With the most recent tariff dispute still in full force, it is unsurprising that auto manufacturers have been beaten down. However, if you look beyond the headlines, you will find that there are deeper, more fundamental reasons to be bearish on the sector. There are a number of signs of weakening demand that have raised their heads in recent times.
Rising supply, falling demand
The first of these is rising inventories, as measured by the amount of time that cars spend on dealer lots prior to being sold. This is a good proxy for inventory size, as with weakening demand, cars will sit on lots for longer and longer. A study by JD Power found that:
“The number of new vehicles sitting on dealer lots is rising. On average, new vehicles sold in May spent 74 days on dealer lots, the highest level for the month of May since 2009 when the industry was dealing with the effects of the great recession. In fact, 29% of vehicles sold so far in May have sat on lots for 90 days or longer, up from just over a quarter of vehicles last year.”
Meanwhile, a report by Bank of America (BAC, Financial) lists a number of additional factors, in particular the mismatch between production output (especially for light trucks) and declining consumer confidence. Citing data from the University of Michigan, it said that consumer confidence for buyers of automobiles is at its lowest since mid-2012.
Lending standards have tightened
Interestingly, even though rates have come down, it has become harder to secure an auto loan. The Bank of America report continued:
“The interest rate on auto loans has come down along with the drop in market rates. This should incrementally support demand for autos. However, according to the Senior Loan Officer Survey (SLOS), lending standards for auto loans have been tightening since 2016 which can be seen through an increase in credit scores of auto origination.
The median credit score on an auto loan is now 710, significantly higher than the low of 683 in 2015 and nearly back to recessionary tightness. While this will help credit quality and reduce the rate of delinquencies - a positive in the long-run - it also curbs demand in the short-run”.
Overall, this is not a systemic risk to the auto market, particularly since a decline in delinquencies is ultimately good. But it will nonetheless contribute to the sales slump in the near future.
Summary
If we are indeed past the point of "peak car" in this cycle, the implications will go beyond the industry. Automobiles are a major component of GDP and consumer spending, and will represent a drag on the economy as manufacturers cut inventories. Yet Bank of America does not foresee a precipitous drop in auto sales:
“In our view, the peak in auto sales is clear and we will likely see some softening going forward, but we do not expect a sharp drop. The labor market is still solid with a healthy pace of job growth and the emergence of wage inflation.”
Disclosure: The author owns no stocks mentioned.
Read more here:Â
Warren Buffett: Life and DebtÂ
Do You Really Understand Your Business? Use Peter Lynch’s 2-Minute Drills to Make SureÂ
Not a Premium Member of GuruFocus? Sign up for a free 7-day trial here.
