Morgan Stanley's auto team, led by analyst Adam Jonas, seems to be convinced that the auto trade is officially over prompting him to slash over 11 million units from his North American SAAR forecast over the next 4 years. Jonas attributes his controversial call to the fact that OEMs have been so aggressive in implementing policies designed to pull forward sales (e.g. longer loan terms, higher loan mix to subprime borrowers, etc.) that they've actually started to pressure used car prices to the point that they're cannibalizing new sales.
We had held to a ‘higher-for-longer’ thesis on the assumption that the OEMs could keep pulling forward demand from the future… For several years, we have expressed our concern over the sustainability of used car values and powerful forces that could drive a multiyear cyclical decline, impairing the ability for consumers to transact and the willingness of financial institutions to lend as aggressively as in the past. Up to this point, we had believed that competitive forces, particularly the ability of the captive finance subs to find new ways to lower the monthly payment and put 'money on the hood’, would help extend the US auto volume cycle a few more years to new heights.
8 years into the biggest auto cycle on record, we appear to be hitting a point of diminishing returns where the tactics required to attract the incremental consumer may be putting even more pressure on the second hand market, leading to adverse conditions for selling new vehicles…
As such, for the first time this cycle, we are directly incorporating our views of used car value erosion into our US light vehicle sales forecasts, resulting in substantial SAAR reductions of several million units per annum through 2020.
So just how bad does MS see new car sales getting? In aggregate, they cut 11.3 million units out of their 4-year forecast and slashed their 2019 estimate by 4.2 million units, or 22%.
Our cuts for the out-years are more substantial. Our 2018 US SAAR forecast is cut to 16.4 from 18.9mm, implying a further 7% decline from 2017 to 2018. Our 2019 and 2020 forecasts are cut to 15.0mm units both years units from 19.2mm and 18.7mm respectively. This pace of sales is equal to levels last seen in 2013. In our view, to maintain a 15mm SAAR and no worse we may need to see government support for new car purchases in the form of an incentive program similar to 'Cash for Clunkers'.
The cuts to our 2019/2020 forecasts are driven by our extensive work over potential used car price erosion due to technological obsolescence at a time when the powertrain (from ICE to EV) and driving policy (from human to automated) is changing in an unprecedented way. In the US, roughly 9 out of 10 new car purchases involve a trade-in or off-lease vehicle making used values a consumer's currency. Our more recent work on the 'Osborne Effect' explores the potential for a buyers' strike whereby consumers delay purchases to wait for an significantly improved product just a few years away.
And while shifting consumer patterns and technology upgrades will always have an impact on the timing of large-ticket purchases, Morgan Stanley's prediction that used car prices will crash up to 50%, over the next several years, was the primary reason behind their call.
Of course, such a catastrophe in the used car market will only serve to exacerbate the minor issue that negative equity in America's passenger rolling stock is currently at an all time high. And, since Americans don't really like to save cash, that puts a real damper on their primary source of a down payments: trade-in values.
That said, ridiculously high inventory levels....
...and soaring off-lease volumes probably won't help new car sales and/or prices either.
Meanwhile, lending standards probably can't get all that much worse...
...which means that the industry is pretty much capped out in terms of sales that can be pulled forward.
Welcome to the other side of the "plateau."