The demise of the auto sector has been greatly exaggerated
admin | December 7, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
Financial market participants have become increasingly concerned that the U.S. economy is quickly losing steam and that the Fed will soon have to wrap up its current rate hike cycle. One key element of this narrative has been that the interest rate sensitive sectors of the economy – autos and housing – are weakening. That statement is only half right. Without doubt, housing demand has softened after several years of unsustainably rapid home price increases and recently rising mortgage rates. In contrast, demand for motor vehicles has been strong in recent months and appears unaffected by Fed rate hikes.
Unit auto sales made a steady recovery from the steep downturn during the 2008-09 recession. In fact, motor vehicle sales may have peaked for the cycle a few years ago, reaching 17.4 million units in 2015 and almost 17.5 million in 2016 (Exhibit 1). Sales slipped modestly in 2017, likely a result of the reining in of what had come to be arguably profligate auto lending to subprime borrowers, though the annual figure of just over 17 million remained quite robust. Despite all of the discussion of weakening in the auto sector, the sales pace in the first 11 months of 2018 is virtually the same as the 2017 performance. Thus, from a broad view, auto sales look quite steady in recent years.
Exhibit 1: Annual unit auto sales
Focusing on Recent Months
The case for a downturn in auto sales as a key piece of a softening in the overall U.S. economy is even weaker when we focus more closely on the performance of sales in recent months. Unit sales have registered an annualized pace of 17.4 million or 17.5 million in each of the past three months (September, October, and November), the three best monthly sales figures of the year. In fact, aside from the spike in sales in September, October, and November of last year, reflecting heavy replacement of vehicles ruined by Hurricane Harvey, the last three monthly readings for unit auto sales were the top three in nearly two years (Exhibit 2).
Exhibit 2: Monthly unit auto sales
Thus, the popular narrative that the interest-sensitive auto sector is faltering fails to match reality. In fact, the reverse appears to be true. Motor vehicle sales have picked up steam in recent months, consistent with the overall performance of the consumer: real consumer spending rose at better than a 3½% annualized clip in each of the past two quarters and is on track to advance at close to that pace again Q4.
Postscript: GM Plant Closings
Over the past few weeks, a key piece of the “auto sector is weakening” narrative has been the announcement in late November by GM that it would be closing several assembly and parts plants. This development has been interpreted by most as evidence of a souring outlook for the motor vehicle industry. However, the GM announcement reflects two key longer-term factors that have little to do with the current health of the overall motor vehicle sector. First, U.S. households increasingly prefer trucks and SUVs to sedans. This trend has been intensifying in recent years, helped along not only by shifting customer preferences but also by more moderate gasoline prices. Truck demand wavered over the last 10-15 years whenever gasoline prices surged toward $4/gallon, but prices at the pump have not even hit $3/gallon in over three years. GM is not necessarily going to be producing substantially fewer vehicles overall in the wake of these plant closures, since all of the plants being shuttered are focused on car models that are being discontinued. Expectations are that GM will produce fewer cars — and presumably more light trucks and SUVs. Second, this decision was probably long overdue based on market realities, and the timing was driven in part from regulatory changes. Very stringent fuel efficiency standards during the Obama Administration essentially forced domestic automakers to produce large numbers of fuel-efficient cars so that the average mileage figures for their overall fleet would meet government standards. These were cars that not very many consumers wanted – ending up in rental car fleets instead of end users’ driveways, while others would have to be sold at deep discounts – and cars that the automakers had difficulty producing profitably. When the Trump Administration made its official announcement relaxing future fuel efficiency standards in August, automakers began to shift production toward larger vehicles that customers more highly value. In fact, the “Big Three” automakers, GM, Ford, and Chrysler, appear to be largely surrendering the car market to foreign nameplates, led by the Honda Accord and Toyota Camry. Aside from niche models, US automakers are focusing increasingly on trucks and SUVs, where they believe they have a comparative advantage and can be more profitable per unit produced. Thus, while the GM announcement is certainly an important development in the industry, it does not necessarily have meaningful implications for the broad economic outlook, and it certainly does not prove that Fed rate hikes are gravely harming demand for motor vehicles.