Full Recovery Remains Elusive for U.S. Freight Industry and Economy

Three years after the official end of the recession the U.S. economy is still plodding along on an upward course but the trajectory is relatively flat. Gross Domestic Product (GDP) growth has been at or under three percent for the last seven quarters. Unemployment is still pervasive, new jobs are being created at a rate that does not even cover population growth, the housing market still has not rebounded, and fuel and food prices have been steadily rising. Consumer spending and retail sales were up in 2011, but the purchased were skewed toward necessities, rather than discretionary goods. Consumer confidence has been on the rise, coinciding with increased spending, but consumer credit also expanded. This indicates that consumers are spending more than they are taking in again. 

Manufacturing and business spending continued to expand. Industrial production increased every quarter in 2011 and rose at an annual rate of 5.4 percent in the first quarter of 2012. Industrial production has not yet returned to pre-2007 levels, reaching 96.6 percent of the 2007 average in the first quarter of 2012. Capacity utilization is 1.7 percentage points below its long-run (1972--2011) average, at 78.6 percent. 

The recovery from the greatrecession has been difficult and is lasting longer than any other since the Depression. High inventories and slow expansion have presented another year of challenges for the logistics industry. For the U.S. freight industry 2011 was generally a better year than 2010. Volumes firmed up early in the first quarter and then flattened out. June saw a strong increase as holiday merchandise that was ordered early in anticipation of steep increases in transportation costs were delivered. Another jump occurred in August, a traditional seasonal peak month, only to plummet for the remainder of the year. Truck capacity has not yet tightened to a point that widespread shortages have been reported, but are close to capacity without a significant volume return. Reduced fleets, driver shortages, higher prices for both new and used equipment and regulations have all had negative impacts on the trucking industry. Meanwhile the rail industry stayed on course with its capital investment program, expanding track and rolling stock. Much needed rate increases were pervasive in the beginning of the year but trailed off as the year progressed. 2011 started out very strong with impressive year over year increases as shown here in the Cass freight indexes. For the first four months of the year volumes ranged from 11.4 to 13.8 percent above 2010 levels. Meanwhile freight payments ranged from 27.2 to 35 percent higher than the previous year for the first seven months. 

Lower consumer spending and high unemployment continue to hold down any significant growth in the economy. Although consumer spending has been edging up, it still remains well below the pre-recession levels. Unemployment levels have dropped, however, much of the drop can be attributed to "discouraged workers," or those that have exited the market and are no longer looking for jobs. When the economy picks up many of these workers will perceive that they have a better chance of finding a job and will return to look for jobs. This may cause a short term rise in unemployment again. New hires were stronger in the last half of the year, but are not growing at a rate which even meets population growth. In March 2012, 200,000 new jobs were added to the economy, the best showing in many months. Imports and exports were strong throughout the 2011 and this benefitted the transportation sector as well as other sectors. Imports have decreased in the first quarter of 2012, while exports increased despite the unstable global economy. 

Inventories have climbed to levels even higher than the highest levels experienced during the recession. Wholesale inventories have trended up faster than retail inventories, as retailers have pushed back excess inventories into the wholesale or supplier market. This continues the trend that inventories are now being held farther down the chain. After the inventory drawdown in 2009 retail and wholesale inventories tracked each other. In 2010, as in 2011, the economy started the year strong and led to conclusions that consumer spending would spiral up. Retailers and suppliers responded by building their inventories, but the spike in retail sales did not materialize. Manufacturing inventories have also been rising as the growth rate for manufacturing slowed in at the end of 2011 and going into 2012. After fourteen months of steady improvement order backlog and new orders dropped in March 2012. 

Trucking companies faced a stiff round of cost increases in 2011. Labor costs rose because of newly negotiated union contracts and the higher cost of attracting and retaining drivers. In addition to the shortage of drivers pushing up driver pay, driver turnover reached almost 90 percent as truckers change jobs to gain higher pay or better benefits. This trend seemed to have calmed by fourth quarter 2011 with the American Trucking Associations reporting a sharp decline in turnover rates at the end of the year. Fuel price hikes moderated but prices still fluctuate frequently. Truck sales are gaining strength, but still have not reached replacement levels; used truck prices have soared and the supply is dwindling. New truck prices, containing the new environmentally improved so-called "2010 engines", jumped substantially over the price of new trucks with the older engines, as have maintenance costs. 

Regulatory changes in place and anticipated pushed costs up yet another notch. Attrition is still eliminating industry capacity, but at a much slower rate. Capacity has tightened in many markets, giving carriers room to raise rates and to choose higher margin customers. Some carriers are reportedly turning away loads because they do not have the drivers to put in trucks. Trucking companies are becoming more selective about the shippers they choose to haul freight for and this will become a more common practice. We went into the recession with a driver shortage and with capacity constraints, and we're coming out with an exacerbated driver shortage and an anticipated severe capacity crunch. 

There is another level of uncertainty that has been introduced into the mix in the form of new regulations. The Federal Motor Carrier Safety Administration rolled out CSA in early 2011 to replace Safe Stat as the new yardstick for safety measurement. CSA is having an impact on the industry capacity and operating costs. The obvious effect is increased cost to do business to bring vehicles and drivers up to standard. A secondary effect is a winnowing out of marginal and unsafe carriers and drivers, which is further shrinking available truck capacity. The cost of hiring drivers with good records and the programs to retain them have added even more on top of higher pay and benefits. Insurance costs are being aligned to CSA scores and generally result in higher payments. Finally, CSA has added expense on both sides of the carrier selection exercise. 

Shippers are concerned about the liability issues they face hiring a marginal carrier over one with a better record and have dropped carriers in favor of a carrier with better scores. The liability risk is real. There have already been judgments against shippers and/or their 3PLs who were found responsible by virtue of failing to exercise due diligence in the selection of a carrier. Recent court cases finding the shipper responsible for a bad carrier were upheld on appeal. Easy access to CSA scores will build an even stronger case for shipper culpability. It will take some time for all carriers to repair their scores and during this time, carriers and shippers should be cooperating to ensure that carriers have needed revenue to make fleet repairs. CSA should be one of the factors considered for carrier selection. Any loss of a carrier will further cut the fleet size. A 2011 Morgan Stanley shipper survey found that 55 percent of those polled were reluctant to use a carrier if even one of its seven BASIC scores came in above the CSA threshold. New hours of service regulations have the effect of reducing the capacity in the industry by lowering driver productivity. Stiffer rules for number of consecutive hours of driving and required rest period between shifts will turn formerly one day trips into two day trips. 

Motor Carriers are being set up for the perfect storm…capacity is still leaving the market; drivers are difficult to find and keep, the truck order backlog is growing, operating costs are rising faster than revenues, and regulations are reducing the productivity of the drivers and trucks they do have. Couple this with rising freight volumes and the trucking sector could find itself unable to meet demand. 

Rail carloadings mimicked 2010 for the most part and ended the year only slightly higher than year end 2010. They still have not again achieved the industry highpoint in 2066. Rates have risen significantly and much faster than inflation. Railroads have gained market share, especially in intermodal as more medium-sized trucking companies began to use intermodal for the first time to combat driver shortages and the high cost of adding vehicles to the fleet. The Association of American Railroads reports that 2011 intermodal volume increased 5.4 percent and carloadings were up a modest 2.2 percent. The rail industry had stronger growth than any other mode during the year. Rail and intermodal carloadings have been somewhat soft in the first quarter of 2012. 

Railroads did quite well in the first half of 2011, but lagged in the last half of the year. The Class I Railroads have been reporting impressive profits since the second quarter of 2011. Intermodal has been a high performing segment for well over a year, but even that showed some weak signs, even falling for several months. Low natural gas prices, and a warm winter contributed to a sharp decline in coal loadings, the industry's foundation commodity. As capacity continues to tighten in the trucking sector, rail has been an escape valve - intermodal is an option for growth and to relieve pressure. The railroad sector is poised and ready to take on more traffic. Railroads continued their aggressive capital expenditure program and the industry is in an improved position over where it was before the recession. Significant investment has been made to upgrade tracks and facilities, such as transload terminals. New locomotives and cars have been ordered and the railroads have been hiring and training new personnel. About 20 percent of the North American fleet is still in storage. 

Air carriers have seen their business dwindle during 2011, but that was not unexpected. Their customers are faced with higher transportation costs and are opting to go with cheaper options when the can. In 2011 domestic air cargo revenue ton-miles were down over 3 percent; while international revenue ton-miles were down less than 1 percent. Despite depressed overall results, more than $400B of U.S. merchandise was exported by air – an all-time high. In addition 29 cargo jets were added to the fleet in 2011. This extra capacity led to falling load factors and downward rate pressures. Jet fuel prices and labor costs were on the rise in 2011, further stressing an already weak industry. High inventories are expected to curtail spending on air freight for replenishment, so demand for air cargo is expected to be slow in again in 2012. 

Excess vessel capacity is a serious issue for ocean carriers and has been for the last several years. New container ships are being added to the fleet every month. The trans-Pacific trade vessel capacity will increase 25 percent, pushing utilization ratios down to 87.5 for eastbound rates and 46.1 for the westbound leg. Ocean carriers have record over-capacity and some of the lowest rates since the height of the recession. Ocean carriers were operating at losses and did not end the year well. For almost two years now rates have see-sawed as rate hikes failed to stick and spot prices plummeted below cost. Service has taken some serious hits as routes were eliminated or time between sailings increased greatly. 

Most U.S. ports reported increased TEUs in 2011, but it was certainly not a banner year. 2012 barge traffic on the inland waterways followed much the same pattern as 2010 and ended the year slightly lower than 2010. The inland waterway system plagued with delays caused by aging locks and sediment build-up.

FIRST QUARTER 2012 AND BEYOND

Freight volumes have gotten off to a very slow start in 2012 and are not expected to ramp up dramatically. Volumes have been growing faster than rates in the first quarter, but not by much. Contract rates negotiated last year anticipating significant increases in 2012 has dampened the overall trend in rates. Truck spot market rates rose throughout most of March 2012 as demand rose and capacity tightened. Record high inventories and low demand has held down freight movement so far in 2012 and likely will for much of the year. Truck shipments have been on the rise, particularly at the end of March 2012. Rail carloads for the first three months 2012 were down 2.2 percent compared to the same period in 2011, while intermodal loadings were 2.4 percent higher than a year ago. 

The Institute for Supply Management's manufacturing activity index edged up again in March 2012 and at 54.3 remains above the 50 level that
indicates expansion. The Production
sub-index rose 3 percent, but a future indicator for freight movements, New Orders, was down 0.4 percent. There have been some promising signs of strengthening including:

• Businesses hired over 200,000 new employees in March
• Consumer confidence is up and retail sales are inching up
• Consumer spending has increased every month this year
• Exports are growing despite the shaky state of the global economy

On the other hand there have been some cautionary flags raised. Consumer credit on the rise, meaning consumersare spending beyond their income. Imports have been down during the first quarter. Many of the nation's ports have seen a drop in the number of containers they have processed. 

The U.S. economy is expected to continue its slow growth pattern slow growth – with GDP around or under 3 percent. High inventories are clouding the predictions of a strong peak season. While hiring is growing and the unemployed rate is slowly dropping, expect higher or stagnant unemployment rates because of discouraged workers re-entering the market place as the economy improves. The country has been operating under a series of Continuing Resolutions instead of a new Surface Transportation Budget. With two months left on the most recent extension, no agreement on the Hill, and an election coming up, do not expect much progress on this front. Under all options under consideration, a smaller budget is forecast. The global picture is not strong either; most forecasts are currently very gloomy overall. The EU – continues to have members on the brink of financial disaster; China's economy has slowed from double-digit growth to about 8 percent. 

Looking ahead for 2012 annual logistics costs, expect inventory carrying costs to be up. Interest rates will remain low; inventories will draw down slowly, but may rebuild at year's end; warehousing space is still available in most markets, but expect higher rents; and insurance rates will remain relatively stable. The inventory to sales ratio is an indicator of the health of inventory management. The ratio has been flat at 1.27 for almost five months, meaning there has been little progress in reducing inventories which have reached pre-recession levels. Inventory management techniques are improving and these practices are likely to be some of the major lessons learned coming out of the very trying period we have endured for almost 5 years. 

Transportation costs will accelerate during the year, even if there is only modest growth in volumes. Truck capacity will continue to tighten; the driver shortage will persist at least through the end of the year, but turnover rates will drop and stabilize; more companies will consider or move to the asset light model; companies will add brokerage divisions as a new major sources of profit; and CSA and hours of service regulations will push up costs and reduce productivity. Rail will have no capacity problems; will continue substantial capital investment to improve throughput, and eliminate the height restrictions to double-stacking on the eastcoast; rates will go up; intermodal will outshine traditional carloads as more traffic moves to intermodal. Ocean rates will continue to be volatile. Carriers are returning ships to service and will have abundant capacity, but their schedules and service levels may not reflect that. Ocean carriers have been experiencing losses for several years and should begin to tighten up on contract and spot rates. Service expectations probably will continue to be a sore spot with shippers. Container ships should pick up by mid-year. Domestic inland waterway traffic should continue to rebound with an increase in rates, but navigation will remain challenging in some spots on the network. The forecast for air cargo is gloomy at best; there will be extra capacity reducing utilization ratios.