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China-US Imports Rise Yet Rail Freight Contracts

With economies ‘locked down’ and travel restricted, the pandemic has disrupted U.S. industrial production and impacted derived domestic rail freight traffic negatively.  The Federal Reserve reported manufacturing output fell by 13.7% in April, its largest monthly decline dating back to 1919.  Record declines in spending and employment are creating State budget disasters.  Furloughs caused by the lockdowns are creating current economic disasters for furloughed workers and their families.  The American Association of Railroad’s (“AAR”) April reports U.S. rail traffic falling 25.2% and intermodal falling 17.2%.  April’s originated carloads averaged 196,107 per week, the lowest weekly average for any month in more than three decades.  

All major car loading commodity groups fell including coal, autos, steel, lumber, chemicals, scrap, petroleum products, sand, and food products.  Autos and auto parts traffic disappeared in April because the auto industry shut down for the month.  Petroleum products and frac sand fell due to the price collapse in the crude oil markets.  

Earlier this year, China pledged to increase purchases of American farm, energy, and manufactured goods by at least $200 billion over two years ($12.5 billion over a 2017 base of $24 billion in 2020, and $19.5 billion above that base in 2021).  China’s farm imports from the U.S. of $5.05 billion in the first quarter were up 110% from last year (up 72% in January, down 27% in February, and up 37% in March).  Soybeans were up 210% from last year, pork up 640% from last year, and cotton up 43.5%. 

To hit trade-deal targets U.S. farm exports to China will need to double this year.  But China’s First Quarter GDP contracted 6.8%, its first drop in the twenty-eight years since Beijing began reporting quarterly gross domestic product in 1992, and a further contraction is expected in Q2.  China’s follow through on the trade deal may be challenged by a U.S./China strategic confrontation resulting from Beijing’s lack of transparency in its handling of the outbreak of the coronavirus. 

Regardless, China is the largest manufacturer in the world and the largest commodity consumer; 1.1 Billion more people live in China than in the U.S., and China’s working-age population is 900 million (geographically China is 98% the size of the U.S.).  The Eurozone economies (as a whole) contracted 14.2% in the first quarter (the U.S. 4.8%).  To match the U.S. population of 328 million requires combining the populations of Germany, France, the United Kingdom, Italy, Netherlands, Belgium, the Czech Republic, Austria, and Switzerland.  The world’s globally integrated manufacturing networks remain in disarray.  Most expect Q2 to be worse than Q1.  This is not a normal contraction. 

But with 25% of the 1.672 million North American Rail fleet in storage, the disruption creates the opportunity to deploy capital as the economy reopens.  Americans will return to work and rail transportation will remain economically compelling.  For careful, conservative, common sense, and competent solutions, call RESIDCO.

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Navigate to Tomorrow’s Fleet Environment

The past aviation super cycle was driven by growing demand from Asia’s emerging middle class (China) as well as the expansion of no-frills carriers.  With much of the world now subject to air travel restrictions more than two-thirds of the world’s passenger aircraft are parked.  The reality is that most of these aircraft will be parked for the remainder of 2020.  

Boeing expects air traffic may not return to 2019 levels for two or three years (David Calhoun at a recent investor presentation announced, “we will be a smaller company for a while.”)  Airbus, the European plane maker, is cutting jetliner production initially by a third, and embarking on a plan to ‘right-size’ its business.  In a ‘Best Case’ scenario traffic will return to ‘normal’ mid-2021.  While both are optimistic air traffic will eventually revert to its long-term growth path, the reality is they just do not know when.

‘Lockdowns’ are causing businesses to lay off workers where face-to-face interaction is unavoidable.  Over the past six weeks, the Labor Department’s initial jobless claims have totaled over 30 Million (unemployment is forecast at 20%, the highest since it reached 25% during the Great Depression).  With the U.S. economy shrinking at a seasonally adjusted annual rate of 4.8% in the First Quarter and a further decline expected in the Second Quarter, we are entering a recession.  

Conservative ‘Worst Case’ estimates expect a ‘U’ shaped recovery – two to three years for air traffic to return to trend line growth;  Domestic narrow body smaller aircraft traffic first, International traffic later.  Airline executives are now leaning toward smaller aircraft that can be more easily filled in a time of depressed demand. Delta is keeping all 31 of its fleet of A220s flying, despite grounding more than half of its fleet (it has firm orders for an additional 64). Boeing terminated discussions with Embraer SA (which produces a rival to the A220) and will now rely on returning its 737MAX to service.  Will cabins be configured to allow social distancing while we wait for herd immunity, require everyone to wear a face mask, take temperatures at the gate, or a vaccine appears? Ultimately, how quickly global traffic recovers will depend on how well the current outbreak is contained and how the global community chooses to work together to limit future outbreaks.

The trend toward younger fleets started after 9/11.  Markets were surprised when many U.S. carriers decided not to bring back the 737 Classic.  Similarly, the COVID crisis is creating a dynamic that is forcing Carriers to ‘right-size’ existing fleets, retaining newer models, taking delivery of aircraft in the current production inventory (e.g. Boeing’s 737MAX — with financing supplied by the added liquidity the Fed is providing), and retiring older units[1].  Air travel is not going away.  Look closely, the pandemic is likely to create asset investment opportunities.  But, be prepared for a ‘choppy sluggish’ recovery even after the virus is contained.  To navigate to tomorrow’s fleet environment, call RESIDCO.

[1] With oil’s collapse, economics (and load factors) will ultimately decide whether existing equipment remains attractive.

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