High inventories to dull, not destroy intermodal peak season

BNSF1_0Not since the Great Recession has the inventory to sales ratio been as high as it is today. Even in 2006, when upwards was the only direction, the inventory-to-sales ratio wasn’t this high. So either a correction is necessary, or something has changed to allow such a phenomenon to persist. Already a slight slowdown in freight has been observed, and documented extensively. Trucking and intermodal rate growth has softened. Beyond the numbers, several observers of the industry have commented on a reduction in demand. The freight industry has hit a mid-year lull.

The reason we are here is all over the news. Poor trade volumes, combined with and in some part causing turmoil in China, have roiled stock markets. This has put pressure on consumer spending; as wealth disappears increased saving is a typical response. Lower oil prices were supposed to increase consumption, but it now appears consumers have simply banked the savings. Both behaviors by consumers have caught businesses off-guard. The standard economic symptom of a surprise in consumption is a significant change in inventories, and with non-farm inventories gaining in near exact proportion with declines in sales this summer, it would appear business had not an inkling.

Inventories are a primary driver of near-term freight conditions, and the impact has been noted. Intermodal growth this year has been the slowest in five years; will intermodal follow the trajectory of the rest of the freight industry and finish the year in a deceleration?

There are several reasons to believe that while the global economy faces headwinds, intermodal volumes will likely be largely unaffected. Chief among these is that while saving has increased, spending is still growing in spite of increased saving.

Fundamentally, the U.S. economy is strong relative to the remainder of the world and this has pushed up the value of the dollar. As volatility increases investors buy safer assets, U.S. assets, and this drives up the dollar. Increased savings, reduced oil imports and tightening monetary policy all put upward pressure on the dollar. The effect is an increase in the buying power of U.S. consumers abroad, spurring substitution of domestically produced goods for foreign ones. The majority of intermodal container traffic stems from imports. Even as U.S. GDP growth slows, growth in the share of consumption that is imported has taken up the slack, leading to large growth in intermodal container shipments this year, port strikes aside. These headwinds to the global economy are backwinds for intermodal, as it heads in the opposite direction of the global economy.

This is not to say that intermodal is a fortress. Container volumes are closely correlated with U.S. GDP. The IHS first-quarter forecast called for the slowest intermodal container movements growth since 2009, and this is surely correct. Low oil prices have made trucking more competitive and weaker manufacturing growth has reduced overall demand. Further, trailer loadings have been reduced as parcel shippers and trucking companies relocating empty trailers rely increasingly on tractors instead of intermodal platforms due to lower oil prices. But the largest segment, international containers combined with transloaded domestic containers, intermodal movements stemming from imports, continues to grow robustly.

The segments of the economy that are most closely tied to intermodal shipments have the healthiest inventory levels. Retailers overall saw a 4 percent increase in inventories in July, accompanied by a 2.3 percent gain in sales, leaving the inventory-to-sales ratio at 1.4 compared to 1.37 last year. Manufacturers saw their inventory-to-sales ratio gain 0.6. The story becomes clearer when looking at inventories by the kind of business. Furniture is the largest containerized commodity group imported, and furniture stores show a decline in inventories from last year.

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