When Richard Kaglic stood before the Cleveland Roundtable of the Council of Supply Chain Management Professionals (CSCMP) to offer his views, the senior economist for Eaton Corp. started with the only good news he had. A snow storm was rolling in. From there, it was downhill.
Quips about the weather aside, Kaglic and other “watchers” and “forecasters” are unanimous in the view that, if the third quarter looked bad, the fourth will be worse. And don't look for any real relief in the first quarter of 2009. From there, the prognosticators vary somewhat on how much and how fast we'll start to see any improvement.
In the US, talk of another economic stimulus in the new presidential term rises and falls with the economic tide. As Kaglic points out, the first half of 2008 gave the appearance the US might avoid much of the downturn. The Federal Reserve had lowered interest rates and Congress passed a stimulus package. But, the stimulus failed to achieve its goal in large part because the positive effects of putting more cash in the hands of consumers was swamped by a surge in oil prices.
“The US economy is in a recession,” said Kaglic. “It's going to be, by recent historical standards of 1991 and 2001, a fairly prolonged recession and it's going to be a fairly deep recession.” Unfortunately, he continues, other global economies are following the US down that road. Even as he was speaking, media reports were carrying admissions by Japan and some Western European officials that their countries were now officially in a recession. Even emerging economies which had exhibited booming growth — notably China — are seeing that growth slow or stall.
“Volatility in the markets is important,” continues Kaglic. “That volatility can lead to uncertainty, and uncertainty in and of itself can be a paralyzing factor. It can paralyze financial markets, it can paralyze credit markets, it can paralyze the economy.”
Looking at the global purchasing manager's index, Kaglic notes in the first half of the year, the index was bouncing around at the “50” level, indicating neither growth nor contraction. But in September and October the index fell well below 50, into the area indicating contraction. “The good news is that we are probably in the midst of the worst of it right now,” observed Kaglic. “We think that we're going to see the biggest contraction in total output in the fourth quarter. It's going to be ugly again in the first quarter. It's not going to be as ugly, but it's going to be ugly. We see a little bit of stabilization in the second quarter, and we see a slow climb out in the second half of the year.”
Exports had shown some promise in moderating the impact of the US slowdown, but that could be cut short by the fact the economic slowdown is global. Construction equipment, for example, had benefited from global expansion and a weak US dollar. But the economic slowdown has reached those nations where construction was on the rise, curtailing some of that growth. And the instability in financial markets had fueled a flight to quality investments which has boosted the value of the US dollar, leading to a “two-pronged hit” on the promising construction equipment export market, according to Kaglic.
Inventories typically account for a small proportion of gross domestic product, he continues. “But changes in inventories can wreak havoc on GDP estimates.” Looking back at the recession of 2001, Kaglic notes, a lot of people said it was because the tech bubble burst. “But, people forget there was a big inventory liquidation as well. And that inventory liquidation at times subtracted 3% off the top line gross domestic product. So it was in large part an inventory led contraction in 2001 in addition to those other factors.”
The inventory to sales ratio has been rising lately. “But the anecdotal information we're getting is, it's manageable. It's not so much an inventory problem as it is a sales problem. Sales are declining, thus the inventory to sales ratio looks bad.” But when you dig into the numbers, this is durable goods inventories and durable goods sales. “What you see [with transportation equipment removed] is a disconcerting trend,” says Kaglic. Manufactured durable goods sales have been flat or only slightly ahead for the last year and a half. Durable inventories are rising. “This does not bode well for production as we move through the fourth quarter and the first quarter of next year. Firms with bloated inventories won't have to boost production to meet demand, they will simply take it out of those inventories. That, says Kaglic, will weigh on GDP growth in the fourth quarter and in the first quarter of 2009.
Aerospace has been another bright spot in an otherwise gloomy outlook, but the situation there is also changing. The first nine months of 2008 saw freight volumes decline as well as passenger traffic. Boeing, which had remained optimistic because it had backlogs to 2012 (and it pointed out, only 10% of those were in North America) is feeling the global effect and may only have backlogs through 2009.
Follow industrial production, agrees Thomas Albrecht, managing director, Stephens Inc. Speaking before the combined National Industrial Transportation League (NITL), Transportation Intermediaries Association (TIA) and Intermodal Association of North America (IANA), he pointed out that industrial production is down 3.5% and could be off by as much as 10%, which will drive freight volumes. Joining him on a panel at the combined session, John Larkin, managing director, Stifel Nicolaus, described the US economy as unsettled and pointed to a 26-year low in the Institute for Supply Management's (ISM) purchasing index, saying it was clearly apparent in the decelerating freight volumes. Those numbers were weaker from July to August and then again from August to September 2008, he said. Companies are in a cash preservation mode, drawing down inventories rather than investing in new production or purchasing. October took a big drop, he said, and November would not look better when numbers are released. But, on a slight note of optimism, he pointed out credit markets appeared to be starting to operate again [as of mid November 2008].
Urs Durs, vice president of Lazard Capital Markets, added on a global scale that the difficulty in finding or acquiring letters of credit (or the high cost) contributed to the economic malaise resulting from the lack of credit. Many companies have good balance sheets and business plans, he noted, the economy is the issue.
The logistics industry is in the third year of a freight recession, added Larkin, pointing to the third quarter of 2006 when both auto sales and housing dropped. The situation worsened in the weeks before the panel discussion as rail car loadings fell and the dollar gained strength, slowing exports. The Morgan Stanley Truckload Index continued to indicate low volumes, said Larkin.
The recovery won't look like previous recoveries, said Albrecht. The prolonged downturn will continue to flush out capacity, he says. Lengths of haul are getting shorter. One-way truckload is going away. And the types of loads are changing.
Larkin agrees that smaller and fewer shipments are resulting from packaging changes that increase the number of items in a shipment (conversely reducing the number of shipments). Supply chain owners are looking for ways to take product and weight out of their shipments and they are reexamining their network design. “You can't build your supply chain around $1 per mile transportation,” he observes.
The three panelists said forecasts on oil prices are impossible. At best, the price per barrel of crude should stabilize around $60 or within the $50 to $100 range in 2009. They appeared to agree that the $45 level at the time they were speaking was the bottom of the market and was unsustainable. The price is likely to approach $100 in 2009 and again in 2010 and beyond. A contributing factor in the difficulty forecasting is the role of speculators. They were not a factor in the past when forecasts could be based strictly on supply and demand, noted Larkin. High oil prices with low freight volumes could accelerate capacity exiting the field, he continued. Smaller companies got a respite from the drop in prices, but as they edge back up, fuel cost will be a factor for those carriers. There is a natural process of eliminating excess, says Larkin.
But there are less-than-natural drivers as well. Lazard's Durs pointed to the “death of trade credit” causing steel making to grind to a halt. “It's not a function of demand. If credit can return, we'll get back to business, albeit in a recession,” said Durs.
Other cost factors that are not market driven include a complex series of developments at the ports of Los Angeles and Long Beach. Importers like the ports because they are located in a large consuming market, says Larkin, but there is a limit to the amount of accessorials and fees the freight can tolerate, and it will shift to other gateways. He notes Vancouver and Prince Rupert in Canada, Lázaro Cárdenas in Mexico and the expanding Panama Canal open alternatives to LA/Long Beach.
Another factor is mode shifting, but it has its limits. Container ships can slow to save fuel, but bulk ships such as tankers cannot, points out Durs. In addition, containers are easy to build, and more containers mean lower rates.
Similarly, bulk commodities are largely captive to rail in domestic transport, says Albrecht. Railroads can be more aggressive on rates and service for freight that can't convert to truckload. And more intermodal freight could start to go back to the highways in 2009, he adds.
There are limits to how much freight can move via domestic intermodal continues Larkin. This is due in part to the fact railroads have created long-haul, high-density lanes with efficient ramps on either end. Some cities won't be as competitive on intermodal, he adds.
Still, railroads will invest in corridors where they can develop shorter to medium-haul intermodal lanes, but a railroad's definition of a short haul lane does not necessarily match that of a truckload carrier. Trucks can reach 500 to 600 miles where a short haul for a railroad is 900 to 1,200 miles.
In addition, the proximity of the shipper or consignee to an intermodal ramp drives the economics, says Larkin, and if the move to or from a ramp is too complex or too far, the economics break down.
Perhaps the toughest segment is less-than-truckload (LTL) where carriers have high fixed costs and shippers have a strong incentive to reduce costs by shifting away from the mode. The focus on shorter, more regional distribution puts national networks under pressure as well.
DHL's exit from the domestic US express market will push its volumes to other carriers, but likely very little will find its way to LTL carriers.
So, from a rate and cost perspective, bulk commodities shippers and parcel shippers could have the least leverage given the fact they have fewer options. Anecdotal evidence from shippers, carriers and third party logistics providers also indicates an attitude that hammering carriers on price is a short term tactic with longer term negative consequences everyone wants to avoid. With markets across the globe contracting and a strong focus on domestic networks, the mood seems to be that everyone is being soaked by the same storm, and perhaps some cooperation is in order to ensure the greatest number survive.
Global Purchasing Manager Index
New Orders (>50 = Growth)
|Region||Aug 08||Sept 08||Oct 08|
Source: JP Morgan/Reuters
Eurozone = Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, Netherlands, Portugal, Slovenia and Spain.