A Bumpy Landing for Class 8 Trucks

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.)