A leasing company peer was lamenting the state of the railcar marketplace, the downward and steady pressure on railcar lease rates and the dim prospects for a 2017 rebound. The discussion turned to the topic of the seeming disconnect between the rail economy, which has been declining, and the overall economy, which continues to move forward albeit at a slower than optimal pace. Why might a seasoned leasing veteran be concerned at this anomaly?
Here’s why: Railcar loadings have always been a forward economic indicator; however, railcar loadings and rail tons have been on a decline since 2014. During that same timeframe, the U.S. economy has been growing, and unemployment has been decreasing (putting aside the discussion about members of the work force that have dropped out). In general, the U.S. economy seems stable, but there is limited growth, and current growth trends heavily depend on consumer spending (2015 was a record year for auto sales) to make up for weakness in business investment.
Here are a few quick economic stats and the changes in the past 12-24 months:
• Unemployment of 6.6% in January 2014 down to 4.9% in July 2016.
• GDP growth running at an annual average growth rate of 2.1% since the end of the recession—the slowest expansion pace since 1949.
• Industrial production over the past 12 months remains slightly lower at a decrease of 0.5%. Manufacturing output has increased by 0.2%. Economic watchers suggest that manufacturing will improve in the second half of 2016.
Railcar loadings drive railcar demand, which in turn drives lease rates. If loadings are a harbinger, loadings suggest the economy is contracting instead of expanding. The decrease in railcar loadings generally across all segments (but especially in coal and energy) has led to dramatic improvements in rail system velocity. As a result, railcar demand has softened and lease rates on railcars of all types have dropped (in some cases, such as coal and small cube covered hoppers for sand) to extremely low levels. New car orders have decreased to the point where the existing backlog is running off at a rapid pace and prices are coming down. We hear on the street that railcar manufacturers are dropping prices to try to make any demand for any railcar a new car order.
To understand the discrepancy between the rail marketplace and the U.S. economy, I consulted with Eric Starks, President of FTR Associates and an annual Rail Equipment Finance Conference participant, for an explanation. Here’s what he told me: The disconnect is less tied to economic issues that grab headlines like the strong U.S. dollar (already priced in and supporting U.S. intermodal loadings) than to weakness in the overall global economy (impacting commodity prices) and near zero or negative real interest rates (low returns on retirement capital inhibit consumer spending).
What really grabs Starks’ attention is the downturn in energy-related rail business and continued weakness in manufacturing. The dropoff in coal loadings (roughly 20% from 2011) and other energy products has been significant. If energy were at historical norms, the rail economy would seem “almost normal.” Instead, we have an imbalanced market where high inventories of consumables hinder manufacturing and business investment. Lacking confidence in the direction of the economy, Starks notes, businesses are holding cash on the sidelines waiting to confirm a return on future investments.
So what will change loadings growth on the rails and what will this mean for the U.S. economy? Starks again returns to manufacturing and innovation, which should pick up if the consumer eats into those high inventories. Signs indicate potential additional manufacturing growth, but on the consumer side, something (such as housing starts) needs to replace autos in leading the pack. A possible increase in agricultural product moves (due to a bumper harvest) has the chance to begin to lift rail loadings off current lows. Growth in rail loadings will be an indicator of growth and strength vs. the teetering in today’s market, where we worry today might just slip into recession.
I finished by asking Starks, if the Federal Reserve moves to raise rates, will that slow growth and potentially the rail economy? Answer: It’s a double-edged sword. Better returns on bank-held cash might free up additional consumer purchasing power, but could slow growth as investment costs increase. The Fed should have tried to move rates to something more normal some time ago. My advice? Buy two of everything to get the railcars moving again and eat into those inventories. Except autos—buy three of those. And by all means turn up that air conditioning!
From Railway Age's September Financial Edge column.