The Commercial Vehicle Market Cycles Down the Hill

Dec. 11, 2015
This economic recovery has most assuredly been slow and steady. Just look at GDP growth for the last 5 years...

This economic recovery has most assuredly been slow and steady. Just look at GDP growth for the last 5 years:
2010 = 2.5%
2011 = 1.6%
2012 = 2.3%
2013 = 2.2%
2014 = 2.4%
2015 = 2.5%

Only 90 basis points of spread over a six-year period. Of course there are fluctuations, but economic growth has exceeded 3% very few months during this time. A free market is supposed to generate a business cycle, however the business cycle has been muted coming out of the Great Recession. Possible explanations for this include:

Recessions that damage the financial system, as the Great Recession did, take longer to recover from, and economic growth is restricted for an extended period of time.

•  The recession was so severe, businesses and consumers were very cautious in spending and investing. This lack of capital flowing into the economy has slowed growth.

•  The Great Recession made businesses risk averse. Companies did not take chances that had the potential to generate big rewards; the type of gains that fuel GDP growth.

•  Interest rates have been held constant at an unnatural, 0%, rate. In a free market economy, the cost of money should never be zero.

•  Quantitative easing – the government attempts to manage the economy, and thus dampens the natural cycle.

•  Government policies which limit economic growth. The current administration greatly favors regulation over free market policies. This flattens the cycles and restrains GDP.

However, despite all the complaints about a weak, sluggish recovery, the past six years have been very good for manufacturing. The slow, steady growth has provided companies with a more stable, predictable environment. This enables producers to plan and schedule better and to operate at peak efficiencies. As long as sales are increasing, even moderately, costs get reduced due to the efficiencies and profits rise.

That is why corporate profits at manufacturing firms have been so healthy the last few years. However, the combination of slow growth and risk aversion means companies try to maximize already existing resources. This results in fewer new factories, new hires, and equipment purchases. This, in turn, impacts GDP and new job creation. Corporations have been criticized for “sitting on profits,” but this behavior is highly rational under the current environment. There is limited benefit to reinvestment, and the perceived risk still remains.

The Class 8 truck and heavy-duty trailer market is known for its large business cycles. This market is tremendous in good economic times, and horrible during recessions. It would be expected that the stable GDP numbers would have smoothed out the industry cycle some this time.

Very interestingly, it appears this is not the case. The commercial equipment market has continued to cycle up despite extended moderate economic growth. The industry has been impacted by the slow recovery. The sales gains in the early years of the recovery were modest, and this did extend the cycle. For example, commercial trailers are experiencing their record sixth consecutive year of growth (5 years was the previous record). However, the commercial vehicle industry has cycled very high, as it normally does, despite all the factors discussed previously.

The Class 8 market has been extremely hot, but has now begun to cool. Backlogs peaked in February, and builds peaked in May. Orders over the last six months are down 35% year-over-year. It was expected that the market would gradually decline into a “soft landing” and not collapse as in previous down cycles. Because, of course, the economy is still growing, so the cycle should moderate, right?

However, preliminary Class 8 truck orders were alarmingly low for November, indicating that production is going to drop faster than anticipated, especially with inventories at record levels. The normal down cycle may be in play despite a moderately growing economy.

Another consideration is that down cycles in the commercial vehicle markets often precede weakness in the general economy. The good news is that the trailer market, while peaking, has not begun its down cycle quite yet. Many economists believe that because the economy is not cycling up rapidly, the next recession, due sometime in the coming years, will not be that severe. But let’s see how fast and how far the commercial vehicle market falls for clues on the general economy.