CARMAKERS’ SECRET
U.S. consumers are paying more for their vehicles, bailing out Detroit as sales sputter
U.S. buyers are paying more for vehicles, keeping firms alive while sales sputter,
The longer the good times last in the auto industry, the messier the crash.
U.S. light-vehicle sales likely totaled17.3 million last year, unexpectedly topping 2017’s result and just below the 2016 record of 17.5 million, according to a late-December estimate by data provider Edmunds. Final sales numbers for 2018 are due Thursday. Profits in Detroit have also held up surprisingly well, given the cost pressures unleashed by President Trump’s tariffs on steel and aluminum imports.
The industry’s secret: New vehicle prices are breaking records, averaging almost $38,000 in November, according to Kelley Blue Book. Consumers aren’t buying more new vehicles, but thanks in part to a bubbly secondhand market, the ones they are buying are bigger, more expensive and more profitable for auto makers.
This new industry pattern can partly be explained by a heady consumer economy, with unemployment at a record low. President Trump’s 2018 package of tax cuts included accelerated depreciation of light trucks and bigger SUVs bought for business purposes. This “Hummer loophole,” in combination with other deductions, has given an underappreciated boost to sales, thinks Randeep Grewal, senior portfolio manager at London-based hedge fund Trium Capital. Nearly half of sedan owners who traded in their cars last year opted to buy a light truck.
The trend in auto financing is another factor. Lenders are get- ting more restrictive, nudging less affluent buyers into the secondhand market.
“Those that can buy new are really buying what they want,” says Ivan Drury, data strategist at Edmunds.
Buyers priced out of the new market have boosted secondhand sales, driving prices to a record over the summer. A year ago some analysts feared that the used market would be flooded with vehicles coming off leases. Instead, dealers have reported shortages of inventory.
Strong used prices feed directly back into the new car market and the profits of General Motors, Ford and Fiat Chrysler. Expensive used cars make new ones look better value, while rising secondhand prices also subsidize the cost of leasing cars, allowing leasing companies — including the captive finance arms of GM and Ford — to offer eye-catching monthly price plans while also making fat profits. More than a third of U.S. new vehicles are sold on such leases.
The debt-fueled feedback loop between new and used pricing has prolonged the good years for auto makers, but it also magnifies the potential for pain when secondhand prices turn. At that point, leasing companies won’t be able to offer the cheap monthly plans they used to, forcing consumers to buy less fancy models.
What could trigger the correction? Rising interest rates are already pushing up the cost of owning a car, but it is hard to know when this really bites. Rates will increase more slowly this year if growth slows as expected.
Strong profits in Detroit have lasted longer than most investors imagined, which is why car stocks fetch such a low multiple of profits.
But the taste for more expensive vehicles can’t keep making up for flagging sales forever, particularly with money getting tighter. There are no bargains in the auto industry — neither in the dealerships nor on the stock market.