Latest / Market Pulse / Auto Industry Outlook for 2023 with Jonathan Smoke
Transcript
- Equifax Market Pulse podcast Ep. 20 Transcript Katherine (00:02): Welcome to the Market Pulse podcast. I'm your host, Katherine Doe, a product marketing director here at Equifax for our risk portfolio. In this episode, we're focusing on the auto industry and how auto dealers and lenders can build resilience into their 2023 planning. But first, we'll get a quick economic update from Dr. David Fieldhouse, director of Consumer Credit Analytics at Moody's Analytics, David. Katherine (00:37): Turning back to the auto industry, we're seeing that used retail vehicle sales are down and auto loan performance continues to deteriorate, and that's according to the latest Cox Automotive Auto Market weekly summary. We're also anticipating a bright spot this year could be the expected EV market. To help us dig deeper into these insights and more, we're pleased to welcome back Jonathan Smoke, chief Economist for Cox Automotive. Thanks for joining today, Jonathan. Jonathan (01:15): That's great to be with you, Katherine. Katherine (01:17): Over the last two years, we know that auto industry has experienced severe inventory constraints leading to record high vehicle prices and with a looming threat of a recession or perhaps a downturn in 2023 and supplies starting to see signs of recovery. Over the last two years, the auto industry has experienced severe inventory constraints leading to record high vehicle prices and with the looming threat of a recession or perhaps an economic downturn in 2023. But we're starting to see signs of recovery with the supply chain. What are your predictions for this year in terms of vehicle sales? Jonathan (02:45): Well, our predictions are not bullish for 2023. It's an unfortunate timing for the industry that many of the supply problems are starting to resolve just as the prospect of a recession all starts to manifest itself. Production is not back to normal, but it has started to recover and has been improving quickly over the last several months. We started 2023 with about 800,000 more vehicles in new vehicle inventory than we had a year ago. And most of that improvement came actually in the final four months of last year. But that still leaves us with less than half of the inventory we had at the beginning of 2019. So we are by no means, quote unquote, back to normal. There are lingering production and supply chain issues, but we mainly see them when we look at vehicle production from the different regions of the world. Jonathan (03:38): Basically Asia and European production still see problems and have seen the least amount of recovery so far. But by contrast, north American production is close to normal. And as a result, we basically see domestic brands in the best shape from a supply perspective, while Asian and some European brands are further behind. The lingering supply chain issues lead us to assume that we won't bounce back to pre-covid production and sales levels in 2023. But if we can avoid a recession, we should see recovery in new sales start to begin. And we think the most likely range is somewhere in the low fourteens. 14, one to 14.6 million is most likely, and that would only be a gain of about three to 7% from last year's 13.7 million. But in addition to lingering supply chain and production problems outside of North America, what's possible in sales is also limited by the prospect of a recession and deteriorating demand. Jonathan (04:40): And I believe that manufacturers are weary to push production growth aggressively in that context. They have their suppliers already pushed, they have labor challenges, and there are new UAW contracts coming up for many several manufacturers this year. So to see 10% or more growth, they run the risk of driving up labor and input costs to get that growth just as demand weakens. So one of the reasons why we're pretty conservative in our outlook is simply put, if I were a manufacturer, I'd rather sell 13 million with no incentives like they did last year than sell 15 million with 20 nineteens level of incentives, which was dramatically higher and more expensive for them. So as a result, I think many are already pulling back or at least getting ready to pull back from otherwise would be what would be even stronger momentum. And that's a key reason we're on the low end of what some others are projecting. Jonathan (05:41): Yes, we could sell more, but the key question is really at what price. And then finally, if we do have a recession, we'll see production decline as a result then of lower production and weaker demand. We think we could see another leg down of 10%, much like the decline that we had in 2022. But if you add the 2022 and 23 declines in such a recession scenario, the decline would not be as bad as an average recession that we've experienced historically. Furthermore, we're very supply constrained, and this would end up being a far more profitable recession for manufacturers and dealers alike, which is a concept that none of us really contemplated prior to kind of living through these current conditions. Katherine (06:29): And that's a lot of great insight there. I did want to go back to you mentioned the USS and supply chain and production is looking more favorable than in some other regions. Why is that? Is it anything to do with policy? Is it covid waves of covid continuing materials? Jonathan (06:52): Yeah, it's, it's a combination of things. One is our approach to covid means that North America has basically built-up immunity through exposure and through effective vaccinations as diametrically opposed to the covid strategy that China pursued, that is leaving them still subjected to a lot of risks of outbreaks, but also shutting down parts of the economy as they deal with those outbreaks. And as a result, Asia has essentially taken several steps back at times in 2022 when in North America we were powering ahead. And I think Europe would probably be in the same place that we are in North America, had it not been for the war in Ukraine. And the war in Ukraine has disrupted some of the assembly work that happens across Eastern Europe. But most importantly, it's really the overall impact it's had on energy costs and energy availability that has otherwise throttled the overall production that we see across the board in Europe. So it's really the, you know, I guess it's good policy on covid, bad luck you know, having to do with the war and, but those things aren't going away. So again, it's another reason to expect to be conservative and expectations for how production rebounds in those regions of the world in 2023. Katherine (08:24): And so you mentioned a lot, but I do, I am curious, what do you see as the most they're the biggest challenge or the thing that if you were in this industry as, as maybe let's say a dealer or a lender maybe each of those, which, which is the biggest challenge for each? Jonathan (08:49): Well, as we just discussed, a recession looms large, and I think that's on everybody's minds. It has implications for supply that people are not considering like I just mentioned. And of course, it would impact demand, you know, simply there's a positive correlation with vehicle demand related to job creation. So job loss doesn't help vehicle demand if we were to experience it and a recession would delay the recovery of the new vehicle market yet another year. And when we look at the broader landscape for the used vehicle market, that delays the recovery that eventually ha follows in the used vehicle market as well. So that's definitely a top challenge. But beyond that e economic cycle concern, I think the single biggest challenge facing the auto industry in 2023 and for years to come frankly, is affordability. It is changing who can buy in the new vehicle market, and as a result it is changing what is being produced with changes that have already occurred in what was produced over the last three years. We have a lack of affordable and young supply in the used vehicle market today. And then when you combine that with interest rates now being at levels we haven't seen in 20 years, and we have a problem creating payments that are affordable to median and lower income households and to consumers with less than prime credit. And that's not a situation that's going to, to improve for in the foreseeable future. Katherine (10:53): So affordability, that's a great segue. In my personal life, I was chatting with a neighbor about wanting to put a fence in my yard and got some quotes and, you know, lumber as, as that, that's also gone up and down through Covid. And I got the quote and I said to her, you know, it's the price of a used Kia to put in a fence in my tiny yard. And then I realized it's actually not , it would be two used Kias in today's market with affordability. You mentioned making affordable payments or payments affordable for consumers is a challenge. So is that changing the profile for auto shoppers and what does that look like for loans terms what does that mean for the market? Jonathan (11:42): Yeah, it has huge implications and I love the fact that you immediately related it to a housing related situation because affordability is unfortunately a hot topic in two major industries that are critical to living and working in the us housing and au automotive. And it's the lethal combination of product price inflation that has been a result of constrained production and supply corresponding with very strong demand combined with now 20 year highs in interest rates. So it can't be solved very easily without changing all of those factors. And, and we don't see a resolution to those factors anytime soon. And an auto affordability is also being challenged by tighter credit conditions, because one way that payments have been otherwise lower than what we would've seen over the last five to 10 years has been, average terms have been expanding. But one of the things that we observe observed happening, especially towards the end of last year, is that average terms are now shortening again. Jonathan (12:53): And when you combine that with the other thing that we observed throughout last year with down payments growing that really causes the consumer to have to put more money down get less affordable payments. And of course that it's the payment that really matters in the affordability calculation. The changes so far when you look at the composition of who's buying and how that's impacting the, the loan pool has been most dramatic in the new vehicle market. Last year we saw for example, when we look at income distribution share gains of about seven percentage points in people with incomes over 125,000 at the expense of share of people who are in lower incomes at median than and lower levels. In addition, we're seeing a clear drop, and I think it's even more dramatic in the credit data. Jonathan (13:51): So we use our dealer track platform is one of the top two indirect lending platforms in, in the country. So as a result of it through it, I can see very real-time indicators of who's buying and what payments are they making, you know, what kind of rates. Well, last year we saw a clear drop in subprime and deep, deep subprime consumers in that platform for the new market. Historically we have had lower subprime representation in who gets auto loans compared to the US population, because, for example based on Equifax data looking at Vantage score, I think subprime is currently about 20% of consumers with a credit profile in, in the us but prior to the pandemic, we averaged about 15% of new auto loans going to subprime. And that makes sense. The vehicle market is catered to a higher income, higher credit quality consumer. Jonathan (14:50): A lot of financing options like leasing are almost exclusive to higher credit quality consumers, so it makes sense that they would be underrepresented, but at 15%, still a very important part of the market. Well, guess what? It was in December on our platform, 5% was subprime. And similarly deep subprime was closer historically to about 7% of new loans. It was 0.5% in December. So basically almost completely disappeared. And the trends in, in used are similar, just not as dramatic yet. So effectively what this all means is we're reducing who can buy the buying pool is smaller, but then when you think about it in terms of the loan base, it means that we have a much higher quality loan base, and that is likely to impact what we see in terms of loan performance going forward, frankly, for the better. Katherine (15:52): There's, for lenders for sure that would help portfolios. I guess if you're thinking about the broader economy or implications for labor, if, you know, people in lower credit profiles can't get a car or transportation, what are the implications there if we're seeing fewer and fewer subprime? Jonathan (16:14): That is absolutely a huge implication. And, it's why I'm more concerned about this over the longer term than necessarily just what it means right now because regardless of where rates go, one of the problems is what is being produced in the new vehicle market. And you know, I mentioned that earlier manufacturers have shifted to producing what higher income and wealthier consumers can afford, which is increasingly more expensive vehicles like full-size pickups and SUVs and luxury vehicles. But this is being done at the expense of affordable sedans and entry level vehicles. And that's even a phrase that probably doesn't really apply to the new, to the new vehicle, any market anymore entry level vehicles. The problem is that there are only so many of those households. So as a result, we're probably also being oriented to a new vehicle market that's going to produce fewer new vehicles than we historically have seen, because the buying pool is shrinking. Jonathan (17:20): So, and then even it gets even more complicated because within the segments and models being produced, we are mainly seeing only the high-end configurations being produced as well. So when you add all that up, that means the used market will be fed by fewer of, and increasingly more expensive vehicles that will take years of depreciation to eventually create a price point at which an affordable payment can be produced. And that's even if interest, interest rates stop going up and eventually start coming back down a bit, it's an environment where demand will be constrained and fewer transactions can be made as a result. And the implications for the US are huge because we are very dependent on private transportation. We have something along the lines of a 93% vehicle ownership rate. So vehicles are a key part of how we get around. Jonathan (18:16): And if anything, the pandemic has caused people to migrate to places that are even more vehicle dependent than what we had previously. And public ridership is down. There are a lot of things that basically say the car is even more important. And this absolutely, just like housing, I believe transportation affordability will be a strain on the US economy and, and what we can produce. And you know, I guess the good news is there's going to be a lot of people seeking solutions to this because there's plenty of people who will represent opportunities if you can come up with new solutions. I also think if you're trying to look for the silver lining, well there's a couple one vehicles are lasting longer. So that gives us an opportunity potentially to work our way through this. Jonathan (19:13): And as we talked about the loan basis, higher credit quality two, which should mean that loan performance is stronger and can enable lenders to you know, pursue other areas where risk could be increased. Because it's being offset by, you know, that stronger loan performance. And one of those could be a return to longer terms that might make sense even in a used market that traditionally has been much shorter terms and much higher risk. And I do think eventually rates will peak. There's no question that everybody's forecasting that rates will peak sometime in 2023. It's just a question of when they start coming down and how much they will start coming down. So when that happens too, we will eventually at least no longer see this affordability calculus getting worse and worse every month. But, you know, it's a multifaceted scenario and, and no, no easy solutions, but one, I think the industry including auto finance nee needs to be looking for ways to solve. Katherine (20:21): Well, let's change gears a little bit. Certainly lots to look at on the horizon with affordability. But in terms of how consumers are shopping during the pandemic we saw a lot of consumers turn to online shopping certainly pre-ordering. Do you think that trend or either of those trends will continue or will we go back to brick and mortar business as usual? What's on the lot? Jonathan (20:49): I think it's a little of both. The shift to online shopping and pre-ordering, no question was accelerated by the pandemic. But we don't see evidence of it fading when it comes to what consumers say they want to do and, and how they're acting out. But I think it's a little bit more complex than that. And it's not just about low supplies, basically created the only environment that this would take place. The recent research our market research team at Cox Automotive did found that three quarters of shoppers indicated that they are more likely to buy from a dealer in 2023, who provides the ability to comp complete nearly all of the buying process online. And I think that's an indication that consumers just expect it. And frankly, I think it's directly related to how understanding the credit situation and what their rates will be and how that relates to their payments is such an important and upfront part of the purchase process that in their minds you have to be able to do all of the process upfront because they can't even figure out if they can make a purchase happen without knowing the end endgame of the old world. Jonathan (22:09): That was completely dependent on literally working through departments at the, at the dealership. But it's, it's sort of ironic because I would, I would point out that we continue to, to be buying a physical asset that, you know, that we're talking about and we believe that fully digital vehicle purchases, meaning transactions that are a hundred percent done online and the vehicle is simply delivered at the, at the consumer's house without any other interaction, will actually only represent a small percentage of the business. And we don't really anticipate that going up much because actually what the consumer surveys indicate. And more importantly, what we observe consumers doing is that most buyers desire and want, you know, what the industry refers to as an omnichannel vehicle buying experience, they want to complete some purchase steps online. They absolutely don't want to have to repeat. Jonathan (23:12): They want it to be very efficient. So the thing that would make them most upset is to do some things online, then show up and find out they have to start all over again with that TRA transaction, but they actually want to go in the dealership. They want to touch, drive, and smell that new car. So, you know, for, for us in the business of providing the platforms and helping to do the transaction, it basically means we have to give them their cake regardless of how they're going to slice it and eat it. But I, you know, I, I do think it, it does mean the credit part is freed from the old shackles that really prevented a lot of people from exploring what's possible. Katherine (23:53): Yeah. De demystifying some of that process and putting a little bit of power back into the, the hands of the consumers probably a good thing as we look ahead. So let's change gears again. I mentioned at the top of the podcast the EV market and the EV landscape changing so much. And looking ahead it looks like the, the stats we're seeing that EV makers are cutting prices to make vehicles more affordable. And over the next few years more than a hundred EV models are due to be introduced. So what are you anticipating in terms of adoption? Any barriers that the industry needs to overcome? All the things we've already talked about with pricing supply chain what do you think? Jonathan (24:42): Yeah. Well, the EV part of the market is, is the positive part of the market. No question about it. There's no negatives there. We're forecasting growth. We've started the year yes, with a lot of high-profile price cuts being discussed. And at the same time, we have the new tax credits that we think will also play a role in demand this year. So there's no question the EV market is the star growth part of the auto market. It's where all the excitement is going to be, and it's frankly where all the future is going to be kind of based on what happens. And we're going to see some important growth milestones for electric vehicles in 2023 that is, is enabled by supply. We expect more than a million pure battery electric vehicles to be sold in the US for the first time. Jonathan (25:33): There's going to be 27 new model launches that are helping to power this. Most of those model launches are coming from traditional brands. So way more than what we've seen up until now. This means the average dealership is going to have something to offer consumers, and this isn't just a Tesla thing and a California thing, this is happening across the country. And what I mean by it being supply driven is that I don't think we're close to saturating the potential demand from willing buyers with these volumes with expanded product availability as well as those lower prices and tax credits coming from the government to motivate buyers. We expect continued good news in terms of what we see for sales. And so if we sell what is produced and delivered, we think battery electric vehicles will reach 8% of all new vehicles sold in the us. Jonathan (26:32): Which, you know, we hit 5% this past year for the first time. And, and 8% will be continued strong growth. And actually what I find most interesting is if you add in all hybrids and look at quote unquote all electrified vehicles they will reach a quarter of all new vehicles sold in the US in in 2023. So electrification really is, is becoming more common stream. And that means the car park is increasingly becoming more electric and down the road. That means more used vehicle sales will also be electric. And of course, that's where we're focusing on a lot of the opportunities or challenges, because historically the used vehicle market judges the value of a used vehicle primarily on mileage. And in the future, mileage isn't going to mean much for a battery electric. Instead, understanding where that car has, has been driven, how often it's been charged, how it's been charged, those are the kind of things that are going to tell you what is the health of the battery and what is it's likely life. Jonathan (27:42): You know, I don't want to overstate and necessarily say there are no barriers. There, there definitely are barriers, but what we see in consumer survey data is, is that the objections to electric vehicles are declining. The top three are the lack of charging stations and infrastructure. Which prior to last year, the percentages on that were the majority of people, but for the first time, we fell below 50% of people saying there was a lack of charging stations. So we are seeing growth, and that's a chicken and ag issue. We need more vehicles out there in order to justify having more charging stations that could be managed more profitably in order to make people feel more comfortable. So I think we're making progress there. The performance of the battery it, it concerns about that battery and ultimately the cost of the battery are the two other issues. And we're seeing consumer's views of that also improve as we're seeing much longer range being offered in what's being provided. And I think as the facts sort of bake back up historically how long these batteries last, I think we'll start to address some of those challenges. So I think we're well on the way of seeing the beginning of those stages to eventually getting to a market that is 25 than 50% you know, electric sometime over the next decade. Katherine (29:12): Well, lots more to look for on the landscape for the EV market as well. And I've got a couple fun kind of closeout questions for you here, Jonathan. This has been a really informative episode. I always love to end with in your consulting engagements and in all your work with Cox Automotive, what do you find yourself not being asked or consulting on that you think the industry needs to focus on more? What are we missing? Jonathan (29:41): Well, especially the finance part of the business, I would say what's top of mind that not many people are talking about is cash. With auto loan rates moving higher quickly last year and now at 20-year highs, we actually saw a big rise in all cash deals that kept going higher as the year progressed. And this has huge implications for profit pools, for dealers and manufacturers and lenders alike. If people are buying with cash, that is diminishing the very number of finance transactions that we see. And it also has implications on future behaviors. We simply don't know what's going to happen with those buyers with regards to how does that change when they come back to buy does it fundamentally change their loyalty to brands in the way that financing like leasing has traditionally helped keep, helped make people extremely loyal to the, to the brands that they've purchased from. So I think that that's a huge factor to pay attention to. Unfortunately I would argue that if rates are continuing to go up and we still have this ironic situation that the most affluent consumers are sitting on a pile of cash then it's very likely we're going see even more cash deals in 2023. So you know, I think it's important to understand that really impacts what we see coming down the funnel. Katherine (31:14): I understand that you're a DJ in your spare time and I love that. So if you had to pick a song to represent the auto industry in 2023, what would it be? Jonathan (31:31): Well, I want a cheat and I'm going to give you two. And this is, it is sort of like asking me what my favorite song is to a music lover that's really challenging. But I publish an auto market playlist every few months on Spotify that includes songs that capture this, the themes that I'm seeing in the economy, in the auto market. And I just published my latest playlists and it focuses on songs from the early eighties. So there's way more than two if anybody wants to find it on Spotify. But they are all songs that happen to be at the birth of mtv. And I, I chose that timeframe because it was the last time the fed raised rates so much that it caused a recession. So the first song appropriate to that scenario is, do you really want to hurt me by culture club from 40 years ago in 1983? Jonathan (32:21): Cuz I think realtors and auto dealers alike are singing this in their best boy joy, boy George voice. Now thanks to what we've already seen. And unfortunately, the Fed is not done yet. And despite the challenges for the second song, I believe many auto dealers and manufacturers can find a way to succeed in 2023. So my favorite out of all of the playlists is also from 1983 which was the year we got past the recessions of 1981 and 1982. And I'm going to share the lyrics to see if you can guess it, Catherine. So no one wants to be defeated showing how funky and strong is your fight. It doesn't matter who's wrong or right. Just beat it Katherine (33:10): And beat it. Michael Jackson. Beat it. Right? That that's gotta be okay. Jonathan (33:13): That's right. So if you're in the auto business, listen to Michael for inspiration.