US Market Peak Heralds A New, Nervous Normal

Where do we go from here?

Where do we go from here?

After a five years of strong recovery in the US auto market, the jitters are coming back. Even with September sales posting nine percent growth year-over-year, the market’s nervousness with automaker equities is unmistakable. Ford’s stock has taken the most dramatic beating in recent days, but shares of all the big NYSE-listed US-market players are showing increased volatility and steady-to-sharp downward pressure. Even Nissan’s 19% sales boost in September, one of the month’s strongest performances, has been rewarded with a sell-off.

So what gives?

Though every automaker has its own story, the general nervousness around autos is largely explained by the fact that the US auto market has reached its pre-recession volume, and there’s little reason to think it has much further to go. Seasonally-adjusted sales have exceeded 16 million units for the last six months, even reaching as high as 17.5 million units in August, and a quick look at the market’s historical performance shows that growth above these levels doesn’t tend to last long.

More importantly, the market has returned to the “old normal” on the strength of expanded credit rather than job growth. The rise of subprime and 72+ month loans probably don’t create as much risk for the broader economy as the mortgage bubble did in 2008, but there’s no denying that it pulls demand for new cars forward. Unless auto credit loosens much further, something people don’t seem to be crying out for, it’s not easy to imagine the car market continuing to outpace jobs and wages the way it has since 2010. In other words, the US looks increasingly like it belongs with Japan and Europe in the dreaded “mature market” category.

With growth in Russia, India and South America running into structural and political obstacles, global automakers are running out of markets in which to predict the volume growth they need to compete. The combination of volume and margin in the US market’s credit-fueled recovery, which has seen Americans largely upgrading to more profitable trucks and crossovers, has helped cover weaknesses in other markets. If the fluff goes out of that cushion, the scramble for global volume is turning into a fight for margins that would have more marginal players heading into trouble (and doubling down on a Chinese market that, volume opportunities aside, has its share of challenges as well).

There’s already a taste of this competition in the premium space, where too many pretenders are chasing a limited high-margin segment. As the US market slows, firms with big exposure, weak premium brands, heavy dependence on pickup and SUV margins and questionable profitability on mass-market models (see: the artists formerly know as the “Detroit Three”) will feel the squeeze in all-too familiar ways. Indeed, any automaker currently “buying volume” under the cover of opaque US market reporting runs the risk of some serious pain.

After all, the most far-sighted players in the US market have spent the recovery focusing on protecting margins rather than expansion. Toyota started tightening the belt over a year ago, announcing it would make no new plant investments until at least 2016, consolidating its North American headquarters and focusing on “investment efficiency”. It’s easy to understand why: while Ford, GM and Chrysler cut tens of thousands of North American jobs between 2006 and 2010, Toyota endured bitter overcapacity for several years without a single US layoff. Having clawed back from that ordeal, Toyota’s management seems willing to leave some expansion-driven sales on the table in order to avoid repeating the experience.

Which brings us back to the investors turning bearish on auto stocks. Clearly a good deal of pessimism about margins across the auto business is justified, as a maturing US market will turn up the competitive pressure. But investors also have to realize that the chase for short-term profits is precisely what leads to the auto industry’s unsustainable business models and self-destructive cyclicality. Automakers who haven’t gotten greedy during the recovery will survive the downturn, and are already planning for the next recovery.