Fender Bender

These days, the big U.S. carmakers resemble large financial service conglomerates. Is this just a reflection of the credit bull market and the manufacturing bear market…or is there something else at stake? Investing legend Gary Shilling shares his views…

Ever since 9/11, U.S. auto sales have been relatively flat at a 16.9 million average annual rate. To maintain those sales levels, automakers have been forced to offer a steady and increasingly expensive array of inducements that may continue to be necessary, even after concerns about terrorism, high gas prices and other negatives have receded into the mists of history.

The goodies started, of course, with the zero-interest rate financing deals initiated in October 2001. The idea, of course, was to tempt frightened Americans into dealer showrooms post-9/11. Sales that month shot up more than 30%. The auto companies originally planned those concessions as one-shot deals, but continued them because they worked so well and because they became necessary to sell cars at a time when the pockets of consumers had been stuffed with tax rebates and two rounds of tax cuts.

Then incentives became bigger and better. Soon, triple-zero financing with no money down, no interest on the auto loan and no payments for six months or a year, hit the scene. The alternatives offered for cash purchases – namely rebates – have only grown over time.

Automobilie Purchase Incentives: Flat Sales

Consumer spending has been robust in recent years and this favors big discretionary purchases like vehicles. And new car prices have been rising less rapidly than the CPI for four decades, making them more attractive, price-wise, than the average good or service. Another factor that might appear to favor strong vehicle sales over time is the increasing age of existing cars. The older the auto, the more likely that it gets junked and replaced by a new one.

In the face of all these incentives to buy, what does the flatness of vehicle sales in recent years tell us?

For one thing, light trucks, mainly SUVs and minivans, have been sold in such great numbers that the average age of those trucks, already on the road, is falling. This works against new sales. More importantly, the key reason that vehicle age has been rising since the mid-1970s is that the quality of cars has been increasing. Cars don’t rust out after only a few years any more. No more Pinto-quality cars being made in Detroit. As a result, the U.S. cars, as well as foreign automakers’ products, are often reliable for a decade or more.

With fewer cars being junked, demand for new ones is reduced. This, no doubt, has a lot to do with the subdued level of sales in recent years, and will continue to do so in the future, as quality and longevity continue to improve. In addition, the number of vehicles per household has flattened in the past 25 years after doubling in the earlier postwar years. Now, with 2.14 vehicles per household and 2.62 people per household – including children too young to drive – further gains are unlikely and saturation is now a permanent feature in the auto industry. While households maybe able to afford multiple cars per person, and rising incomes over time encourage this, there will only ever be, however, finite room in the garage and driveway.

Much of the long-term demand for vehicles will rest on the growth in households. But the Census Bureau projects annual growth of 1.0% in the years ahead, less than half the rate of earlier decades and even below that of the muted 1990s.

With the outlook for demand unsure, it looks like the need for big incentives will continue long after the recent recession and high fuel costs have passed. Furthermore, car buyers have grown accustomed to rebates and may not be willing to purchase without meaningful concessions. Which automaker is really going to have the gumption to announce an end to big rebates and other popular incentives?

Automobile Purchase Incentives: US Auto Cartel

This presents an especially difficult challenge for domestic producers, and in the future, their stocks may under perform the general market. Domestic automakers dominated the U.S. auto market from inception through the 1960s and, as a result, developed a cartel mentality that they have not been able to break. In the 1970s, imports poured in and, rather than meet them head-on, Detroit rationalized their penetration by arguing that imports were mainly of small cars and that it didn’t mind losing the sector to European and Japanese producers, since it wasn’t profitable anyway.

When those foreign producers started to build auto plants in this country, Detroit welcomed them, reasoning that these foreign-owned automakers would be saddled with the same oversized costs and inefficiencies that had infected the U.S. companies. But the transplants soon proved that they could utilize American workers efficiently and pay them much less than the United Auto Workers’ scale.

Today, the big Japanese producers are making many more vehicles in the U.S. than they import. But that doesn’t mean that imports are no longer a threat to domestic producers. The world has the capacity to make about 80 million cars a year, but global demand is only about 60 million. And the U.S. is the prime target for excess auto production just as it is for most of the world’s surplus goods and services. Furthermore, China and other developing countries expect to greatly increase their auto-capacity and auto-exports, and they have America in their sights.

Since most of the materials that go into vehicles are internationally traded and priced, the biggest cost- disadvantage pressing Detroit is labor expenses. With wage and benefit costs around $80,000 per year, UAW members are no match for the lower wages of workers making imports and transplants. At GM, health care costs, alone, exceed steel costs per vehicle. This has given Detroit tremendous incentive to outsource to cheaper suppliers and move assembly to Canada and Mexico, and to promote productivity vigorously. In combination with U.S. producers’ lost market share, these forces have slashed UAW membership from 1.5 million in 1979 to 624,000 at the end of 2003.

With global excess auto production capacity, limited growth in U.S. demand and Detroit’s oversized labor costs and lingering image problem, American producers will probably continue to lose market share. The days when GM had 50% of the U.S. market are long gone, and the current 27% share may soon slip to 25% or lower.


Gary Shilling
for The Daily Reckoning
July 27, 2004

Editor’s Note: Dr. Gary Shilling is president of A. Gary Shilling & Co. Inc., an investment advisory and economic consulting firm and publisher of the monthly INSIGHT newsletter.

Prescience has empowered Dr. Shilling to beat the stock market by a wide margin over many years while providing consistently accurate forecasts to his subscribers. Twice ranked as Wall Street’s top economist by polls in Institutional Investor, Dr. Shilling was also named the country’s number one Commodity Trader Advisor by Futures magazine. And last year, MoneySense ranked him as the 3rd best stock market forecaster, right behind Warren Buffett.

A regular columnist for Forbes magazine, Gary Shilling appears frequently on radio and television business shows and has written six books, including ‘Is Inflation Ending? Are You Ready?’ in 1983 and, more recently, two books detailing his forecast for the new world order and its consequences for your wallet.

Yesterday, Pater Familias took his family on a brief tour of Southern Maryland. We drove by one subdivision after another, the houses getting bigger and bigger. Each one had a grand entrance and a bucolic address. Usually the place was announced with curved brick walls, iron gates, and an Anglican name such as ‘Heathmont Downs.’ You feel as though you might be entering the grounds of a private lunatic asylum.

"Wow," said one of the children, staring at an immense, ugly house with white bricks, small windows and wooden decks protruding from every wall, "those people must be very rich."

Either that, or very poor.

"Some of these places are 6,000 square feet and more," explained a cousin. "And some of them are lived in by older couples without children. They don’t really need the space. But it’s a way to leverage the housing boom. A lot of people think they should buy the biggest, most expensive house they can. I don’t know about anywhere else, but housing prices around here have been going out of sight. They’re right. They’re making a lot of money by buying expensive houses."

The housing market in this part of the country has gone mad. People buy houses they don’t want, don’t need and can’t really afford – in order to get rich. They’re all right…as long as house prices rise. But if they go down, they’ll be stuck with a huge, expensive home…and a huge expensive mortgage.

Yesterday, stocks went down again…bonds and the dollar too. Real estate will be next…stay tuned. First, the news…then the views, below…


Eric Fry, our man on Wall Street…

– The stock market ALMOST gained ground yesterday, but didn’t; the Dow Jones Industrial Average fell less than one point to 9,962. The Nasdaq, meanwhile, set a fresh 10-month low, slipping half a percent to 1,839. The dollar, gold and bonds all followed the stock market lower. The greenback slipped about half a percent to $1.214 per euro and gold slipped 20 cents to $388.95. Treasury prices also dropped, pushing the yield on the 10-year note up to 4.48% from 4.43%.

– The poor lumpeninvestoriat can’t seem to catch a break. Almost everything is falling almost every day. Only cash is producing a positive return…and yet no one is holding it. Folks are still buying houses, it seems, but not much else. The National Association of Realtors reported that existing home sales rose 2.1% in June to a new record high.

– Meanwhile, stocks have become about as coveted as a week- old bowl of oysters. But there’s a new initial public offering (IPO) in the wings that might change all that…an event that might just jostle the market out of its malaise. The Internet search engine, Google, is readying a massive Internet-era-style IPO – a gaudy $3.3 billion affair that would value the company at a whopping $32 billion. For comparison, Yahoo is valued at $37 billion. Or to put it another way, Google’s market cap would be about 65% of eBay’s, at $48.6 billion, and more than double Amazon.com’s $15.3 billion market cap.

– The stock will not make its Wall Street debut until a couple of weeks from now, but the Google brass is already talking up the offering in a road show that begins soon in Manhattan. Will the mere buzz of a hot Internet IPO lift the market out of its lethargy? Will it spark buying interest through the entire stock market? We wouldn’t rule out the possibility.

– Also weighing in the bulls favor is the fact that the VIX Index of option volatility is showing increasing levels of fear among option buyers. The higher this index rises, the more likely a rally is to appear. For now, however, the path of least resistance in the stock market still seems to be down. Problem is, the index has not quite reached the levels that typically indicate an imminent rally. But if stocks keep sliding for a few more days, they will be primed to rally by the time the Google IPO hits the dance-floor.

– Despite increasing levels of anxiety reflected in the VIX readings, most long-term sentiment gauges still show record, or near-record levels of bullish sentiment, which is not a good thing for stocks.

– "Advisers are significantly more bullish today than they were earlier this year when the stock market was at levels similar to today’s," observes Mark Hulbert of Hulbert’s Financial Digest. "[which] increases the likelihood that the correction that began four weeks ago has further to go…"

– "Advisers are becoming less and less concerned about downside risk," says Hulbert. I base this assessment on readings of the Hulbert Stock Newsletter Sentiment Index (HSNSI), which reflects the average equity exposure among a group of very short-term-oriented market timing newsletters. As of Thursday night’s close, for example, the HSNSI stood at 23.1%…much higher than where it stood at other times, earlier this year, when the Dow stood at current levels.

– "For example, on May 25, the Dow closed at 10,118, some 68 points higher than where it closed Thursday. Yet, as of that trading session’s close, the HSNSI stood at minus 14.8 percent, or nearly 40 percentage points lower than its current level."

– In other words, the lumps are not nearly as scared as they ought to be. Most of the stock-buying masses still prefer stock-buying to most other investment activities. Here at the Daily Reckoning, we prefer investment inactivity. We prize the tedium of cash to the intermittent terror of buying overpriced tech stocks. Come to think of it, our favored investments are more likely to appear in the Periodic Table of the Elements than in the Wall Street Journal.

– Our Paris-based editor cherishes stones and gold, while the blue collar crew here in the States prefer dirt and cash. We still like stocks, of course. But only when they are as cheap as a first date with a teetotal-ing vegetarian.


Bill Bonner, back in Maryland…

*** We listened to a bit of the Democratic National Convention last night and tried to explain to Henry the significance of it.

"The parties get together before each election in order to select their candidate," we said, plausibly.

"But I thought they had already decided on John Kerry," the 14-year-old protested.

"Well, yes…but they need to choose him officially. And they need to figure out the party platform."

"What’s that?"

"Well, that’s where they tell the nation what they’re going to do if they’re elected. So people know what to expect."

"I thought you said that Bush was elected because he promised to be a conservative…but then he turned out not to be a conservative at all. Didn’t he spend a lot of money…and start a war? And I thought you said politicians never keep their promises anyway. So what difference does it make what they say they’re going to do?"

"Well, that’s right…they’ve usually already selected the candidate…and it doesn’t seem to make much difference what they say…still, sometimes you can get a better idea of what kind of people they are and what they think."

We were listening to the speeches on the radio. Al Gore, Barbara Mikulski, Jimmy Carter…and then the Clintons.

"Dad, they all say the same things," noticed Henry.

"What’s that?"

"That Americans are good and that everything was fine until the terrorists attacked. And…oh yeah…we need to get rid of George Bush."

According to Democratic Myth, America was a paradise when George Bush walked into the White House. Then, the terrorists attacked and all of a sudden it was a new world. Hillary Rodham Clinton told the crowd that she immediately marched downtown to the site of the attack and thought she was staring into the gates of Hell. America is now engaged in a serious war with serious opponents, say the Democrats.

But even the destruction of the World Trade Center towers had its good side, according to the party of Carter, Johnson and Clinton; it brought people together. Uniting people was a major theme among the Democrats. They seemed almost pathological about it. Hillary’s husband made a point of it, as did almost all other speakers. He thought that every major crisis was merely an opportunity to ‘build a more perfect union.’

After a while, we began to wonder if America already had too much union. Why shouldn’t people think different things…do different things…and go their separate ways? But the Democrats all seemed to want to get people together and get them all thinking alike and working towards the same goals. Meanwhile, one of the convention’s themes was supposed to be ‘strength through diversity.’ It didn’t seem to matter that the two ideas are contradictory.

As they say on Wall Street, when everyone is thinking the same thing, no one is thinking. No one seemed to be doing much thinking at the Democratic National Convention. We looked at the delegates in their stupid hats, with their insipid signs and vacant faces. We wondered whether any of them had ever had a thought in his life.

The American union was near perfect when Bill Clinton left Washington, according to the speakers. Then, the Republican President misled the nation on Iraq, and bungled the war against terror in order to attack Saddam. He squandered the nation’s treasure and its honor…and allowed greedy lobbyists for the rich, who have Republicans in their hip pockets, to eliminate vital social programs so millionaires could get a tax break.

None of the speakers mentioned that their man Kerry had gone along with the war and practically everything else. In fact, hardly a single cockamamie scheme has made its way through Congress, since he’s been there, without getting his signature on it.

None mentioned the consumer debt bubble…the dollar…the trade deficit…or seemed to care how the federal government was going to make good on its promises. None worried that democratic voters got poorer, not richer during the Clinton years. Except for getting along with other nations better…and stealing more money from the rich…none mentioned anything their man would do differently.

Nor did anybody bring up this little item, showing that the Democrats are as deep in the pockets of rich lobbyists as Republicans. Maybe deeper:

"…The study also found that Republicans raised more than Democrats from individuals who contributed small and medium amounts of money during the 2002 election cycle, but Democrats far outpaced Republicans among deep-pocketed givers."

"Republican candidates and parties topped their Democratic counterparts, $68 million to $44 million, in fundraising from individuals who contributed under $1,000 in itemized contributions for the 2002 elections. Among donors giving $1,000 or more, Republicans again beat out Democrats, $317 million to $307 million.

"But the trend was reversed among individuals at higher giving levels, from whom Democrats raised far more money than Republicans. Among donors of $10,000 or more, Democrats out-raised Republicans, $140 million to $111 million. Among donors of $100,000 or more, Democrats raised $72 million to the Republicans’ $34 million. And among the most generous givers – those contributing $1 million or more – Democrats far outdistanced Republicans, $36 million to just over $3 million…"

*** More from Alexis de Tocqueville:

"Democracy in America" by Alexis de Tocqueville Volume 2, Section III, Chapter XXII

"No protracted war can fail to endanger the freedom of a democratic country. Not indeed that after every victory it is to be apprehended that the victorious generals will possess themselves by force of the supreme power, after the manner of Sulla and Caesar; the danger is of another kind. War does not always give over democratic communities to military government, but it must invariably and immeasurably increase the powers of civil government; it must almost compulsorily concentrate the direction of all men and the management of all things in the hands of the administration.

"If it does not lead to despotism by sudden violence, it prepares men for it more gently by their habits. All those who seek to destroy the liberties of a democratic nation ought to know that war is the surest and the shortest means to accomplish it. This is the first axiom of the science."

The Daily Reckoning