Is The Auto Industry Slowdown Signaling Trouble Ahead For The Overall Economy

While it's not as applicable today, there used to be a saying that "as goes GM, so goes the economy."  While the "Big 3" aren't quite as big as they used to be, they still offer vital clues about the overall economic health of the United States.  Unfortunately for anyone who has been paying attention, those "vital clues" are all flashing red warning signs as each passing day seems to bring more news of idled plants and/or shift reductions (see here and here).  Of course, rising interest rates, tightening credit, softening used car prices and rising subprime auto delinquencies just as the North American auto SAAR seems to be peaking out well above normalized replacement volumes are probably not great signs either.

Perhaps that's why Goldman's David Tamberrino recently downgraded the U.S. auto industry on the thesis that sales would trend back toward normalized demand of 15mm units per year over the next two years.  Of course, as we've pointed out numerous times in the past we tend to agree with his assessment of normalized demand based on a driving age population of 255mm and a 17.5 year vehicle useful life which implies normalized demand for annual sales of ~14.6mm units.

We lower our Autos and Auto Parts coverage view to Cautious from Neutral. As we progress through the later stages of the US auto cycle, we expect a sales plateau through 2017 held up by increasing OEM incentives. Beyond this, we see US light vehicle sales mean reverting back toward normalized SAAR of 15mn from 2018 through 2020 as pent-up demand clears through. In addition, as we dissect some of the drivers of the later stage growth, we expect the non-recurrence of several tailwinds (higher leasing penetration, higher non- and sub- prime FICO score penetration) in addition to macroeconomic factors (rising interest rates and crude oil prices) to be headwinds to further growth and the favorable pricing environment for both OEMs and suppliers.

 

Meanwhile, Deutsche Bank's Tim Rokossa was slightly more constructive on U.S. autos in his "2017 Auto Industry Outlook" piece published this morning.  Ironically, however, his "optimistic near term outlook" came in spite of his warnings on "further declines" of used car prices, rising rates, "credit tightening" and "lengthening ownership cycles"...apart from those minor issues everything it just fine.

Used vehicle prices have begun to moderate, and we’ve been anticipating further declines (lower trade-in values hurt new car affordability; more attractive used vs. new prices also cannibalize new car sales).

 

We expected rates to start rising.

 

Credit has been tightening (Note the Fed’s Sr. Loan Officer Survey, Ford pulling back on leases, several lenders pulling back on subprime).

 

We expected ownership cycles to lengthen (due to longer loan terms over the past few years, rising levels of negative equity in trade-ins).

Yes, we should probably ignore the fact that declining interest rates and lengthening terms allowed U.S. consumers to increase their average vehicle purchase price by 21% from 2008 to 2016 with only a modest 5% increase in monthly payment.  Good-bye Ford Focus, hello BMW 3-Series.

Rates and Terms

 

Of course, we should probably also ignore this rise in 61+ day delinquencies among GM's subprime borrowers.

Subprime Delinquencies

 

As Barclays' Chief U.S. Economist Michael Gapen recently wrote in an article for The Hill, "something’s gotta give and we think that time may be coming." 

Altogether, it is likely that the greater use of incentives, availability of credit, and willingness of automakers to hold additional inventory above historical norms reflect a preference for quantity of sales over quality. These trends have limits, as automakers cannot sacrifice margins and earnings forever.

 

As the saying goes, something’s gotta give. We think that time may be coming.