When will the auto boom end?

When will the auto boom end?
jvgillette.com • March 31, 2014
by James V. Gillette

Automakers, suppliers, investors, dealers, governments, certainly anyone with interests in the U.S. auto industry, would dearly love to know when the current auto industry recovery that began during the summer of 2009 will end. Capital investment, hiring, volume estimates for future vehicle programs all require an assumption of how long we might expect the current prosperity to continue. There is no way to ascertain a precise answer.

Setting aside a “Black Swan” event (an unknown unknown), there are some indicators that will give warning of stress factors building that may lead to an imminent decline in the auto market. Fortunately for the near-term, none of the traditional causes of an auto industry decline in the U.S. are currently affecting the market.

Past auto “recessions” since World War II have resulted from:

  • Monetary policy tightening in response to inflation pressure,
  • Energy shortages and resulting price spikes and rationed supply,
  • A major strike at General Motors (back in the day when the company was a larger force in the U.S. economy), and
  • An excessive build-up of household debt and weakening of consumers’ ability to continue to purchase durable goods on credit.

 

The precipitous decline of U.S. light vehicle sales that began in 2008 was predictable, although not to the extent nor to the timing. Indicators were in place from 2005 that clearly showed that the 16 million-plus rate of sales was not sustainable. By the summer of 2007, stresses were building that would have led to a sharp decline in auto sales even without the Lehman event in September 2008. At the time, I began showing clients and industry groups a number of time- series charts that would likely foreshadow trouble. (Although let me be clear, while I talked about the weakness in housing, neither I nor most other analysts had any idea of the magnitude of the underlying financial derivatives problem.) The clearest signal at the time came from the Federal Reserves “Financial Obligations Ratio” (FOR), which calculates the average household debt service as a percent of disposable income. By 2007, the FOR had reached levels never before seen.

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Since the recession’s trough, household balance sheets (on average) have been repaired and household wealth has now grown above previous highs (thanks to the financial market recovery and a modest resurgence in housing values). This bodes well for continued new car and truck purchases.

When will the current cycle end? The average cycle approach.

Assuming the U.S. economy remained in its expansion mode through March 2014, the current economic recovery has lasted 58 months, equal to the 58.4 month post-World War II average. The longest post-war expansion was from March 1991 to March 2001 for a total of 120 months. The shortest economic expansion of the period was during 1981-12 for only 12 months.

Cycles in Light Vehicle Sales correspond roughly to the economy in general. The long 1990s economic cycle, however, did have a few years when auto sales declined slightly: 1992, 1995, and 1997. Readers who were involved in the auto industry will recall the painfully slow recovery of sales during the early half of the decade followed by an all-out boom toward the end when sales hit an all-time record in 2000 (17.3 million) and haven’t climbed to those heights since.

The recession that began in March 2001 (well before the 9/11 attacks) was hardly noticed by the auto industry thanks to massive incentives thrown at consumers to “Keep America Rolling.” It was the first recession in history (at least since World War II) where auto sales remained quite stable.

There are two points here: one, recessions do not have a regular periodicity. We can’t conclude the current expansion is getting long-in-the-tooth and must end soon. It could go to 120 months or even longer. Two, even if we experience a mild recession, automakers can mitigate the effects by cutting prices as long as credit is readily available.

Other “stressors” of auto industry health are healthy or a long way from causing a problem

Where do we stand today?

  • Monetary policy strongly supporting North American recovery … (but …there are risks that could shorten the auto boom),
  • Plentiful energy supply – Middle East politics still tenuous but overshadowed by moderate demand and domestic production, and
  • Subprime auto lending is plentiful (an eventual stressor); subprime mortgage lending very limited.

 

Other events, trends, or actions that typically begin to erode auto demand in the U.S. economy are all currently flashing positive signals. For example:

  • The age of light vehicles in the U.S. remains on average above 11 years. This is the longest we’ve experienced in modern history. Of course, the greatly improved durability of vehicle built during the last two decades is enabling this longevity. It will take a few more years of sales well above 13 million units to materially lower this average. At some point, even a well- built car parc needs replacement. (As a side note, Europe’s situation is troubled by a younger car parc that can wait longer to be replaced.)
  • Related to auto age is the supply of used vehicles and their resulting price points. During a prolonged auto cycle, trade-ins and vehicles coming off lease eventually drive used car and truck prices down creating competition for new vehicles for consumers who are more price sensitive. We are not there yet.
  • In spite of the highly charged political debates surrounding the topic, employment continues to improve. While this remains a politically charged issue, monthly data from the U.S. Department of Labor Statistics shows demographic segments that are the typical new vehicle buyers are in pretty good shape.

 

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With the possible exception of subprime auto credit, which seems to more plentiful today than prior to the “Great Recession,” the excesses that could end the party are not present. When will they be a problem? It’s impossible to say with any degree of precision. Given human nature and the dynamics of a market economy, we know it will happen. My own guess, barring a “Black Swan,” late 2016 at the earliest; 2018 at the latest. Please note this is an informed opinion, not a scientific assessment.

By looking at a large number of economic, demographic, and auto industry indicators, I conclude that the trend level for new light vehicle sales in the U.S. is approximately 15 to 15.5 million units per year.

 

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We achieved that in 2013 and now should see two or three years above that level until the average age of the car parc begins to recede and excesses build.

One last point: vehicle exports from North America have surged in the past ten years. The market for OE components is becoming more dependent upon vehicle sales conditions in other parts of the world and less sensitive to fluctuations in domestic demand.

I’ve been asked a few times in my career if I “guarantee my forecasts.” In response, I usually sit for a few moments in stunned silence wondering how to answer a question based on an obvious lack of understanding of the definition of “forecast.” The auto industry, let alone the world economy, is too complex to predict future outcomes with any degree of precision. Being in business requires that we take risks and it behooves us to gather a reasonable amount of information relevant to the underlying causes of those risks. The U.S. auto industry appears to be in good shape for the near-term as noted above … but I can’t guarantee it.