Class 8 truck orders for Q4 are down 46% versus last
year. The market that looked so strong
just a few months ago, has taken a pronounced downturn recently. Production rates are falling and OEMs are
laying off thousands of workers. What is
happening, and why is it happening now?
Industry and financial experts started calling as soon as
the signs of trouble started appearing last October. I reminded people that FTR had been
forecasting a Q4 downturn since the beginning of 2015, and now it was indeed happening. The forecast was built on our Economically
Derived Demand model which is designed to predict Class 8 cycles. I also reiterated that the forecast called
for a “soft landing” in 2016.
Not So
Soft
My favorite phrase in 2015 was “soft landing.” I probably said the phrase over 100 times to
thousands of people, if you count presentations, reports, webinars, and
articles. “Soft landing” perfectly
described what was expected in 2016 and in addition, people liked to hear the
phrase because they were fearful of a market crash like 2007-2009. A relatively mild 13% decrease (for the year
after peak) in Class 8 truck build had been forecast for 2016.
Now it appears the landing will not be so soft. The latest FTR forecast is for a
19% decrease
for 2016, with the market at times operating at a rate more than 20% down from
just a short time ago. A bumpy landing,
but not a crash as of yet.
Overheating
A major cause of typical Class 8 industry cycles is OEMs
overbuilding in the upturn and then having too much inventory, which results in
a deeper downturn. The financial
community was very concerned about this happening in 2015. The OEMs had assured financial analysts that it
would be different this time. When the
financial people asked me about it, I said an overbuild was a possibility but
shouldn’t be a big issue because we were expecting something called a “soft
landing.”
But the market did overheat and now OEMs are sitting on
record inventories, which are causing them to slash production rates and lay
off workers. We’ve all seen this movie
before, and this is the part that is painful to watch. If the OEMs were trying to manage demand
better this time, what went wrong?
Warning
Signs
There was a troubling disconnect early in 2015. In Q1, retail sales were 12% lower that
production. Although fleets were willing
to place humongous orders in 2014Q4, they were not in a hurry to take delivery 4
to 6 months later. Of course inventories
shot up, but that was not thought to be a problem because the market was
considered smoking hot (due to high orders and increased production) and trucks
were expected to start flying off the dealer lots very soon.
But that never happened.
Retail sales exceeded production in only four months in 2015, and the total
net difference for three of those months was a paltry 1,600 trucks. Under normal conditions, inventories should
have peaked in Q2 and then started a linear decline. Instead, inventories kept right on climbing,
peaking in October and falling a paltry 300 units in November.
It would appear fleets overestimated the amount of trucks
they would need in the second half of the year.
This “over optimism” spilled over to the dealers, who stocked up in
anticipation of increased sales throughout 2015.
The huge order volumes in 2014Q4 were also driven by
concerns of limited production capacity which caused fleets to issue “place
holder” orders to secure future build slots in case they were needed. Many of these orders were cancelled in 2015Q4. It also appears fleets were more careful in
bringing equipment into service after the Great Recession. They placed big orders and brought the trucks
into service more gradually, as needed, then stopped adding equipment when
prudent. All this adds up to another
overbuild and record inventories.
Who
Gets The Blame?
I don’t think you can blame anyone for the predicament this
time. The OEMs received massive orders
and responded. The fleets saw a strong freight
market and the growing need for new equipment for the first time in several
years, and displayed strong confidence in the market. The dealers saw an opportunity for increased
sales and thus responded accordingly.
This is a very cyclical industry, in a free-market economy,
driven by forces mostly outside its control, operating in a strong competitive
environment. The OEMs competed strongly for all this new business, and this
competition is key. It’s similar to being in a race that you are running hard
to win, but you do not know where the finish line is. Under these conditions, you are going to run
too far every time.
Other
Factors in Play
Unfortunately, this decrease in Class 8 cycle demand comes
at a time when the manufacturing sector of the economy is faltering. The ISM (purchasing managers) Index has been
below 50 (indicates contraction) for two months, exports are weak, the energy
industry is reeling, and business inventories are bloated. Some economists are even claiming that we are
in a manufacturing recession. Of course
this industrial weakness is pushing truck build down even more than expected. Without these negative economic factors,
maybe the “soft landing” scenario would have played out.
Bumps in
the Road
Right now we are nervous because of the production cuts,
layoffs, and declining orders. However,
December preliminary orders were almost 28,000, not too shabby in an average
year. Backlogs are still relatively
healthy, but high inventories will remain a hindrance to future growth. Once the smoke clears, the market should find
the proper balance, and the runway should smooth out. We will keep on rolling, just at a slower
speed.
What
About the Economy?
A drop in commercial equipment demand often precedes a
decrease in GDP. Trucks carry the bulk
of freight in the U.S. so less trucks and trailers needed, means less economic
growth.
The larger than expected decline in Class 8 truck demand
may indicate weaker growth for 2016 compared to 2015. However, the GDP will be better in Q1 than
the previous two years, if this season’s mild winter continues.
This post first appeared on the FTR website. FTR is the leader in analyzing and forecasting the commercial transportation industry. For more information on FTR reports and services, please click here.)
