Car Sales Just Might Save The EconomyBy Lacey Plache August 8, 2011
July car sales, coupled with recent growth in jobs, constitute a direct challenge to growing concerns that the auto industrys ability to regain sales momentum as production recovers is in jeopardy. Such concerns have surfaced recently as a result of declining consumer confidence and weak economic conditions. However, July car sales increased to 12.2 million units on a seasonally adjusted annualized basis (SAAR), after two months in which sales sharply fell in response to shortages and higher prices. Fridays jobs report revealed that 117,000 nonfarm jobs were added to the economy in July, contributing positive economic news to what has become an increasingly dismal economic landscape. The report not only beat consensus expectations of 75,000 for July, but also revised Junes very low 18,000 to 46,000. Together, these two data releases indicate at least one path that could take us out of the current soft economic patch and return the auto industry to its earlier 2011 momentum, namely a virtuous cycle in which auto sales spur growth in jobs which then spurs more growth in auto sales.
Headed In The Right Direction
The July car sales increase marks yet another reversal in the path sales have followed this year. The SAAR averaged 13.0 million units during January to April, but fell to 11.8 million in May and further still to 11.4 million in June, reflecting aftershocks of the March 2011 Japanese earthquake. After the earthquake, production disruptions led to supply issues, which in turn resulted in higher car prices. Higher prices naturally led to reductions in sales. As production revives, inventories and prices should also improve, followed by improvement in sales. July sales showed the beginning of this sequence. Of course, based on the SAAR, July sales were still weaker than pre-earthquake sales, but given that the industry is not yet back to full production, expecting a full recovery of sales would be premature at this point. Rather, the encouraging implication of the July results is that the sales recovery from the earthquake does indeed appear to have begun as expected.
Toyota in particular was a key contributor to the sales recovery in July. Toyotas data reflect its return to full production in June for eight of the twelve models it builds in North America, including the top-selling Camry and Corolla. As Toyota production resumed, it reported that its inventories began to grow, and incentives and sales have increased accordingly. Nissan is also making progress, aided by the happy occurrence that its production was less affected than Toyotas or Hondas. In contrast, Honda, the most impacted by the earthquake, is lagging behind its competitors in production and, thus, sales recovery. Its sales actually decreased in July, reflecting in part the fact that its production will not return to normal until at least August.
Car Sales Helping Jobs Helping Car Sales
Also encouraging is the indication that the car sales recovery already is having a positive impact on the broader economy, as shown by Fridays jobs report. Private nonfarm payrolls increased by 154,000 in July, surpassing the consensus forecast of 108,000 by nearly fifty percent. Auto industry jobs accounted for half of the 24,000 jobs gained in manufacturing and ten percent of total jobs gained. In addition, the auto industry recovery also was cited as a contributing factor to Julys wage growth. Average hourly earnings rose 0.4 percent, surpassing expectations of 0.2 percent. Julys wage growth was the highest month-to-month increase since November 2008.
As I discussed last month, if the expected rebound in car sales can help fuel a labor market recovery, the ensuing job growth will then support a further recovery of car sales. The situation facing the auto industry is as follows: for the next few months, supply will expand as production returns to normal, thereby exerting pressure on prices to become more competitive. Both greater availability and lower prices will encourage car sales and, in particular, trigger the release of deferred demand from consumers who held off making car purchases earlier this year when supply was limited and prices were higher.
Edmunds estimates that more than 2.5 million (and possibly more than 3 million) units, on an annualized basis, have been deferred. Based on these expected sales, Edmunds is forecasting that the SAAR will return to more normal levels in the high 12 million units range, and then increase to the high 13 millions as a bubble of deferred demand inflates sales. However, after this deferred demand is depleted, maintaining the SAAR at or above 13 million units, as the industry experienced pre-earthquake, will require sufficiently strong underlying economic conditions to drive demand.
Until Fridays jobs report, the recent economic data, including output, income, and sentiment, increasingly had supported the likelihood of the current economic soft patch turning into another recession. One economist, David Rosenberg, asserted that this recession is inevitable and may have even already begun, while others raised their odds in favor of a new recession (e.g., Martin Feldstein gave it a 50-50 chance of occurring, while Larry Summers checked in at 1-in-3.). Given the current weakness in many parts of the economy, the contribution from growth in car sales to improving economic conditions during the next few months could be critical to strengthening the economy enough to support car sales later this fall.
Hope Amidst Many Headwinds
The weakness of other economic factors that have supported car sales in the past also illustrates the important role to be played by the virtuous cycle of deferred-demand-driven car sales and economic growth. For example, wealth effects generated by both a strong stock market and grossly inflated housing prices supported consumer confidence and, as a result, consumer motivation to make large purchases of durable goods, such as autos, prior to the recession.
Recently, economic weakness and increasing uncertainty due to the debt crisis in Europe and the debt ceiling negotiations and threat of default in the U.S. have led to increased volatility in the stock market, which dropped over 1,300 points in the two week period from July 21 to August 4. On August 4 alone, the market lost over 500 points. After a slight rise on August 5, the stock market fell an additional 300 points further still on the morning of August 8 in reaction to the weekend news that Standard & Poors downgraded the U.S. debt from AAA (the highest rating) to AA+. However, there may be some limit to the markets reaction since not all ratings agencies share S&Ps views; Moodys, for example, is maintaining its AAA rating for U.S. debt, albeit with a negative outlook due to political squabbling in Washington. Still, the heightened uncertainty and the accompanying loss in market value likely means that consumer confidence, which already has been falling with earlier stock market volatility related to rising fuel prices and the production disruptions in autos and other sectors, will fall further, unless counter-balancing forces emerge. One such force, housing market performance, is also unlikely to contribute to a wealth effect, or confidence, in the coming months, since the housing sector is still beset with declining home prices and high levels of loans in foreclosure. In fact, it is unclear that a recovery has even begun in that sector. Decreased consumer confidence will dampen consumer motivation to buy autos and thereby threaten autos sales.
Our 2011 Forecast Is Still 12.9m
The sales strength demonstrated earlier in 2011 showed that the auto recovery was gaining strength. While various headwinds, especially post-earthquake supply issues and rising prices, exerted drag upon the recovery during the past few months, we believe that lower sales were not a fundamental decrease in demand but rather the result of deferred demand. This deferred demand has the potential to revive car sales as Japanese automakers return to full production and prices are driven downward by growing inventories. However, recent events have raised the question of whether deferred demand will actually be released or be deferred further by declining confidence and declining economic conditions. That is, are we at the beginning of a virtuous cycle of positive feedback between car sales and economic conditions, or a vicious cycle in which weakness in car sales and in the broader economy is mutually reinforcing? The interplay between July car sales and job growth indicates that a virtuous cycle is still a viable possibility, but the continuation of the cycle in August is critical. Thus, based on evidence from July, we still expect that sales in 2011 will hit our beginning of the year forecast of 12.9 million units and are currently maintaining that forecast. Whether we maintain it beyond August depends critically on how car sales grow and the resulting impact on the economy in the month ahead.