, since it is starting again, I think a great rendition of "Won't Get Fooled Again" is in order:

State of Transportation - XPO Logistics

I have reported on XPO logistics  (Follow this link on XPO to see all my thoughts) a lot as it fascinates me how a company comes out of nowhere and becomes so large so fast.  It also amazes me just how much money a company can lose and still be wildly successful (think Amazon.com).  But, since I am not a financial person I trust Bradley Jacobs understands these financial rules and is using them to his advantage.

The real reason I listen to their calls every quarter is no CEO I know of is as honest, direct, and has as much just common sense as Brad Jacobs.  I had the pleasure of meeting and talking with him a few weeks ago and for someone who has done as much as he has, he really is a down to earth person who knows this business well (especially for someone who is relatively new to the brokerage business) and, something that is refreshing, he is very upfront and honest.  So, listening to what he has to say about the industry is very interesting.

On this quarter's conference call he said three things which really were insightful on the market and match what I have said relative to telling shippers not to engage in the fear trade.  Here they are (Paraphrase):

1. This is a lousy business environment for brokerage companies due to the fact that shippers do not have much of a problem finding trucks.  The reason for this is the market is balanced at best case (for transportation providers) and may even be edging to the shipper.  The shipper has no problem finding trucks (except for unique and specific lanes). 
2. XPO is able to find trucks and is able to "clear their board" relatively early in the day so it is pretty clear that trucks are available.  
3. This is probably the most important: When he was asked if he is seeing any issues with Hours of Service or other regulatory issues he clearly said no.  In fact, he said that the one thing which he hears most is just the transportation companies complaining about it.  

My mind is not made up on brokerage in general or XPO for the long haul.  I still wonder why good transportation departments need a "middle man" but I know there are reasons - I always think of them as back up capacity - but people do use them for their core transportation.  The dream of the internet was to eliminate the "middle man" yet in this space the middle man seems to be growing.  

Having said all that, I listen to the XPO call every quarter as you can learn a lot about what appears to be a strong emerging company and the industry in a very straightforward manner. 

The Fear Trade Picks Up Steam - Don't Be Fooled

One of my favorite songs from childhood is "Won't Be Fooled Again" by The Who and this is my theme for what I have called the "fear trade" in transportation.  This is the time of year when people put their freight out to bid and as expected, and right on queue, some of the major transportation providers are putting out press releases and other statements to start the fear trade - make shippers fearful that truck capacity is magically disappearing and that trucking companies are suffering.

As reported in LogisticsViewpoints, both Schneider and Werner have, on queue and somewhat coordinated, put out press releases and statements saying there is a big problem with capacity, productivity is down and the big bad regulations are making it hard to run their business.  This will, I predict, be echoed by many others over the next few days.  All while earnings at the best run trucking companies are better than they have ever been and OR rates are at record levels (the REAL data in their annual reports).

These statements, of course, are designed to create the fear trade and to get the shippers to buy into a "fear premium" as they go into bid season.  Now, for the real data:

Using CASS data from the October report we see that both expenditures and shipments are down year over year.  In fact in 7 months of 2013 we have seen shipments down year over year which indicates, as CASS rightfully points out, that the economy is slowing and the shippers are finding alternative ways to deal with transportation problems (i.e., network redesigns, packaging, better inventory management etc.).  During these turbulent times it appears shippers have rolled up their sleeves to find innovative ways to solve transportation problems and it appears the transportation industry is issuing press releases.  The graphs below tell the story:

As I reported recently, I told my readers not to overreact to the numbers from September.  They were too strong to be sustained and if you see any other economic indicators you will know that strength was not supported by the underlying economy.  And, this month we find that to be accurate.  They were not supported.

Another interesting statement out of the CASS reporting was that for the first time since 2008 the National Retail Foundation is forecasting a decrease in holiday sales by 2.5% and this is supported by the less than robust holiday stocking.

For sure I am not saying to ignore capacity - if you claim the world is going to end and you live long enough, sooner or later you will be right.  However what I am saying is three-fold:

1.  Let the data speak.  Don't get wrapped up in the fear trade.  Watch this blog, watch the CASS information, watch macro economics and, of course, watch your own sales as a shipper.  These are the most telling indicators.

2. Look at your network and understand your network relative to freight flows.  I have said it many times that transportation is not a homogeneous network.  There are specific lanes (Northbound out of Mexico as an example) that are always under stress.  However, if you ship westbound you should be getting great deals almost always.

3. Understand that there is another side of the equation and that is demand.  Shippers have done an incredible job of productivity enhancements through packaging, product design, loadability studies, and network design which has allowed them to service their customers with higher quality goods at lower costs and lower transportation requirements.  There is no reason to think this will stop.

So, in conclusion, do not get caught up in the fear trade.  Do not think you need to pay a premium now as an insurance policy against future capacity.  One thing is for sure, capacity will flow to where the margins are and even if you pay more now it will not ensure future capacity.  If you pay a premium now you will be in a "Pay me now AND Pay me later" scenario.

Stay calm, stay focused and keep reading the data.

And now, enjoy the Who and Won't Get Fooled Again:

Application of "Signal and The Noise" to Predicting Freight Volumes

I am deep into reading Signal and The Noise by Nate Silver - This is the guy who almost perfectly predicted the outcome of the last election, state by state, while virtually all of the talking heads and big public polling houses go tit all wrong. I have not finished the book yet but so far it is a fascinating read.

So, why discuss this on a transportation, logistics and supply chain blog?  As many of you know, I am a closet forecaster.  I use my data I observe and report on in my Macroeconomic Monday feature to try to determine what will happen in the transportation markets.  I have my ups and downs and so far, however, I would say I have been far more accurate than the official transportation pundits (Magazines which are essentially paid for by the trucking industry, analysts who "cover" the industry but in reality are just trying to push stock prices up.. etc.) who have, for the last few years, reported a dramatic speed up in freight, a dramatic drop off in capacity and a huge inbalance driving rates up.  I am sure they will be right one day but for now, if you had listened to them instead of me three years ago, you would have been paying far higher rates than you should have been.

Nate Silver describes a phenomenon in the book which I think is one of the core reasons why some of my predictions have been just a bit more accurate.  The concept is that of being "Out of Sample".  What this means is people will apply previous history to future results yet they will not realize enough data has changed which causes their examples they are using to not be representative of the current situation.  So, the general belief that when the economy "heats up" there will be a problem with capacity fails to account for:

1. Growth in intermodal
2. Smaller packaging and product
3. Movement of people to cities
4. Software and collaboration models
5. 3D printing
6. The fact that more and more of GDP is not product driven but services and financial driven

And I am sure a lot more.  My point here is that those who just extrapolate previous history to the future are doomed to have a failed prediction - my predictions seem to be a bit better because I am accounting for changes the external environment and accounting for them in my models.  

To be clear, this may and most likely will change however for now I say (as I have for almost two years now) say that capacity / demand is fairly balanced and you should act that way.  In the words of John Maynard Keynes, "When the facts change, I change my mind".  I will keep my eye on the facts and will change my mind but one thing I will continue to work on is making sure I do not succumb to being "out of sample." 

What Does 1.7%GDP Growth Mean for Transportation?

This week the first look at Q2 GDP came in and the number was 1.7%.  Headlines were anywhere from "GDP Crushes Expectations" (Set  the bar low) to "GDP Hardly Booming but no swoon in sight".  The key factor for which headline you believe is what were your expectations to start with?  Personally, I am in the camp that regardless, 1.7% is very anemic growth rate, it will not solve our unemployment problem and it will keep our economy somewhat mired for a long time.

But, what does it mean for transportation?  I believe this is just another indicator to show demand is very tepid and will remain that way for some time.  Revisions for GDP growth in Q1 were revised downward which means my experience meter seemed to have a better handle on GDP than the experts (I just look around and talk to people - Q1 was clearly worse than people had said).  The Q1 number was revised down from 1.8% to 1.1%.  Last three quarters have been less than 2% growth in each quarter.

For transportation this translates into lower demand and while there may be a little bit of capacity issues due to hours of service (HOS), demand is going down faster than capacity so net-net we are at balance or, in fact, slightly over capacity.  In total we are seeing real overcapacity in intermodal as the big rush to get into that space has caused a huge container growth at the various IMCs.

The story from the transportation economists a few years ago was when you see 3% GDP growth that is when transportation rates will start going up.  Of course, they have now changed that tune since 3% isn't anywhere near possible in the near future so the fear game is on hours of service.

However, my advice continues to be:  Those who do not allow emotion, fear and "the government regulation boogey man" get to them will use real data to determine what is really happening.  They will find capacity is there, rates are steady and in some cases going down, and for the foreseeable future that will be the story.

Keep calm and be diligent about your data analysis and you will find, while low GDP is not what we want for other reasons, this is probably a good time to be a buyer of transportation.  If you stay calm while your competitors panic, you really can pick up some competitive advantage points during this period.

The Boom Box Replaced By The iPod

The anchoring continues by many transportation executives where they publish all sorts of comments that say "if" this happens and "if" that happens then prices will go up.  As you know I have been arguing for a while that while capacity has decreased what has been missed in almost all the analysis is the miniaturization of product resulting in, of course, far less truckloads needed.  

Well, it appears there is some enlightenment... albeit a bit late.  I read a comment from an industry executive who said that the ipod replacing the boom box is causing the demand for loads to decrease at about the same clip as the capacity decrease. 

The ipod was rolled out in October 2001 - it is now May 2013 -  better late than never. 

Holiday Sales Disappoint - Leading to Inventory Issues?

First, Merry Christmas and my wishes for a very happy holiday season.  Regardless of what you celebrate at this time of the year the messages all are the same: Happiness to all of you and your families!

Unfortunately, it was not a happy retailing holiday season.  As ABC and others are reporting, holiday sales have disappointed and have actually had the lowest year over year increase since 2008.  That is a haunting statistic yet not one my readers would be surprised about.  The impact on transportation can be summed up in two words: Excess Inventory.

Normally, after the holiday season the transportation industry prays for an "inventory restocking" cycle. However given the dismal sales, and the fact inventories were already elevated (as measured by the inventory to sales ratio), my estimation is the restocking cycle will not even be noticeable.   Transportation rates will remain somewhat depressed and my predictions of the transportation industry continue to hold:  

1. Rates are somewhat elevated (relative to the true capacity and demand picture) and the buyer who holds their ground should be able to negotiate good contracted rates.
2. The buyer needs not "fear" the capacity issue (which has been discussed since about 1980) until deep into 2013 at the earliest. 
3. Great rates favor those who do their homework, understand these macro trends, and are prepared to discuss them at "the table".

Going into last year, FTR predicted a potential for a 10% increase in rates which was very far off the mark.  I saw some "panic buying" (i.e, shippers accepting large increases using this prediction as justification). Going into this year we continue to hear "this is the year of the capacity crunch" and while shipping conditions are "benign", "shippers can expect to see increases in 2013" (again, have heard that since 1980).  However, the macro economic data, along with the data around the digitization and miniaturization of products, leads me to believe demand is being pulled faster than capacity and shipping conditions will favor the shipper for the vast majority of 2013.

Update 12/26/2012 10:15AM: More reports of slow holiday sales: "This Was Definitely Not A Merry Christmas for Retail" - Business Insider

The Coming Capacity Crunch. Y2K All Over Again? UPDATED: Added Former Government Officials

I must admit I do believe there is a capacity crunch coming but I am also starting to get very skeptical.  Does this sound like the "Y2K" scare all over again?  There is a cabal of vested interests in creating this scare.  Too many people are profiting from the scare. Here is my quick inventory:

1) Carriers:  By scaring the hell out of people they are trying to raise rates in advance of costs.  Carriers will say they want to raise rates to "protect capacity" but then when you look to see what is being done with that money, it is essentially being pocketed.  Driver wages have not moved one bit.  I might understand if the money was going to driver wages but it is not.  Where is it going?

2) Consultants:  Lots being built on this just like the consulting of Y2K.  Create a crisis then charge a lot of money to help solve the crisis. 

3) Leasing Companies:  The story goes that the capacity crunch is on and so you will want to look more to dedicated fleets. Voila!  We have a solution for you if you will just lease these trucks for 5 years. 

4) Trade organizations:  Their story is in order to stay in front of the capacity crunch you have to join and pay fees to attend special seminars like "What to do when the capacity crunch hits".  There are thousands of these seminars and they do not amount to much.

5) Former Government Officials:  This is the best part of the entire cabal.  There are former government officials (Link is provided as an illustration of the revolving door between government appointee then consultant.. I do not personally know Mr. Burnley) who are directly complicit in forming the laws which most likely will cause an artificial capacity constraint (i.e, tinkering with the HOS rules).  They then leave government and make a lucrative career out of consulting on how to deal with the problem they helped create in the first place. 

Unlike Y2K where the narrative was a technical issue (turned out not), this issue is purely economics.  The key question is at what point will capacity come back to the market and what will be the market clearing equilibrium price for services.  Further, what will be the alternatives and when will the costs get to the point where alternatives are used by the shippers. 

I am not saying this is not real but like most things it probably is getting very over-hyped as an entire industry appears to be building around the anticipation of the event rather than the actual event.  

I also wonder, from an antitrust standpoint, how much of this is the carrier base "signaling" to their competitors of intentions.  They clearly are publicly signaling their intention of decreasing capacity and raising rates.  Something perhaps someone should look in to.