TranSystems Transportation Activity Index, July 20, 2010



Commentary:

What Early Stage Earnings Season is Telling US

The US market is in the heart of earnings season for the second quarter. There is one thing that is obvious about the markets: they thirst for information. Markets react primarily to solid economic data released periodically from reputable sources. But during earnings season, there is an interesting desire by the market to look at the specific trends emerging from companies that are truly “in the trenches”. With some of the benchmark companies reporting earnings already this season, there are some emerging trends that we should all take note of. The TTAI illustrates some of these trends.

General Comments:
As we see in the TTAI, there are some metrics across transportation and industry sources that should give us all a bit of caution. For June and July, there has been a “softening” of activity that we warned would be coming. To put the problem in its simplest form: primary consumer demand for products is still weaker than it should be. Inventory building over the first six months has led to a new round of conservatism in the marketplace and especially with those that purchased goods early on and have seen their inventory levels grow. This has created the soft patch mentioned earlier - and several reactions are occurring:

• Corporations are now starting to hold off on capital expenditures till volume resumes strongly – the exception seems to be some investments in updating computer equipment to new dual-core processors.

• Consumers have started to go back into a conservative holding pattern – affecting primary demand for goods.

• Housing markets are still slowing.

• Inflation is in check and deflationary pressures have seeped into some markets – suggesting that retailers and wholesalers are getting nervous about inventory levels and are starting to discount products to fuel new sales growth.

Since the transportation markets (both passenger and freight) are driven by broader economic conditions, it is important to understand where things are headed (to the best of anyone’s ability). There are several different items to watch as we move into the fall:

1. Port warnings: the nation’s ports have warned the transportation sector to expect a slow-down in the fall. Many analysts are questioning whether the current growth rates and tight capacity conditions can be maintained through the fall given some of the information being reported out of China on slowing exports and US manufacturing activity that seems to be slowing. There are additional bits of information coming out from the rail and trucking sector that also corroborates what the ports are conveying to the market – that the inventory building process thus far in 2010 may be met with struggling demand – throwing some weakness into the market in the latter part of the year.

2. Earnings are strong but the warnings are clear: Several major blue-chip companies have reported earnings and the trends seem to be the same: strong profits for the second quarter but lagging top-line growth. That tells us all a few things worth noting:

1. Companies continue to do a good job of managing costs into a tough face-wind.

2. Until they see strong top-line growth, companies will be reticent to try and hire new staff or take on aggressive growth activities.

3. Uncertainty over tax burdens and changing regulatory environments are making it difficult for companies to plan into the next year (health care, banking reform, and potentially environmental legislation uncertainties).

4. Unemployment still very high: As we get new unemployment figures from the government over the next several weeks, analysts believe that the unemployment number may actually go down. But, there is a significant footnote to this fact. Many disenfranchised job seekers are finding ways to permanently leave the job marketplace. In other words, fewer people are looking for work and more are “just staying home”. The “effective unemployment rate” (which includes the unemployed, underemployed, and those that have quit looking for a job) is still going to be in the 17-19% range. There is discrepancy on how high this number really is – it is difficult to actually track. High unemployment will continue to create a problem for the broader economy because it affects nearly 70% of US GDP and corporate spending can only fuel so much. Eventually corporate spending must be met by increased customer spending (consumer spending in disguise). Consumer spending is still much weaker than pre-recession levels.

There are conditions in the marketplace that could allow us to go on about the warning signs that are still around us. And, to be fair, there are a significant number of elements of the broader economy that are improving. What is important to understand is that there are several key drivers of most economic activity – and especially those that impact transportation are limited to just a few. As we look at those elements, we see warning signs for the second half of the year (warning indicating that the recovery is likely to flatten or stall). If the current economic cycles continue, growth is truly around the corner. The market simply needs to capture some momentum in the right areas.

For transportation, the story is one of tighter capacity which is helping pricing stabilize, but not a tremendous amount of growth involved. Given the corporate “right-sizing” (borrowing an eighties and nineties term) of the past two years, companies are profitable at these levels – there just isn’t a lot to get excited about on the growth side of things.

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