Bill Wood: Negative pressures mounting for automotive supply chain

Please pardon the pun, but the U.S. economy just drove past a significant milestone on our way back to a full recovery from the pandemic. The data that measures the total number of vehicle miles traveled in the U.S. just got back up to its pre-COVID level in 2023.

So, after three years in which we endured an economic shutdown followed by a subsequent surge in "working remotely" and also an elevated level of political handwringing about rising carbon dioxide emissions, Americans have finally gotten back to sitting in their cars just as much as they ever did.

The long-term trend in the miles traveled data correlates positively with the long-term trend in U.S. demand for motor vehicles, so the fact that Americans are using their vehicles just as much or even more than ever is positive news for plastics processors that supply the motor vehicle industry.

But in the short term, there are a number of other factors that will affect demand for cars and parts in the next few months. These factors will include interest rates, fuel prices, the prices for cars and parts, supply chain issues and employment trends. When I look at all of this data in the first quarter of 2024, I am beginning to see downside risk emerging in the near-term trend for motor vehicles.

For most of the past 100 years, we have known that demand for motor vehicles is sensitive to changes in interest rates. This is true because the vast majority of vehicles purchased are financed with credit. This relationship appeared to break down during the past couple of years as interest rates jumped dramatically, yet due mostly to pandemic-related kinks in the supply chain, demand for new and used cars stayed robust. But like any good hundred-year relationship, this one might experience some difficulties, but it probably ain't over yet.

I have charted the 12-month moving average for motor vehicle assemblies in the U.S. I am concerned by the fact that the overall trend has been mostly flat for the past eight months, and the quarterly total from the fourth quarter of last year was down almost 4 percent when compared with the same quarter a year earlier. In other words, this is starting to look like it could be a cyclical peak.

Now I know there was a strike during that time, which undoubtedly had a negative effect on the data from the end of last year. But as we get into 2024, prices for new and used cars are also quite high and so are interest rates. Gasoline prices were relatively low last year, so that left a bit more cash in consumers' pockets, which they could have used for car payments. But the prices of motor fuels have an inconvenient knack for trending upward as well as downward. They are up more than 9 percent so far this year.

My point with all of this is I am increasingly concerned the auto industry has an emerging issue pertaining to affordability. The rising prices for new or used vehicles combined with the substantially higher financing costs are starting to outweigh the pent-up demand pressures stemming from the pandemic-induced kinks in the supply chain.

We always knew this would happen at some point—that the auto market would reequilibrate after COVID, and it would once again become sensitive to prices and the prevailing interest rate environment. But until just recently, this normalization in the market was not really apparent in the data. Perhaps I am oversensitive, but it strikes me as at least a possibility that some clues are becoming clearer. Rising demand and restrictive interest rates cannot coexist forever.

So, what does this mean for the next few months?

I do not expect demand for autos to fall substantially. The latest trends in vehicle sales and also prices paid for both new and used vehicles indicate there is still underlying demand for motor vehicles and parts. This underlying demand is also corroborated by the trend in the aforementioned data for vehicle miles traveled.

But as I said, the negative pressures are mounting. Eventually, these pressures will show up in the data on vehicle sales as well as the prices paid for vehicles. It also means profit margins will be squeezed. Lower margins are common during times when demand growth is slowing but interest rates remain restrictive. This is the type of environment we will most likely encounter in the next few months.

Big companies, such as big automakers, tend to do better than small companies during these times because of leverage. They have greater leverage over the prices they pay to suppliers, and they also have access to lines of credit and operating capital at lower rates.

Smaller companies, such as many of those that supply the automakers, do not have such leverage. They typically cannot raise prices, nor can they easily cut their costs. These companies thrive during periods of low real interest rates and strong economic growth, but I do not see such conditions emerging until at least 2025.

As of right now, I am not pessimistic about the outlook for this year, but I do think it is necessary to monitor the risks closely. There is an array of other factors that may also have a significant effect, either positively or negatively, on the fortunes of smaller companies this year. These include things like technological innovations, the prices paid for materials and fuels, and the value of the U.S. dollar vs. other currencies, especially the Chinese yuan.

For now, I will continue to monitor the trends in the number of motor vehicle assemblies and all of the other relevant data series. A soft-landing scenario may mean this data stays mostly level for a while longer and then start to trend upward. But if that is not what happens, then I will not be caught by surprise.