Weekly Wisdom – May 18, 2023

By Hightower Great Lakes on May 18, 2023

Cyclical Exposures Are Reflecting Slowdown

It should come as no surprise when we say that the macroeconomic outlook remains clouded. To start, 77% of SPX companies have reported earnings per share above estimates, the Q2 Atlanta Fed GDP estimate is +2.61%, and the S&P Global U.S.

Manufacturing Purchasing Managers’ Index has risen above 50, representing expansion, for the first time since October. In contrast, the recent banking turmoil, slowing retail sales and the University of Michigan Long Term Inflation expectations reaching a 12-year high of 3.2% exemplify the challenging environment.

The broad economy is not in a recession – underscored by positive GDP reports and historically low unemployment. The many crosswinds do highlight pockets of the economy that are struggling, and the freight industry is currently reflecting recession-like conditions. Are these recession-like conditions a response to COVID-era imbalances or reflective of a more serious downturn brewing?

During COVID, demand for goods skyrocketed and freight companies were highly profitable. That trend has reversed. In the past six months, consumer ordering has slowed and companies are destocking inventory. Services continue to dominate the U.S. economy, while goods sectors are proving more cyclical, in line with the broader macro slowdown created by tightening financial conditions.

Cass’ expenditures subindex captures the total amount spent moving freight. The subindex fell -14% y/y in April, and global air cargo volumes are currently down between -8% to -10% from last year’s elevated levels. Chemicals and lifestyle products, including apparel, are leading the decline. Expenditures are still much higher than 2019.

The Freightos Baltic Index, which measures daily price movement of shipping containers across global maritime lanes, has collapsed from its 2021 peak, but remains a hair higher than its 2019 levels.

Chart 1: A Collapse in Freight Volumes and Daily Pricing¹

Is this a Mean Reversion or Recessionary Signal?

Many large global maritime shipping companies have reported stark annual revenue declines as they lap best-in-history profits. Two Taiwanese carriers reported 90%+ drops in profit, while a South Korean competitor saw a 91% plunge y/y.

These year over year comparisons do not get any easier going into the second half of the year, as profits remained elevated in the back half of 2022. However, it is unfair to gauge company performance against anomalous eras, driven by events such as the pandemic and Ukraine invasion.

In a fairer test, Long Beach April import volumes were +23% versus the February lows, and flat against pre-pandemic imports. Further, imports from March to April at Ports of NY/NJ, Savannah and Long beach were up +19%, +15% and +6% m/m, respectively. While these numbers indicate a rebound in U.S. imports, there is still debate about the durability of the increases.

Overall, the freight industry is shedding excess, which includes companies reducing headcount or shutting down. The number of authorized U.S. interstate trucking fleets declined by 9,000 during the first three months of 2023.²

Secular Exposures Are Reflecting Tailwinds

U.S. onshoring trends, tight supply environments and infrastructure policy are driving secular momentum for freight-adjacent beneficiaries.

JB Hunt (JBHT) has cited a capital plan that includes real estate, tractor and trailing capacity investments. XPO (XPO) has a capital plan that similarly includes new trailers and doors “in a market that can use more capacity and sustain growth.”

Recent rail accidents have underscored the need for continued investment into technology, safety and infrastructure. Union Pacific (UNP) “invests almost $2 billion annually back into its network to further improve safety.”

So, while A.P. Moller-Maersk, the world’s second-largest shipping company, continues to cite that it “does not yet see signs of significant recovery and risks to consumer demand remain,” there is clearly secular demand for capacity and efficiency. Beneficiaries should include suppliers and well-capitalized industry leaders.

Chart 2: Transportation Historically Underperforms Prior to Recession, Outperforms After³

Leading Indicators: Bounce From Lows, Momentum Unclear

The Baltic Dry Index is a leading economic indicator and proxy for industrial and manufacturing activity. It indirectly measures global supply and demand for shipping commodities such as building materials, coal, steel and grain.

In October 2021, following the pandemic-related aid, rising demand for goods and supply chain snarls, the Baltic Dry Index peaked at 5,650, then precipitously fell to 1,300 in January 2022. Volatility followed as COVID variants and Russia/Ukraine invasion created further disruptions.

As of recent, this index is well above its February 550 low, but still down -40% y/y and currently hovers around 1,550. There is no clear outlook for how the index will react going into the summer months given the crosswinds of rising PMIs, falling crude prices and recession fears.

Crude oil is a key factor in the Baltic Dry Index. Demand has more or less held up, despite fears, and the supply side is very matter-of-fact; crude oil inventories are historically low – plus OPEC recently cut output. Current pricing is reflecting future caution, rather than the tight market fundamentals.

Chart 3: Crude Oil Pricing Around 15-Year Average Despite Drop in Inventory⁴

A lot depends on the continued Fed policy and impact from restrictive lending. The market has performed defensively in the second quarter, with a handful of secular themes also outperforming. Tight labor conditions continue to fuel discretionary spending, yet pricing power and volumes are waning across goods sectors, enforcing the recessionary conditions across the freight industry.

Click here to read last week’s Weekly Wisdom (5/11).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

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This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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¹ Source: FactSet (chart). As of May 16, 2023.

² Source: Freight Waves. As of April 28, 2023.

³ Source: FactSet (chart). As of May 16, 2023.

⁴ Source: FactSet (chart). As of May 16, 2023.