Well damn. It’s pile on time when it comes to dour analysis of the US auto market.
Earlier this morning we brought you the latest from Goldman who has deduced that i) handing out 72-month loans for used cars to borrowers with no FICO score is probably a bad idea, ii) securitizing those loans is an even worse idea, and iii) it’s a good thing the auto market isn’t as big as the housing market, otherwise we’d be in a world of sh*t.
That of course comes on the heels on Monday’s “surprisingly” bad sales data…
…which woke everyone up to the harsh reality of plunging used car prices and what the knock-on effect of that is likely to be in terms of a deflationary doom cycle in the auto market.
Well, Goldman isn’t done talking about this on Wednesday. In a separate note, the bank’s chief economist Jan Hatzius strikes a similarly downbeat tone, although he keeps things polite by calling what we’re seeing “an unpleasant trend.” Read more below.
Auto sales dropped in March to 16.6 million, below the 17.5-18 million range of last year. Auto credit conditions also turned more restrictive recently with loan officers reporting tighter lending standards, rising delinquency rates, and slowing auto loan growth. As our auto equity research colleagues highlight, car sales have edged lower this year despite stronger incentives. Should we expect further declines in car sales in coming years?
To answer this question, we update our model of trend demand for autos excluding cyclical fluctuations. We break down the level of auto sales into two components, the number of autos needed to replace scrappage and the growth in the stock of autos.
(1) auto sales = auto stock x (% scrappage + %ch in auto stock)
We start with the scrappage rate, shown in Exhibit 1. It has averaged 4¾% over the last five years and follows a slowly declining trend over the long run. A trend scrappage rate of 4¾% implies replacement demand of 12.5-13 million per year given the current auto stock of roughly 270 million.
Next, we turn to the change in the stock of autos on the road, which equals:
(2) %ch in auto stock = %ch in adult population + %ch in licensed drivers/adult population + %ch in autos/licensed drivers
The Census Bureau projects that the adult population will grow 1% per year over the next few years. But this probably overstates the growth in the auto stock because the other two terms in the equation are quite likely to be negative or neutral at best.
First, the left-hand panel of Exhibit 2 shows that the share of licensed drivers in the adult population has fallen by 0.3 percentage point per year since 2008. The start of the decline in 2008 and the pickup in 2015 raise the question of whether the decline is cyclical. While the cycle likely played a role, the right-hand panel of Exhibit 2 suggests a more structural explanation. There has been a long-standing trend decline in licensed driver shares among younger age groups. Until a few years ago, this decline was offset by an increasing licensed share among older individuals. But as the licensed share among older people has stabilized, the decline among younger groups is now dominating the aggregate trend. Even assuming that half of the recent weakness has been cyclical, we expect the licensed share to decline by 0.1-0.2pp per year.
Second, the trend in the number of vehicles on the road per licensed driver has changed over the last 15 years. As shown in Exhibit 3, this ratio rose sharply until the early 2000s but has edged a bit lower since then. Although it is uncertain if the weakness is due to cyclical versus structural forces, we would pencil in a flat trend in coming years.
These estimates imply that the stock of autos on the road is likely to increase at a trend rate of about 0.8-0.9%, or 2-2.5 million per year. Combined with our estimates for replacement demand, this implies an underlying trend rate of auto sales of roughly 15 million, in line with our auto equity analysts’ estimate. Our central estimate depends on a range of assumptions, including an annual 0.1-0.2pp decline in the adult population driver share and a flat number of autos per driver. To gauge the uncertainty, Exhibit 4 shows trend car sales for a range of assumptions about these two parameters. While the range for trend demand is relatively wide, even the highest estimate of 16.1 million is still 0.5 million below the recent March low. (Longer term, the risks to these estimates are probably on the downside, especially if the “sharing economy”— exemplified by companies such as Zipcar, Uber, Lyft, and Via—makes deeper inroads into the transportation sector).