November 2019 Volume 1

ECONOMIC UPDATE

FIA Quick Read Economic Update By Christopher Kuehl, Ph.D. Cut in Capex Spending Tell-Tale?

could fall more than 37% Y/Y. Domestic Economic Issues The Black Owl Report: An Executive Intelligence Brief Confidential – Armada Executive Intelligence Brief – Confidential - 3 - Wolfe Trahan (www.wolferesearch.com) predicts that Class 8 production and output will drop from 2019’s estimate of 348,000 units to less than 220,000 next year. There is a combination of factors at work here. The transportation sector has certainly been in a secular recession over the past two quarters. Overblown inventory building activity as companies worked to get ahead of tariff risk has led to some stagnation of the reorder cycle and slowing of supply chain activity. We’ve written much about it. However, trucking firms are reducing their capital expenditures as mentioned prior, and that’s showing up in a reduced volume of Class 8 orders. There was also a manufacturing backlog with orders from last year and many companies took steps to work around it with newer used truck purchases or delaying new orders until backlogs were worked through. Lastly, there’s just a lot of uncertainty about what next year will bring. In many cases, we could have a much more robust economic environment for the transportation sector if we get strong sell-through during the peak retail season. Inventory rebuilding activity would boost everything from transportation activity to manufacturing, rawmaterial demand, etc.The flip side is that global economic weakness continues, and we see continued deceleration. If that’s the case, then the transportation sector will swoon along with everything else. Rig Counts Still Dropping The Saudi Arabia oil supply news faded fast. Oil prices remain elevated based on global demand (which is weaker) and a strong US dollar (which normally pushes oil prices low), but the geopolitical premium on the price-per-barrel is slipping. There’s also something else at work that is a bit more dramatic. Watching the Baker Hughes rig count summaries, there’s a noticeable decline inNorth American rig counts taking place (and it’s been this way much of the second half of the year). US total rig counts are down 216 from a year ago, Canada is off by 48. The big question is how much new investment and spending is still taking place, is hiring still happening, and what’s the outlook? When we look at the rail sector, petroleum is still its number one performing commodity group this year. Petroleum shipments are up 15.9% year-over-year through week 41 according to the Association of American Railroads. Demand for US petroleum seems strong. Globally, supplies are still being hampered in a few countries. Venezuela has become chronically impacted with very little output. It will take some time and a regime change before it comes back online. Iran and Russia are still under different levels of sanctions. Libya, Nigeria, and other smaller producers are being hit from time to time with terrorist and civil war activities that restrain output. Saudi Arabia is essentially back at full output (by

We can talk all day long about a strong consumer and how the fundamentals of the economy seem strong; but there also comes a time when momentum starts to take over and a wave of corporate moves begins to shape the US economy, and it will take a significant event to reverse that course. There was a small blip in an earnings release yesterday that caught our eye. Not to single out a company, but this one has a bigger impact on the broader economy. UPS reported earnings and they had a nice little beat on Q3 earnings. But buried down in their release is part of their go-forward plan for next year. Because of what they see as a global economic headwind and slowing US conditions, they have cut their estimates on capex spending by $500 million next year. UPS is not alone. When you look at current capex spending, we see the decline as a broader trend across the US corporate sector. Corporate spending was down .4% Y/Y through August. Money is still cheap to get, many companies are sitting on large amounts of cash, and most industries have less than 35% of their firms investing in advanced analytics and automation. So, there’s nothing holding investment back…except fear. The term “animal spirits” ties back to 1936 and John Maynard Keynes and it helps explain some of what drives actual financial decision-making. Some people can be confident in their future and still not spend. Some are depressed about the future and still spend. Animal spirits conjures up the notion that there’s a series of factors that lead to confidence; confidence that leads to actual spending. For now, even if businesses see the underlying fundamentals of the economy and see that they are strong, they are pulling back on spending regardless. There’s an element of fear that has them moving tepidly forward. Perhaps some sort of resolution on Brexit and perhaps a few tentative trade deals will release enough tension that investment and spending will take back off. It’s a wait-and-see game.

Staggering Change in Class 8 Truck Orders. If you watch large truck orders (Class 8’s), there has been a significant drop-off in those orders. For the first time in more than 29 months, Class 8 orders dipped and went negative in September. The outlook for 2020 might be worse, with some forecasts suggesting that orders

FIA MAGAZINE | NOVEMBER 2019 21