“IN LIKE A LION, out like a lamb” is an apt description for 2022 as the year began with incredibly tight trucking capacity, global supply chain challenges, abnormally low inventories and shortages of raw materials and components. As 2022 concludes, fundamentals are weakening, causing angst for financials markets and consumers. And while the overall supply chain is still not back to normal, trucking capacity is loose, inventories in many industries are close to being in balance (especially retail and CPG companies, where arguably there is too much inventory) and various prognosticators are worried the Federal Reserve Board will induce a recession.
Factors that drove much of the 2021 through mid-2022 strength have abated, including the “retail therapy spending cycle,” consumers flush with abnormal amounts of liquidity, and slowing inventory replenishment.
So what are the pertinent things to watch as we head into 2023? We believe three areas bear the most scrutiny in terms of their freight creation impact: housing, inflation and corporate capital spending.
Housing. With rising interest rates, housing has not only lost momentum, but an outright correction is underway in many markets. Several years ago, the ATA estimated that for every new house, approximately eight truckloads of freight are needed—everything from building materials to furniture.
How much will housing correct?
Housing has two end markets: new housing [starts] and existing home sales with both markets similarly impacted by demand, prices and affordability. In 2022 housing starts were about 1.6M units and 2023 may see starts fall 13% to 18% or 1.3M to 1.4M units. However, a collapse like that of 2008-2009 is a long shot-at best.
First, the housing boom preceding the great recession was built on a proverbial house of cards, i.e., lots of subprime loans, inadequate capital bases at banks and flimsy lending standards, among other factors. The result was that from peak to trough housing starts fell 73% from over 2.0M units to 554,000. From 1959, when the Federal Government began to track housing statistics, through 2007, annual housing starts averaged 1.55M units and never fell below 1.0M units. Yet for six straight years (2008-2013) annual starts were below 1.0M units each year. And even though starts have been over 1.0M units since 2014, the 13-year average from 2008-2020 was just 984,000. Since 2008 we estimate that total housing starts have been underbuilt by nearly 7 million units, while single-family homes have been underbuilt by 4M to 5M units.
Second, financial parameters around housing today are much healthier. Currently 65% of all mortgages are to buyers with a credit score of 760 or more compared to 25% in the great recession and just 18% of loans are to those with a credit score under 720 compared to 50% previously. In terms of subprime, just 3% of mortgages today are subprime compared to a 13% average from 2003-2007 (with a peak of nearly 20% in a couple of quarters). Also, banks have boosted Tier 1 and Tier 2 capital in the last decade to better withstand delinquencies and defaults.
However, affordable housing is a huge issue and will impact 2023. From August 2021 through June 2022 existing home sales fell ∼3% to 6% year-over-year most months. But with mounting interest rates, existing home sales fell 20% year-over-year in both July and August. With the 30-year average mortgage solidly above 6% now, compared to 2.65% in January 2021, affordability has become an issue. A 6.4% 30-year mortgage on a $340,000 loan is now $2,126 a month in principal and interest compared to barely $1,400 when the rate was 3%. During the great recession median home prices fell 19% nationally, while a correction of 5% to 10% is likely in the next year.
Housing summary. Housing, both starts and existing sales, have already started a correction that may last into early 2024, but it should be a more “normal” correction rather than the crash that occurred in 2008 and lasted a decade. New starts are likely to be off 15% to 20% and median prices are likely to decline 5% to 10% compared to over 19% last cycle.
Inflation and wage growth. The second critical area will be inflation’s impact to consumers, both wages and purchasing power. While many workers are getting some of their highest raises in years, purchasing power is declining as inflation-adjusted real average earnings have fallen 3.2% in the last 12 months. Consumers initially had ample cushion to absorb a loss of purchasing power as savings rates were very high, credit card debt was at a multi-year low and home equity lines of credit (HELOC) balances had been falling for over a decade. But those trends have reversed with credit card debt growing at the fastest pace in 20 years; HELOC balances are rising for the first time since 2011; and the personal savings rate of just 3.5% is down from over 9% less than a year ago and is well below the 8.2% level in the two years before the pandemic.
Inflation erodes purchasing power, and it’s not just the headline numbers, so often impacted by energy costs. For example, inflation for repetitive purchases such as eggs (39.8%), coffee (17.6%), soup (18.5%), butter/margarine (29.3%), milk (20.5%), bacon (9.0%) and fish (8.7%) are all above headline numbers, while utility bills for gas (33.0%) and electricity (15.8%) are also taking a toll.
With Americans scrambling to keep up with reoccurring expenses, discretionary spending will weaken on items like electronics, furniture, appliances, sporting goods, etc. All of this will have a more pronounced impact upon freight volumes in 2023 compared to 2022.
Capital spending. The third big freight creation bucket to watch is capital spending. While much of Corporate America is currently going through budgeting and CapEx forecasting, we expect the rate of capex spending to slow if not decline, something that began in 2H’22. For example, in Q1’22 CapEx spending for the S&P 500 grew 21% yoy and in Q2’22 the growth was 26.9%, but in Q3’22 the growth slowed to 7.6%. Inflationadjusted the Q3 CapEx figure was negative. While 2022 full-year CapEx will end up growing about 15%, we believe 2023 CapEx will at best match the rate of inflation (meaning zero growth in CapEx SKUs) and may decline in real terms.
During 2022 companies across numerous industries had the latitude to raise prices to give substantial pay raises and to more broadly offset profit margin pressures. Yet that trend is slowing, and in some cases, starting to reverse as witnessed by public company announcements. When freight is strong and capacity is tight, strong industrial production is historically the difference between a ho-hum market and a robust market. With margins likely to be under pressure, look for modest 2023 CapEx growth, a negative for freight creation.
Overall summary. 2022 was an odd year with so much more freight than capacity early in the year, followed by mid-year “normalization,” but trends are deteriorating to conclude the year. The Fed does not have a favorable track record of engineering soft landings. As profit margins contract, layoffs will rise. Specific to trucking and logistics capacity, there will be a cleansing of marginal operators, which has already begun with micro fleets (10 or fewer trucks). Some mid-sized fleets will be vulnerable due to their inability to refresh their equipment in a timely manner. But the industry will adapt and by this time next year optimism is likely to be on the rise heading into 2024.