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Remember the looming "car-mageddon" I warned you about in January? Well, the auto sector continues reeling, and it's worse than I previosuly thought.

In short, I hypothesized that falling used vehicle prices, which lead to negative equity, tighter credit, surging missed auto payments¹ (the highest since the 2008-10 crisis), and stagnant wage growth would put considerable pressure on the auto sector.

So, seven months later, how do things look? Well, not very great. 

Let’s take a closer look at all this.

Rising Inventory Levels: A Signal of Sluggish Sales 

Automakers and dealerships are grappling with a significant challenge with all the excess inventory sitting idle on lots.

The slowdown in sales is primarily due to the increased difficulty of affording a car without an auto loan. For instance, car prices and interest rates are significantly higher than pre-pandemic levels. Thus, auto demand has suffered.

• Credit plays a huge role in the auto industry, with financing a vehicle being the only viable option for many. In 2023, a striking 81.98% of new car buyers and 40.44% of used car buyers required a loan². This reliance on financing amidst unfavorable economic conditions has created a major hurdle for the auto industry.

To highlight this point, according to Bloomberg³, inventory levels of major vehicle makers have steadily risen over the last two-and-a-half years.

Keep in mind that these triple-digit inventory levels recall the dark days for Detroit when overproduction was rampant. Too many cars chasing too few buyers led to depressed prices and shrinking profit margins.

• In Economics 101, we learned that when demand is low, prices must drop to encourage more buying. Think about how stores hold sales to attract customers and sell excess inventory.

To put this into perspective, according to Edmunds, car dealers are adding incentives (discounts) to clear out last year's models to make room for the 2025 models.

• Many vehicles are being marked down, with Electric Vehicles (EVs) seeing particularly high incentives, often exceeding 15% to 20% of average transaction prices, according to Kelley Blue Book.

Now, as a car buyer, this is a good opportunity. But for automakers, it's a desperate move that's obliterating profit margins.

• Remember it’s always a double-edged sword.

And this is exactly what we’ve seen happen. . .

Discount Strategies: The Double-Edged Sword of Price Cuts

Just last week, automakers faced severe hits to their earnings as they offered deep discounts to try and boost sales, only to see their margins crushed.

• Nissan Motor⁴ saw its operating profit plunge by 99% year-on-year in the second quarter of 2024 as sales slumped in the United States.
  
• Stellantis⁵ (maker of Jeep, Chrysler, Dodge, Fiat, etc) reported a 48% drop in first-half net profit due to weak U.S. sales.
  
• Tesla⁶ delivered 443,956 vehicles in the second quarter, 5% fewer than it did last year, and revenue dropped 7% after multiple rounds of slashing prices.

Thus, a weakening consumer is forcing these car companies to re-evaluate how they need to cut prices enough to bring customers back.

This situation – I believe - is likely to spark an 'auto-price war' as each company tries to undercut the others to gain market share.

For example, if Ford wants to sell more autos than GM or Tesla, they will cut prices lower or offer better terms. Meanwhile, unless GM or Tesla want their lunch taken, they’ll also cut prices even lower to spark interest away from Ford and back to them. And on and on.

So, it looks like auto producers are feeling the pain of falling prices and declining demand – weighing margins down (or in some cases – like we saw with Nissan and Stellantis - obliterating them). And this problem will likely continue at the current trend.

But still, there’s one other way you may be thinking about that could fix this.

“Can’t these automakers simply become more productive, therefore lowering costs in line with prices so that margins won’t diminish?”

While that’s true – and easily the best outcome – I am very skeptical of this.

The Stagnation Of U.S. Manufacturing Productivity

U.S. manufacturing sector’s productivity has been in a ‘dead man walking’ scenario (aka stagnant) for roughly 20 years - especially since 2008.

Keep in mind that without increased productivity, wages can’t really rise organically. Nor can innovation. Therefore, firms get squeezed by rising costs and begin laying off employees (or use debt to mask it).

To highlight this:

• Automaker Stellantis announced plans⁷ this week to once again reduce its U.S. employee headcount through a broad voluntary buyout, as the company attempts to reduce costs and boost profits.
  
• Tesla's internal data⁸ reveals that the company has reduced its workforce by at least 14% this year, with more cuts anticipated.

This is why the latest United Auto Workers strike⁹, which occurred in late 2023 amid demands for higher wages and fewer hours, was merely a temporary fix. Because without increased productivity, you can’t pay workers more (or as I mentioned above, use debt to mask it for the short term).

Now, while many structural issues have plagued the U.S. manufacturing sector (which I’ve touched on before here and here), this current situation doesn’t help in any way.

In fact, things are likely only going to get worse – thanks to China’s severe glut of producing electric vehicles (EVs). . .

China's EV Overproduction: Fueling the Auto Sector Crisis

As I’ve written to you previously – China is overproducing autos to try and export their way out of a severe slowdown.

• China’s Economic Slowdown: China is currently going through its own version of a 2008-esque property crisis. Thus, Beijing’s method of keeping growth going and reducing layoffs is to overproduce manufactured goods – a big one being autos.

The problem is that China is dumping these abroad (since it can’t find buyers at home) at a startling pace.

To put this into perspective, in June, Chinese brands captured 11% of the European electric car market¹⁰, achieving record registrations as manufacturers hurried to beat the new European Union tariffs that took effect earlier this month (it was zero in 2019).

Keep in mind that Europe – specifically Germany – is a major auto producer. So I am sure they aren’t happy about this.

Meanwhile, a report came out stating that BYD – China’s largest EV maker - is preparing to launch EVs in Canada¹¹, with lobbyists actively working in Ottawa ahead of the prospective launch. Analysts suggest that Canada could serve as a strategic entry point for the automaker's ultimate goal: the American market.

Finally, Japan – another major auto producer – is feeling the brunt of the Chinese EV glut. After launching its first EV, the Atto 3, in January 2023, BYD captured nearly 3% of Japan’s EV market in the first half of 2024¹² (that’s a huge gain in just one year). And according to JAIA, Japan's BYD passenger car imports increased 184% year-over-year.

• Competitive Pressure: Will Toyota, Honda, etc. be happy about BYD gaining ground on their home turf? Likely not.

The point is: that as China continues trying to overproduce and export their EVs all over the world, it saturates the market – leading to unemployment, crushed margins, and plant closures in the U.S., Japanese, and German automakers. I believe things will quickly turn from hot to cold in the auto space at this rate

Wrapping it Up

The auto sector cis still on shaky ground with many headwinds facing it. A weakening consumer, declining margins, enormous amounts of debt, and China's overcapacity have all become problems. Thus, I expect a further auto price war to amplify in the coming year.

My Quick Take:

• The Good: Anyone wanting to buy a car can get a better deal.
  
• The Bad: Automaker margins will see their profits squeezed, possibly impacting their share prices, and long-term viability, and leading to layoffs. More worrisome is the chain reaction this could set off throughout other industries (for example, how much steel, electronics, or copper go into autos?).
  
• The Ugly: The auto sector gets drowned out by Chinese EVs, leading to a contentious trade war that causes barriers of entry (import taxes) to surge like walls all around the world—potentially causing the gears of global trade to grind to a halt, leaving consumers worse off.
  

PS – an auto sector crisis will keep pushing used car prices lower, which would cause mounting negative equity for car owners who took out debt to buy the vehicle (aka when the debt is more than the car’s value). There’s over $1.616 trillion in auto loan debt, so beware.

But as always, this is just some food for thought.

Take care.

Sources:

1. Credit Cards and Auto Loans - FEDERAL RESERVE BANK of NEW YORK (newyorkfed.org)
2. Should I Buy a New or Used Car? Financing and Interest Rates (debt.org)
3. Carmakers Dangle Big Discounts as Inventory Swells - Bloomberg
4. Nissan's operating profit plunged 99% in April-June quarter | NHK WORLD-JAPAN News
5. Jeep, Dodge-maker Stellantis reports 48% drop in first-half profit (cnbc.com)
6. Tesla earnings: Automotive revenue falls 7% in Q2, robotaxi timing unclear (axios.com)
7. Stellantis to offer buyouts to U.S. salaried workers (cnbc.com)
8. Tesla has downsized by at least 14% this year, internal number shows (cnbc.com)
9. 2023 United Auto Workers strike - Wikipedia
10. China Electric Car Brands MG, BYD Grab Record Europe Market Share - Bloomberg
11. China’s BYD prepping to launch EVs in Canada: report | Driving
12. BYD breaks into Toyota-dominated Japan as EV sales climb (electrek.co)

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