Sunday, June 25, 2017

Same thing only different

In 2009, light vehicle sales dropped to 10.4 million, GM and Chrysler went through bankruptcy reorganizations, retail dealers closed and many folks lost their jobs. The US  government felt the need to act in order to support the very vital automotive industry (3% of GDP & 10% of manufacturing). The Fed also stepped in to help stimulate the overall economy by reducing interest rates.

And printing money along with other Central banks, 
currently creating more than $200 billion per month,
keeping financial markets artificially afloat

...With no bottom in sight for falling new vehicle sales, our government attempted to stimulate demand by approving the 3 billion dollar Cash for Clunkers program beginning on July 1, 2009. Consumers received as much as $4,500 for trade vehicles that qualified for “clunker” status. The trade value of $4,500 represented a $75-$90 reduction in monthly payment on a 60 month loan assuming good credit.

...Consumers responded very well to the stimulus and sales spiked for a brief period till the program ended on August 24, 2009. This program also had an impact on the supply of used vehicles since all qualifying trades were destroyed as part of the transaction.

Cash for Clunkers eliminated a big chunk 
of the bottom of trade-in-able cars 
and created demand for newer, more complex and expensive autos

In December of 2008, the Fed also stepped in to stimulate the overall economy by lowering interest rates to a historic low between 0-.25%. In the following years, the 0% auto loan became the norm. Zero percent loans significantly boost consumer purchasing power by providing monthly payments of only $16.66 and $13.88 per thousand financed for 60 and 72 months respectively. These two forms of stimulus also had residual effects that further boosted sales volume and auto price inflation.

The perceived future value of pre-owned cars went up,
with the artificial Central Bank induced addition of low interest loans,
and purchasing support for the packaged bonds 
in which many of the worst loans ended up in, 
just like the mortgage bust

After the recession ended and demand returned, used vehicle values made strong and steady gains from 2009 till 2011 and peaked in 2014 due to a supply shortage, lower interest rates and increased demand from subprime borrowers after many folks damaged their personal credit by defaulting on a variety of loans.

Many owe more for longer terms than their cars are worth

This period of strong used vehicle value performance resulted in very short trade cycles, which significantly boosted new vehicle sales velocity.


...Those who kept their vehicles slightly longer, found themselves with equity in their trades which further boosted their purchasing power.

Especially pick up trucks,
which became even more valuable when gasoline prices tanked.

Nothing gave consumers more purchasing power than leasing during this time period. Higher used vehicle values led to higher residual values.

The "residual value" is the 'predetermined' give back value of an auto lease,
after the lease term expires

The most impactful portion of a lease is the gap between the sale price of a vehicle and the residual value. Leases boosted consumer buying by producing monthly payments that required as little as $10.00 per thousand of a vehicle’s MSRP. As a result, leasing became more and more popular with 2016 setting a lease penetration record.

$20,000 car = $200 per month lease payment
on an automobile usually under 'bumper to bumper' warranty
for the entire length of a 36 month lease (3 year/36,000 mile warranty)

The stimulating effects listed above have created significant auto price inflation. The average new vehicle transaction price in 2008 was $28,350 and has increased to $35,309 in 2017 (24.5% inflation) while the median household income has increased by only 12.3% as of 2015.

Government supported industries like healthcare and education
have the most inflation in cost within our economy

The price of a new Chevrolet Tahoe LT 4WD was $39,560 in 2008. Today, the price of that vehicle has inflated by 40.1% to $55,455.  The highest trim level has inflated by an astounding 64.6%.

However, the 0% loans could only take us so far. The effect of ultra low lease payments due to abnormally high residual values helped to further inflate the value of new vehicle prices above and beyond what 0% loans could achieve.

The Infiniti G37, now known as the Q60, has inflated in price by 43.8% since 2008.

Once the price of a new vehicle gets so high that even 0% loan for 72 months no longer makes it affordable, the customer can simply be converted to a lease to keep the sales moving. This is very evident today as manufacturers have become more and more dependent on leasing.

Something has changed.

...The set of ingredients that perfectly fueled the recovery have all reversed and now power the perfect storm:

Interest rates are rising. It’s getting harder and more expensive for manufacturers to subvent (buy down as a form of incentive) interest rates.

Used vehicle prices are falling and will [likely] continue to fall. Falling used vehicle values prolong the negative equity period (elongated trade cycles) limiting the buying power of the consumer slowing the velocity of new vehicle sales.

A car purchased for $20,000 with a $19,000 
which is now worth $14,000 as a trade, 
has $5,000 of negative equity needing to be rolled into a new sale

The last is the most dangerous of all. Residuals values, which lag used vehicle values, are adjusting and will continue to adjust lower.

The assumed future value of leases 
has gone against the auto industry and its financing lenders,
just like when real estate prices fell and homeowners 
owed more than they could sell their houses for

What will happen when the new vehicle prices that have inflated beyond the affordability of 0% loans are no longer supported with the buying power that leasing provides?

Just like real estate prices did and have again

What will happen to the sales volume of the above manufacturers that rely on leases for more than 50% of their total sales?

Inventory at dealers will begin to backup.

Already has

New auto production will fall, leaving unemployed middle class workers

We will start witnessing [even bigger] discounts from manufacturers that keep rising in an effort to control a rising day supply problem because new vehicles will no longer be affordable.

Incentives will stop working because as the price of the new vehicle is reduced, it will simultaneously put downward pressure on the trade value of the 1-3 year-old version of the vehicle.

At the end leases, lessees are seeing the resalable cars
worth relatively less than anticipated by the lessors,
which is driving used car values down, 
which increases the negative equity in financed vehicles, 
which makes them harder to trade in, 
which makes new car sales fall

Production might slow or stop for a period of time, but it won’t change the fact that new vehicle prices will have inflated beyond the buying power of the consumer.

Already is

Short term interest rates are currently rising. 

...Profits for manufacturers and retail dealers will fall significantly in the coming years.

...Falling new vehicle sales will mean more dealers competing for fewer customers. This sales environment will lead to massive margin compression and newer entries may not survive. Both manufacturers and retail dealers will be forced to reconsider the cost structure of their business to better compete with companies like Tesla which have a much lower cost of distribution.

Longer owned, relatively more complex late model cars
will be owned for even longer, generating more revenue for the 'fix it' side of the business

Something that’s very different today than it was during our last recession is the ability for companies to replace or reduce the size of their workforce with technological alternatives.

...When the smoke clears, manufacturers and dealers will adopt a much more cost-effective way of retailing new vehicles to the public. This will have a negative impact on both the quantity of jobs and wage growth in the automotive sector.