The unprecedented, good times that the auto industry has enjoyed are starting to contend with economic volatility that’s equally unprecedented. That combination makes answering the “what’s next” question much harder and leaves dealers sifting through today’s economic indicators and consumer buying data as they project a path forward for their businesses.
Looking at the big picture
“We’re getting mixed signals from the economy—annualized gross domestic product (GDP) declined in both the first and second quarter, while in the other direction, U.S. payrolls increased in August by 315,000, roughly in line with the consensus,” says Michael Skordeles, Senior U.S. Macro Strategist at Truist Wealth.
“GDP may signal a slowdown, but labor market conditions are still solid—unemployment rose slightly to 3.7%, and the labor force participation rate saw a small increase, with gains in all major industry groups. Average hourly wages have been steady on a year-over-year basis for the third straight month,” adds Skordeles.
Retail sales are strong and orders for durable goods are up as well while trucking and rail volumes grew again in August. Several manufacturing gauges held steady in August, and new orders rebounded after contracting for two straight months. Also, the pullback in the price paid component over the last five months suggests that inflation may have peaked in manufacturing.
Gas prices have fallen sharply from their peak earlier in the summer, but inflation hasn’t disappeared. Combined with the solid, but cooling labor market, Skordeles believes the Fed will remain laser-focused on combating inflation for the remainder of 2022.
Skordeles expects the economy to deliver more of the same—generally tightening financial conditions, a volatile bond and stock market, and prolonged sluggishness that’s already showing signs of cooling the overheated economy. He also believes that a U.S. recession isn’t necessarily inevitable.
Is auto retailing set for a soft landing?
The auto industry should be similarly positioned for a slow transition back to normal. Bill Jones, head of Truist Dealer Retail Services and CEO/President of Regional Acceptance Corporation says, “There’s a confluence of forces in the marketplace that I think will result in a gradual return to familiar operating conditions in the industry. But those forces are varied and, in some cases, are competing with each other.”
Pricing in used cars has eased—from June to July, the average sales price of a used car dropped 1.2%, in line with the historic annual depreciation rate of 15-20%. “Used cars are going to go back to a normal cadence of depreciation,” says JT Taylor, head of Automotive Retail at Truist Securities. “Last month was the first 30-day snapshot showing that trend. What we’re observing in used car values bodes well for the car business, because the demand is still high, and people are working.”
“We've never been in a recession with unemployment as low as it is right now,” Jones adds. “If you go back to the Great Recession, around one in every 10 people were out of work. That’s not the case now—we’ve got a much more resilient consumer, even with inflation running at a high rate.”
Tightening credit as Fed rates rise
Even with high employment, inflation and the reduced new vehicle output are pricing some consumers out of the new car market. The average price of a new vehicle jumped from around $27K to nearly $50K in just four years, and the full-sized pickups that Americans love now carry an average sticker price of $62K. Those prices leave a substantial number of buyers unwilling or unable to afford a new car or truck, while rising interest rates and a tightening credit market mean many buyers lack the borrowing power to purchase one.
“Lenders are normalizing after the effect of the CARES Act, which pumped liquidity directly to consumers and prompted lenders to provide extensions on loans,” Jones explains. Delinquencies were at historic lows, lifting lenders’ asset quality to new highs. As portfolios return to usual levels, Jones adds, “Lenders in the auto marketplace are being conservative about credit quality, loan-to-value ratios, minimum incomes, risk mix, and risk tiers.”
The market should remain strong for both new and used vehicles for some time. “We’re seeing plenty of pent-up auto demand right now,” Jones says. “Consumers are sitting on the sidelines—subprime consumers have been priced out of the new car market, and there are prime consumers who aren't willing to pay the current prices over MSRP. As prices come down, those people will come off the bench.” Only when that pent-up demand is satisfied can we expect a return to usual market conditions—and more typical margins for dealers.
Facing an uncertain future
While dealer margins have been high, “Most dealers expect a rationalization of margins to happen over the next few years, when supply more properly aligns with demand,” says Taylor.
What will buying patterns look like once this period of constrained supply ends, and how can automotive leaders prepare their dealerships to thrive in the more competitive marketplace of the future? The volatility of recent years makes predictions difficult, but owners should:
- Watch the Boomers. They’re retiring in record numbers, and they’ve always been crazy about cars. The labor participation rate is down, particularly with older workers. Will their exit from the job market change their buying behavior?
- See how high gas prices will alter the market. At this summer’s peak, car buyers briefly retreated to sedans despite their affinity for big trucks and SUVs. Will gas prices stay above the critical threshold that makes sedans more desirable again?
- Consider the impact of environmental concerns on consumer choices. The shift to EVs is inevitable, but slow, with movement at the high end of the market but few options for other buyers. Are government incentives and green sentiment among some consumers enough to drive a dramatic change in purchasing patterns?
Choosing to grow or go
Dealers cutting back on variable expenses have seen higher profit margins in the short term, but strategic investment is critical for long-term success in the industry. “Dealers are advertising less. They are stocking fewer cars. And they're operating with fewer people as they invest in the right tools that boost productivity. But long-term success comes from healthy investment in both the tools that drive costs out of the business and the people who can use them effectively. That’s the winning hand for dealers,” says Taylor.
Jones adds, “There’s a digitization revolution going on right now in auto retail financing, and it’s reducing the need for salespeople, finance people, and office staff. But to invest in that, you’ve got to have a strong balance sheet. Dealers can’t allow today’s high margins to lull them into failing to invest in tomorrow’s success.”
For those who aren’t willing to invest the money or time necessary to join the next phase of auto retailing, 2022 represents an opportune moment to exit, with business valuations high and buyers plentiful.
“Invest in the future of the business or exit at the top of the market? Smart dealers will gravitate to one of those poles,” says Taylor. “This is the golden age of auto retailing—high profits, high value, fairly liquid market for my business if I want to sell, and available businesses if I want to buy.”
When attractive options are plentiful, it’s not time for strategic procrastination. Commit to growth and making strategic investments that will enable your dealership to thrive long-term. If you’re wavering on the investment and the energy that growth requires, think about exiting while the market is high. Don’t hesitate—auto dealers must be ready to compete as the market returns to normal.
Plot your path through the ongoing economic volatility.
Talk to a Truist Dealer Services relationship manager about strategies to help you manage your balance sheet during this volatile economic cycle. For more information, visit Truist.com/dealerservices.