US auto sales set to decline as today’s credit bubble ends

US autos Jul14cIts really not difficult to forecast US auto sales and housing starts if you take a longer term view.  Of course, this wouldn’t suit the traders, who love the “surprise” of a monthly number being higher or lower than the previous month.  But why does everyone else put up with this nonsense?

The chart above demonstrates the point.  It shows auto sales along the x-axis, and housing starts on the y-axis. The available data starts in 1973, and falls neatly into 4 different eras:

  • 1973-84, very volatile, purple.  High volumes in 1973, 1976-9, then saw crisis levels in 1974-5 and 1980-2
  • 1985-98, very stable, green.  Auto sales generally rising, whilst housing starts were plateauing
  • 1999-2007, Y2K and sub-prime mania, red.  Easy money pushed volumes to unsustainable levels
  • 2008-14, slowing demand, blue.  Low interest rates have supported auto sales, but housing remains slow

The chart also highlights the continuum between the purple, green and blue periods.

In the early purple period, the BabyBoomers were fleeing inner city race riots for the suburbs.  Their focus was on buying homes in ‘safe areas’, and they needed to buy cars to commute to work and for day-to-day activities.

In the green period, home starts began to slow as most Boomers had settled down.  But auto sales were still rising as more women entered/rejoined the workforce.  Older children also began to demand their own transport.

In the red period, central banks printed cash to avoid Y2K issues, and lowered interest rates after the dot.com crash:

  • Housing starts recovered towards purple period levels, as people with no credit history were given super-size loans on a no deposit basis
  • In addition, as we noted in chapter 2 of ‘Boom, Gloom and the New Normal’, the subprime boom allowed people to use their home as an ATM
  • $564bn/year was withdrawn between 2001-5 in mortgage equity.  Much of this was used to support record levels of car sales.

TODAY, WE ARE IN THE BLUE PERIOD
Initially, housing starts and auto sales fell back after the Great Recession began to new lows.  Then more central bank money-printing and Federal government stimulus boosted auto sales and stabilised housing starts

But home starts will never return to previous levels, as the demographic dividend becomes a demographic deficit:

  • Aging Boomers are now engaged in a ‘flight back to the cities’
  • They don’t want to be marooned in large, hard-to-maintain homes
  • They also worry about being close to essential services

Equally important is that the recent recovery in house prices has made it more difficult for lower-paid Blacks and Hispanics to afford new homes.  Yet they are the major segment of the US population whose fertility rates could support new home building.

US  auto sales, however, have seen a temporary recovery.  Cheap credit has made it cheaper to buy a new car than to buy a used car.  In addition, manufacturers have increased discounts to capture volume in the peak selling months.  By April, these were 9% higher than April 2013, at an average $2751/vehicle.

Even more importantly, and just as the blog forecast, GM has been especially aggressive:

But it also appears GM are now under Justice Dept investigation for their subprime auto lending, focusing on the packaging and selling of questionable loans to investors.

MANUFACTURERS RESORT TO SUB-PRIME LOANS TO BOOST SALES
These incentives are temporary in nature, as they are unaffordable in the longer-term.  But a clear sign of manufacturers’ desperation has appeared with the widespread use of sub-prime loans to boost sales.  Unbelievably, these are now 27% of all auto financing.

A detailed New York Times investigation highlights how lenders have even been offering ‘liar loans’, just as in the sub-prime housing bubble, with no checks made on income levels.  And as these loans are mostly at sky-high interest rates, it seems unlikely most borrowers will be able to repay their loan.

Clearly, these signs of credit excess suggest the recent auto sales boom is now in an endgame. Nobody would be offering these types of deals, if the market was really in recovery mode.

Thus we can expect to see a continued decline in auto sales, once today’s credit bubble concludes.

WHAT NEXT?
Demographics drive demand.  And in the end, the chart tells the story.  Auto sales and housing starts rose in the 1970s due to the arrival of the BabyBoomers in their prime Wealth Creation period of 25 – 54 years.  There were 52% more Boomers born between 1946-64 than in the previous 18 years.

Naturally enough, this led auto sales and housing starts to reach record levels.

Equally clearly, today’s young, highly indebted Millennials and lower-paid minorities cannot replace this demand.  You cannot remove, for example, the deadweight of $1tn of student debt from this unfortunate younger generation.

Money that the Boomers used to buy homes and cars is now instead being used by the Millennials to pay off debt.  You can’t have it both ways.

About Paul Hodges

Paul Hodges is Chairman of International eChem, trusted commercial advisers to the global chemical industry. The aim of this blog is to share ideas about the influences that may shape the chemical industry over the next 12 – 18 months. It will try to look behind today’s headlines, to understand what may happen next in important issues such oil prices, economic growth and the environment. We may also have some fun, investigating a few of the more offbeat events that take place from time to time. Please do join me and share your thoughts. Between us, we will hopefully develop useful insights into the key factors that will drive the industry's future performance.