Auto Industry (and US Economy) Still Labouring Under Covid

Summary

• Auto sales are soft, and used car prices are still high, indicating that Covid continues to upend the US economy.
• Supply constraints have allowed auto-related companies to charge top dollar, feeding inflation.

Market Implications

• When auto sales start rising, we might be on the brink of returning to normal for real – not just autos, but the wider economy, too.
• A return to more normal production should ease inflation pressures.

Auto Industry Stuck in Neutral

If you want a quick read on how the US economy and corporate America remain unbalanced as we all try to emerge from the Covid fog, a good place to start is the auto industry.

First up is the macro picture. Monthly auto sales have averaged around 13.5mn units annualised for the past year (Chart 1). That is well below the 17mn we might expect in an economy at full employment. It is not that people do not want to buy cars. Car dealers have waiting lists of people ready to buy cars at full price. Car manufacturers cannot build enough of them due to a shortage of semiconductors and other supply-chain problems.

Also, car sales are not trending up. Rather they are stuck in a range, suggesting problems are not easing.

The other key variable is used car prices. For 25 years before the pandemic, the Mannheim used car price index took hits during recessions but otherwise mostly rose gently with inflation. With the pandemic suddenly increasing demand for vehicles and manufacturers handicapped by parts and labour shortages, the used car price index jumped 65% to 236 by yearend 2021. It dropped about 6% in 1Q 2022 but has been wrapped around 220 since then. Again, there is no evidence of a declining trend yet.

In short, the auto industry is stuck in neutral, unable to operate at anywhere near normal capacity – but it is definitely feeding the inflation that is making people miserable.

Car Makers Struggle to Finish Cars

It is a bumpy road at the corporate level too.

Ford (F) reported blowout earnings, with adjusted EPS of 0.68 versus consensus 0.445.  General Motors (GM), on the other hand, missed rather badly, posting 1.14 EPS vs consensus 1.31. Then again, in the first quarter, F registered a big loss and GM had strong earnings.

A closer look shows that F was hurt in 1Q because it could not sell some 50,000 cars that were incomplete in the first quarter due to parts and semiconductor shortages. But it then benefitted in 2Q as those cars were finished and sold. The opposite dynamic hit GM as it ended up with about 100,000 incomplete cars in 2Q.

Both companies kept their full year guidance in place. This implies the 1Q and 2Q fluctuations were temporary – a passing consequence of Covid – rather than indicative of a trend. (In fairness, while both companies are operating at less than full capacity, they are not standing still – both are making headway to reinvent themselves to produce electric cars, but that is another topic.)

Car Rental Companies Are Serving Consumers

Car rental companies Hertz (HTZ) and Avis Budget Group (CAR) also reported strong earnings beats. These came from rising travel and rental volume and being able to charge high prices due to a shortage of rental cars. Shortages aside, this is hardly business as usual – it is largely consumers; HTZ reported that business rentals are still only about 70% pre-Covid levels.

Another factor was large gains on sales of fully depreciated cars, due to elevated used car prices. Analysts generally views these gains unsustainable as used car prices return to normal – but that could take a while.

It Is Not Just Autos

Pulling these various strands together, the US economy is still in the grip of Covid despite a growing veneer of normality.

Companies in the auto business – whether manufacturing or rental – are making money but not how they did before the pandemic. Rather, supply constraints allow them to charge top dollar and pass on much of their rising costs.

When we start to see monthly auto sales move to a clear upward trend and used car prices dropping, chances are we will be able to say that the auto industry is returning to normal.

But it is not just autos. Much of the rest of corporate America will likely be benefiting from easing supply chains too and returning to more normal production. And that is when inflation pressures might finally start to abate.

Whether autos is a leading or concurrent indicator of corporate and industrial America, it is useful because it is so highly visible.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)