Car Crash - The Wait Is Over

Authored by Blinders Off's Daniel Ruiz via,

Before I get started, I’d like to share a few important things that will help bring perspective to my analysis.

  • Eighty-six percent of consumers purchasing a new vehicle use financing. The frequency of replacement (trade cycles) by this group significantly impacts the velocity of new-vehicle sales.

  • Under normal conditions, vehicles financed for 60 or 72 months are traded at 36 or 42 months, respectively. Most leases have a 36-month duration and are held till maturity.
  • Think of new-vehicle sales as potential used-vehicle supply. The moment the ownership paperwork is completed on a new vehicle, it becomes a used vehicle.

Why used vehicle values?

Only jobs and credit are more important than used-vehicle values are to the health of the auto industry. Fully 86% of new-vehicle sales are financed, and under normal conditions the majority of those vehicles are traded within three years. Knowing that most car loans have a 60–72-month duration, we can assume that the majority of vehicles traded at the three-year mark are not paid off. The level of equity in these loans directly affects consumer behavior and in large part determines when the vehicle will be traded for another new vehicle. The frequency with which this very large group of consumers trades vehicles on which they still carry loans is one of the most important factors in new-vehicle sales velocity. I can make a strong argument that when used-vehicle values decline sufficiently, they can outweigh the positive effects of strong jobs and easy credit – we’ve seen this already this year.

2017 recap

Here’s what we’ve witnessed to date after record-breaking new-vehicle sales in 2016. Used-vehicle values fell, slowing the velocity of new-vehicle sales as people chose used over new. Inventory piled up at retail dealers; and after dealers failed to stimulate sales of new vehicles through bigger discounts and incentives, manufacturers were forced to slow or halt production to manage day- supply levels.

In June of this year, used-vehicle values began to stabilize because wholesale supply (inventory from rental vehicle companies) tightened and demand for used cars rose as new-vehicle sales fell (new-vehicle sales provide trade-ins to be resold on the used-vehicle market).

Another drop in used-vehicle values will trigger the same cycle again, although this time it will be much worse because used-vehicle value performance impacts residual value decisions for new leases. When residual values fall, monthly payments will rise, adding another layer of resistance to retail sales growth. Please read ‘The Perfect Storm 2 – Autonomics for a more detailed explanation on the importance of leasing.

Hurricanes to the rescue?

After this year’s sales lagged last year’s for eight months in a row, September marked the first sales gain of 2017. This happened in large part because approximately 600,000 vehicles incurred flood damage during hurricanes Harvey and Irma and had to be replaced. However, I believe that the perceived benefits to vehicle sales of these hurricanes are wildly overstated. To date, approximately 400,000 insurance claims have been filed, but only those claimants with full coverage insurance will receive the replacement value of their vehicle. There were also 125,000 jobs lost due to Harvey alone. Employment is one of the most important requirements when would-be buyers attempt to secure an auto loan.

That said, August and September sales volumes were affected by the storms. While September results were strong, it’s important to note that only 63,881 more vehicles were sold than in the same months of 2016. With so many vehicles destroyed and such a small number of additional vehicles sold, I can’t help but wonder how much September weakness these hurricanes masked. Some analysts are forecasting continued strength through Q1 of 2018 – I strongly disagree. It simply does not take that long to replace a lost vehicle once an insurance claim is filed. I believe the sales spike in September may have included the majority of the demand for replacement vehicles and that the coming months will see little residual benefit from these unexpected events.

The hurricanes were also responsible for the largest spike in used-vehicle values this year. Retail dealers aggressively bought used vehicles at auction, based on speculative forward demand assumptions. I say speculative because normal, healthy demand starts with a sale. A dealer sells a vehicle then buys another to maintain proper inventory levels. This sales spike waved a huge red flag for two reasons. First, all of the vehicles lost will not be replaced, at least not in the short term. Second, with a high day supply of new vehicles and all-time high incentives, much of the replacement demand may be absorbed by new-vehicle sales instead of used-vehicle sales. If retail dealers get stuck with this inventory after paying a strong premium, they will not return to auctions until those vehicles are sold. In early September I was concerned that a drop in demand from dealers occurring the same time that lease return volume picks up in the fourth quarter could cause a sharp drop in used-vehicle values.

Where are we now?

My concerns were well founded. I noticed a buildup of wholesale supply in mid-September that has now grown to the largest I’ve tracked all year. Without adequate demand to absorb the build in wholesale supply, used-vehicle prices have fallen significantly in October. How significantly? Enough to erase all of the gains in September as well as all of the gains going back as far as June, when used-vehicle values began to stabilize.

For months, I’ve been preaching patience to investors with an interest in shorting auto-related equities. I expected a rebound in new-vehicle sales as retail dealers and manufacturers continued to offer larger and larger discounts in response to a day-supply problem that for some reached 2008 crisis levels. A combination of all-time-high incentive spending and replacement demand from the hurricanes satisfied this necessary piece of the puzzle in September. I also expected a bounce in used-vehicle values, which came to fruition as well.

 In my professional opinion, the time to act is now. The events I’ve described should start the same vicious cycle that we witnessed earlier this year, although this time with more acute ramifications.

Will used-vehicle values continue to fall?

The simple answer is yes – mostly because of the performance of used-vehicle values versus residual values on active leases. When used-vehicle values underperform their respective residual values at maturity, the return rates for the captive banks rise. Higher return rates lead to more inventory at wholesale auctions, leading to lower used-vehicle values. Lease return volume will continue to grow steadily along with higher return rates, peaking sometime in late 2019.  Here are a couple of examples of maturity curves going forward, using information found in recent auto lease ABS filings for Ford and Mercedes:

Another factor to consider is margin compression. As more used vehicles enter the retail market, consumers will have more options, and retail dealers will have to compete harder to earn their business. It’s important to understand the difference between new vehicles and used vehicles with regard to margin compression. Unlike new vehicles, which have a set cost for all retailers, used vehicles are subject to natural price discovery. A used vehicle is always awarded to the highest bidder at a wholesale auction. Consider for a moment how used-vehicle managers and buyers think: First, what will the vehicle sell for in my market? Second, what is my estimated reconditioning cost, auction fee, transportation expense, etc.? Third, how much profit do I want to make? What’s left over is the bid limit. As margins compress due to growing competition, the calculations are adjusted and bid limits keep falling.

What stops the vicious cycle of falling used-vehicle values?

As I stated at the beginning of the article, think of new-vehicle sales as used-vehicle supply. The same thing that stopped the decline in used-vehicle values during the last recession will be needed this time around: years of declining new-vehicle sales.

Falling new-vehicle sales volume will negatively impact a wide range of companies in the automotive industry, including manufacturers, suppliers, lenders, and retail dealers. Falling used-vehicle values will affect the same companies, but none more directly than rental car companies, whose largest expense is per-unit depreciation.


auricle Mon, 10/30/2017 - 15:54 Permalink

sounds like the perfect excuse to start phasing out combustion cars and introducing the new EV/hybrid channels. Cash for clunkers ie. rebates on trade-ins. 

Kidbuck N. B. Forrest Mon, 10/30/2017 - 20:17 Permalink

Yup, but if electric vehicles were practical big oil could just sell to the electrical power companies instead of the consumers. Big cars were better, too for many people but the government regulations fucked up their freedom to choose. Just like it fucked up your freedom to choose what school your kids can attend and which disgusting perverts will share your kid's toilet stalls. I

In reply to by N. B. Forrest

techpriest CanadaGoose Mon, 10/30/2017 - 17:59 Permalink

You still have to produce carbon oxides as a part of the process. I think the current state of the art is to use methane (natural) gas, which would emit less carbon but allow a higher energy density to be stored than hydrogen. H2 cars are kind of a bomb on wheels in order to have range - the sorbent technologies have not worked out so well to my knowledge.

In reply to by CanadaGoose

Curiously_Crazy Stuck on Zero Mon, 10/30/2017 - 20:16 Permalink

Nice one. I've got a 2003 WG (WJ but made in Austria for the export market), before that I had a '93 XJ cherokee.230,000kms on the clock and it runs like a dream, I'm gonna keep it for many more years to come. Might not be as trendy as the Land Cruisers, Land Rovers, and Patrols but with quadra drive II it's a damn good 4x4 for the cost and have never had any of the reliability problems its reputation suggests.

In reply to by Stuck on Zero

ToSoft4Truth auricle Mon, 10/30/2017 - 16:17 Permalink

Everyone will be able to keep their combustion engine.  They'll just have to pay slightly more for the privilege: London's £10 T-charge comes into effect in fight against toxic car fumes Drivers of the most polluting vehicles must from now on pay a daily charge of up to £21.50 to drive in to central London. From Monday, people driving older, more polluting petrol and diesel vehicles will be liable for the £10 T-charge, on top of the congestion charge of £11.50, which has been in place since 2003. 

In reply to by auricle

TheAntiProgressive auricle Mon, 10/30/2017 - 16:25 Permalink

I am totally tired of the clueless Greenies espousing electric cars as if that will solve Global Warming or Climate Change.  Where does the electricity come from?  The power plant, which primarily burns fossil fuesl.  Then you lose all kinds of energy in "transporting" the electricity to the end user, termed "transmission loss".  And instead of buying gasoline, you are also paying for all the addons on your electric bill which has it's own bifurcation for everything under the sun outside of the generational fossil fuels used to generate electricity to actually power your little electric "clean" vehicle.  Whatever makes you happy.

In reply to by auricle

HRH Feant2 TheAntiProgressive Mon, 10/30/2017 - 16:59 Permalink

Same here. I have another question. Where the fuck do the greenies think those massive hybrid batteries end up? Here is a hint: in the local landfill!

I had a hybrid car, once. The battery took up the entire back seat (it was installed between the back seat and the trunk). Those batteries are huge and expensive: around $4500 to replace. Plus the dump charges you (or the repair shop an extra fee to dump that thing). I bought the thing because gas prices had increased and they are very fuel efficient, I easily got 50 MPG (Honda Civic Hybrid, 2005).

Watched an interesting Utube video produced by CBC (Canada broadcasting channel) about coffee cups. I know. Why the hell would I watch a show about coffee cups? Apparently Starbucks and Tim Hortons were bragging about how they recycle cups. Even have recycle containers in their stores. And fancy commercials. But the funny thing was the employees throw everything in the trash. Apparently it is not cost effective to recycle coffee cups. One, the coffee shop employees are not paid enough to sort through the trash. Two, the coffee shop owners are not willing to pay a large-scale recycler to sort through their trash, either. So where do those coffee cups end up? In the regular garbage.

I have a stainless steel coffee cup with a lid, from Starbucks. Had the thing about five years. I use it for hot drinks or for water and ice in the summer when I am on the go. If the virtue signaling enviro freaks were that concerned about trash, why don't they carry around a stainless steel coffee mug or water bottle like I do, the tight-wad conservative? Had to throw that in.

I laughed. I no longer do all the recycling crap. Everything goes in the fucking garbage, I pay the bill, they pick it up. Nothing but virtue signaling for the brainwashed masses to talk about how they do all that shit. Who the fuck has time? Even if I have time I don't want to spend it washing cans and sorting and moving various bins to the street, and back. Not one neighbor has noticed I don't recycle. Good.

In reply to by TheAntiProgressive

TheEndIsNear HRH Feant2 Mon, 10/30/2017 - 21:14 Permalink

Long ago one of the primary uses for robots was supposed to be sorting and recycling trash. I guess it's cheaper to have us peons do it (ie; free slave labor). Apparently there is no profit in it even at near zero prices.

I am pleased to say that I have not seen a single recycle container anywhere in the state I have escaped to from Commiefornia.

In reply to by HRH Feant2

Utopia Planitia HRH Feant2 Mon, 10/30/2017 - 21:44 Permalink

The earth could easily be "carbon neutral" if all the greenies stopped producing CO2!  :-)None of those idiots even know what a carbon atom is, let alone all the myriad of carbon compounds in the world.  None of them know anything about "energy" either.  "Oh, I use renewable energy!"  Sorry sucker, ENERGY IS NOT RENEWABLE!  But they sure cling to all sorts of seemingly clever slogans and made-up names.

In reply to by HRH Feant2

Guderian Crazy Or Not Tue, 10/31/2017 - 02:58 Permalink

These greened politicians and activists are riding a dead horse.Not only is the mere production of an e-car an eco desaster, leave alone its recycling at the end of its life-cycle, Not only is the mining of the composits of the batteries an economic, ecologic and social desaster. Not only would we need at least twice the power production, we have available now. It gets better: The entire electric grid of the developed world is on its brink, as we speak -with next to no e-mobility as of today!In my neighbourhood, there is a new real estate project developing. The apartments are on sale. When I visited and asked, whether the garage parking spots would be equipped with electric charging infrastructure, the salesman responded, that that would not be a standard, because the cities electricity utilities company cannot provide the 40 spots with enough power to charge an e-car within the required time. 40 fucking spots in a city of hundreds of thousands of cars? Really?That is a clear indication, that they are not up to it. The problem is not so much overland lines from the power plant to the city utility company, but rather the grid network within the cities. You wanna modernise all those power lines beneath the streets? We'd need helicopters to get to work then!

In reply to by Crazy Or Not

RedBaron616 Mon, 10/30/2017 - 16:08 Permalink

Nicely written article with data backing it up. Nice to see an article written by a guy who is not afraid to have his name published. Too many articles on here are by those who wish to remain nameless. Not this guy. Kudos.

Masher1 Mon, 10/30/2017 - 16:12 Permalink

New car lots are JAMMED to the brim with new and 1 and 2 year old cars. Every single lot i can find here in my area is loaded to the top, no eceptions, Even the used car lots. And every single stupid seller is asking WAYYYYYYYY too much for the crap on those lots. Boycott is working freinds, Keep it up.

Masher1 Madison's_Ghost Mon, 10/30/2017 - 16:39 Permalink

There is not one single nook or cranny in the North American car market that does not have 250 cars jammed into it. All this BS hype is just to keep those in the usury game raking in the cash..... You on the hook for the toll. I bought a used van for $250 bucks, Spent about $1500 repairing it to a functional state and have now over 100,000 Km on it and found it a very good investment. Thinking you need a new car is mostly some rich a-hole wanting you to keep his bank topped up.... Cut him off, buy a used car from a private seller, you will be amazed at the value. there is no shortage of useful transportation for sale at ass kicking prices if you look.

In reply to by Madison's_Ghost

aliens is here Mon, 10/30/2017 - 16:43 Permalink

I am done with new cars. I'll drive my 09 Corolla until the end.I am sick of giving my hard earned money to banks and get screwed by dealers. Both are crooks like Killery. I hope dealers go bankrupt.

Iknowstuff Mon, 10/30/2017 - 17:10 Permalink

I used to know a new car salesman. He called people stupid for buying a new car. Used to refer to it as a 2K$usd fart. If you buy a new car drive it off the lot pull a u-turn and drive right back on the lot the car is now considerd used. You cannot get your money back and the car has now lost $2000 in value. All my life have never purchased new and never will. 2-3 years old with 20k-30k on the clock and your golden. Paid off in a couple of years and own it till it doesnt move anymore. Presently driving a 2005 Jeep tj with 140k on the clock runs great.

Mercuryquicksilver Mon, 10/30/2017 - 17:34 Permalink

Daniel Ruiz includes exceptional analysis. He misses one variation. The majority of cars "totaled" by Texas and Florida flooding will reenter the market as "salvaged flood" further depressing the used car valuation. 

HarryKallahan Mercuryquicksilver Mon, 10/30/2017 - 20:48 Permalink

.They are only salvage title if an insurance company pays off on the loss. The insurance company marks the title as salvage.Otherwise it's just another used car that's been detailed and dried out.Many insurance companies won't insure, and banks will not finance, a car with a salvage title.And anyone with half a brain won't take one, as every electrical device in the car will fail quickly if the cars were submerged . 

In reply to by Mercuryquicksilver

83_vf_1100_c HarryKallahan Mon, 10/30/2017 - 21:11 Permalink

You sre correct on the salvage title. The wife just took a TX dealers course a few weeks ago. There are several ways to convert a salvage title back to clean status. If you see a car hauler with a load of used cars on the interstate, odds are they are salvaged and about to be reborn clean in another state. I learned I need to look deeper at a prospective used car buy and will not buy one that a title search show interstate movement. You can get a clean title on a car that had 2 frames welded together if you jump the hoops. Caveat Emptor.

In reply to by HarryKallahan

Curiously_Crazy Mon, 10/30/2017 - 20:20 Permalink

I thought what stopped the decline in used car prices last time around was the 'cash for clunkers' program removing a fair chunk on the supply side?Though declining new car sales will also have an effect down the track.

HarryKallahan Mon, 10/30/2017 - 21:28 Permalink

.The local Ford dealer here has in the lot, brand new:2017 all models 625 units2018 all models 315 units.It's a big dealer, so its always full of vehicles... so can't say if its unusual.But there does seem to be a lot of 2017 units for this time of year. You'd think the above years would be flipped around.

Knave Dave Tue, 10/31/2017 - 01:33 Permalink

I disagree on the hurricane impact. Normally, it can take three weeks for an auto claim to be processed and to get the money in your hands. Sometimes longer if insurance companies want to fight about it. NORMALLY.Imagine how much longer it takes when insurance companies have 600,000 claims to process above and beyond their normal level all at once, and imagine how much longer it takes when many of their agencies also got wiped out or damaged by flooding. Imagine that those same companies also have hundreds of thousands of homeowner claimes to process for houses and furnishings and thousands of lost-business claims to process. Now imagine that those hundreds of thousands of claims also have to be brought in by people who have no home and no car so have a lot on their minds to deal with and little in the way of resources to get to where they can make their claims.Even after the checks are cut, they have to arrange financing -- maybe not so easy with so many banks under stress in the region and with their own incomes impacted by the flood. Then they have to decide what vehicle they want. It would be a miracle of the bulk of those claims started to result in new car sales as early as September! --David HaggithThe Great Recession Blog