Phone: 630-495-2282 Fax: 630-495-2260 Map/Directions

CPA examines how to move through an automotive recession

November 17, 2010

By Erich Merkle

There has been much talk recently about whether the United States is in a recession. Although we first saw signs of a correction in the housing sector of our economy, the automotive sector remained remarkably healthy, all things considered, through most of 2007.

Recently, however, we have begun to witness a spillover of the problems in the housing sector into U.S. light-vehicle sales. This weakness grew more evident in July as the industry produced a very disappointing seasonally adjusted annualized rate of 12.6 million units.

Why so glum?

A close look at consumer sentiment might help shed some light on the sharp decline in auto sales. The University of Michigan consumer sentiment index historically has tracked very consistently with auto sales.

Declines in consumer sentiment during the early 1980s, early 1990s, and in current years provide a significant amount of downward pressure on consumers’ ability and willingness to purchase new vehicles. A slight dip in consumer sentiment during the early part of this decade wasn’t significant enough to materially pull sales down.

Sales numbers got some help at that time from automakers pushing incentives. General Motors initiated the incentives drive in October 2001, just after Sept. 11, with its "Keep America Rolling" zero-percent financing offers. Other automakers soon followed, which allowed the industry to artificially prop up demand for cars and light trucks for a considerable period of time. Additionally, the very mild recession of 2000-01 was not a consumer-driven recession; rather, it was a result of a contraction in capital spending on the part of U.S. businesses.

Today’s challenges

Consumers today face a number of challenges that will likely make this automotive recession look much more like that of the correction in 1991-92. Consumers are facing high levels of debt against the backdrop of declining asset values.

Home values, once thought to be impervious to decline, continue to slide. As the value of most consumers’ largest asset declines and the price of fuel continuesto rise, consumers have begun to feel less secure financially.

Combine this with deterioration in the labor markets, and light vehicles sales will continue to be muted for some time as a result.

Credit markets in the near term, including banks and the lending arms of automakers, will also place continued downward pressure on light vehicle sales, as many are just not inclined to provide lease financing any longer given the uncertainty surrounding vehicle residual values.

When many of the leases on pickup trucks and sport utility vehicles were made in 2005 and 2006, the residuals of these vehicles were thought to be rock-solid.

New-home construction was hitting record levels and gasoline was extremely affordable by historical standards, creating a very fertile environment for these large products.

Today, new-home construction, which dramatically supports and is highly correlated to sales of pickups, has declined to almost 20-year lows. Additionally, fuel prices are at record levels, even when adjusted for inflation.

When does it turn?

While these types of corrections can be difficult to determine, history does provide some clues. We have been through credit crunches before. Fuel price spikes aren’t new either. We submit that this period of instability in the credit markets and the current spike in fuel prices will not last forever.

Although the automotive industry will weather these latest challenges, the next 12 months will not be without a little pain and uneasiness.

A deeper recession?

It is reasonable to believe that this automotive recession will be deeper than the one experienced in 2000-01, especially given the soft sales numbers to date, consumer sentiment levels, and credit conditions.

The current correction is already well beyond that of 2000-01, with July annualized sales results down almost 9 percent year-over-year.

Conversely, we don’t see conditions in the overall state of the economy producing a correction anything like the one experienced in 1980-81; today’s economy is not experiencing the same double-digit inflation and unemployment levels it was then, so light vehicle sales should bottom out by midyear 2009.

While we should start to see some sales gains on a sequential basis by the second quarter of 2009, gains on a year-over-year comparative basis likely won’t come until the second half of next year.

The writer is a senior manager with Crowe Horwath LLP in the Grand Rapids, Mich., office.