Mr. Larkin: Essentially, we are in the fifth year of the freight recession. It started in 2006 and became quite acute in the third quarter of 2006, when the housing and automotive industries fell apart. Some of the pain was masked during the second half of 2007 and into 2008, when we had a bit of an export boom. The U.S. dollar was weak, but Asia and Europe were still moving along at a solid clip, as they had yet to figure out that they were not decoupled from the U.S. So things began to perk up at the end of 2007 and beginning of 2008, but that was a bit of a head fake. Then some of the largest financial firms, including Bear Stearns, Lehman Brothers, Merrill, etc., had all sorts of problems in the second half of 2008. All the growth we had temporarily seen in late 2007 and early 2008 came to a halt, and we came perilously close to falling into a depression. But TARP and some of the other actions taken by the Fed enabled us to barely miss that.
Freight volumes in the first half of 2009 completely fell off the cliff, down 20% to 30% from what were not terribly high numbers to begin with. We then began to see a little bit of a rebound as we moved into the second half of 2009, and that has carried forward into the first half of 2010, with some analysts believing that this is just going to be a linear, straight-line expansion. Our view is that there are a number of one-time items that are making things a little bit better than they otherwise would be. Those items include stimulus programs, such as Cash for Clunkers; the $8,000 first-time homebuyer credit; the discount rate being close to zero; all of the liquidity that the Fed has pumped into the marketplace; the $800 billion stimulus program, etc.; all of which propped the economy up. As we get out into the second half of 2010, and as we withdraw some of the stimulus - and as people begin to realize that the unemployment rate is still hovering in close to 10%, and begin to realize that there are tax increases embedded in the health care reform law, and begin to realize that the Bush tax cuts are about to expire - it's not clear to me that we're going to have a straight shot up economically.
Interestingly, over this five-year freight recession, for the first three of the five years, the transportation stocks performed brilliantly during the first half of the year, only to give back all their gains during the second half, as the second half of the first three of the five years was actually worse than the first half. A weaker second half almost never had happened historically because you've always had the big surge in freight in anticipation of the holiday season. Last year, the second half was better than the first half, but I think that was more a function of the fact that during the first half, we had auto plant shutdowns, housing flat on its back, consumer savings rates increasing to 6% or 7% and unemployment rising, so the economy was virtually shut down. The second half last year was a little bit better, and that has continued somewhat into the first half of this year. However, volumes are still 10% or 15% below where we were at the peak.
The stocks are behaving as if pricing power is going to shift from the shipper over to the carrier almost momentarily. While we have seen some improvement in spot prices, our channel checks, which are extremely extensive, suggest that contract pricing, which is how most of the freight gets priced, is still very competitive. And in fact, rates, i.e., pricing, are down another 5% to 7% this year on top of all the previous years' decreases. In this industry, where margins are thin to begin with, that's problematic. The sectors that are undergoing the pricing pressure are the truly competitive sectors, which are truckload, intermodal and less-than-truckload. The areas where there is more of a monopoly, or duopoly or oligopoly, situation, i.e., the railroads - particularly in the carload business, and UPS and FedEx - prices in those areas have held up quite a bit better because they generally don't get into price wars with competitors. Many of their customers have limited options. There's not as much competition in those sectors as in the truckload sector. In truckload, there are hundreds, if not thousands, of carriers that can handle loads.
We at Stifel Nicolaus have very few companies rated "buy" at the moment, and that's in contrast to where we were a year ago, when we had almost all of the stocks under our coverage rated "buy." Some of these stocks have doubled, some of them tripled, and the odd stock or two maybe had quadrupled over that period. We think that a bull case from here is discounted into the stock prices and, as I said earlier, it's not clear to me that the bull case will actually pan out.
Tickers included in this excerpt: CHRW, CSX, FDX, FWRD, HD, JBHT, LSTR, NSC, UPS, WMT
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