Economists: Unstable Retail Market to Continue

By Richard Greene, Auto Group Features Editor
October 01, 2008

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WASHINGTON, D.C. — As the National Auto Auction Association's convention kicks off today in the nation's capital, three economists from the NAAA, Manheim and ADESA voiced deep concern that the current financial crisis will persist in squeezing credit sources, leading to less approvals and therefore deflating retail auto sales even further.

On the other hand, Ira Silver, chief economist for the NAAA, Tom Webb, chief economist for Manheim, and Tom Kontos, executive vice president of customer strategies and analytics for ADESA, appeared to be more optimistic about the wholesale market and how wholesale values for full-size trucks and SUVs are showing continued improvement.

Pessimism Surrounding Retail Market

First off, Kontos said it's important to distinguish between the "real" economy and the financial markets that "grease the skids" of the real economy.

"Clearly, the financial crisis currently being addressed by the $700 government rescue plan has had spillover effects on the broader economy, including retail and wholesale used-vehicle markets," Kontos pointed out.

"For example, retail used-vehicle sales have been limited to some degree by decreased availability of credit, and this limits demand for wholesale units in the lanes and online," he explained. "Also, greater difficulty and cost in obtaining floor plan financing may be limiting dealers' ability to stock up on used vehicles purchased at wholesale."

As a result, Kontos said the financial crisis is one of many factors to consider in assessing the potential short-term and long-term performance of retail and wholesale markets.

"Overall, I would characterize the situation as it relates to retail and wholesale markets as serious but not dangerous, provided that the government is able to step in to provide relief and restore confidence," Kontos noted.

Moving on, Silver said he thought that "Main Street" will experience a "basically flat" economy for the remainder of the year, followed by a slowly improving environment in 2009.

"However, the recent chaos in the financial, banking and credit markets has threatened to spill over to the real economy, potentially resulting in a period of very slow economic growth or even an outright recession," Silver explained.

"In such an environment, it is advisable for all businesses to be somewhat cautious and protect themselves from downside risks," he added.

He characterized 2008 as being a "very bad year" for new auto sales as ever-increasing oil and gasoline prices, a weak labor market, a tightening credit market and an "unattractive" mix of vehicles combine to drive new light-vehicle sales down to levels not seen since the early 1990s.

The NAAA economist predicted that it will take some time for financial conditions to improve, with new light-vehicle sales projected to remain "weak" through the remainder of 2008, with about 14 million units being sold, the lowest since 1993.

Regarding new-car sales in 2009, Silver said that assuming oil and gas prices stay near current levels, sales are expected to move up about 5 percent to 14.7 million units as the credit markets recover and the economy strengthens.

Even though the $700-billion plan to shore up America's shaky financial system failed to pass the U.S. House of Representatives on Monday, Silver said it's too early to assume that a bailout plan in some form will not pass.

"I still believe that Congress will agree on some type of plan that will help stabilize the banking system and assist homeowners," he stated.

"Until a plan is passed, I expect that the FDIC, the Treasury and the Fed will provide extensive backing and liquidity to the financial markets," Silver continued. "If no plan passes in any form and the economic policy makers do not come up with reasonable alternative measures, the economy would be in worse shape for a longer time."

However, Silver was quick to add that he strongly believed that Congress will act "decisively" to minimize the economic disruption stemming from the current financial turmoil. And on an upbeat note, he said that it is even possible that additional actions will be taken that might have not occurred had the plan passed Monday. "This could include a Fed rate cut or an increase in FDIC insurance," he said.

While discussing the current challenges, Webb acknowledged that he was probably taking an even "gloomier" perspective than many other economists.

"The dysfunctional credit markets have posed unprecedented challenges to all segments of the business, including dealers, commercial consignors and the auctions themselves," Webb stated.

The credit turmoil, which began with subprime mortgages in the latter part of 2007, became a full-blown credit crunch in 2008, he pointed out.

"With limited access to the securitization markets, retail auto lenders slowed originations and significantly tightened lending standards," Webb explained.

"With less attractive financing terms available to their retail customers, dealers suffered reductions in both unit volumes and gross margins," he said. "Wholesale financing also became more expensive. And now, the impact of non-performing financial markets has bled into the overall economy and significantly weakened labor market conditions."

According to Webb, the initial rejection of the financial rescue package on Monday added yet another unsettling moment.

"But let us not forget, the financial markets were dysfunctional before the vote, they remained dysfunctional afterward and they would have remained dysfunctional even if the bill had passed," Webb noted.

"History shows that the financial de-leveraging caused by credit crunches inevitably leads to a recovery phase that is both delayed and muted," he continued. "Current credit spreads and credit flows indicate that the return to normalcy in the financial markets remains a ways off."

Optimism Surrounding Wholesale Market

Meanwhile, the economists undoubtedly were less pessimistic about the wholesale market.

"The wholesale markets have already made a significant return to normalcy," Webb indicated. "Valuations are rising and sale-through percentages are improving. The retail used-vehicle market still faces considerable hurdles, but dealers have been quick to recognize and adapt to the changing marketplace. Even in this difficult environment, many dealers have been able to achieve quick inventory turns at respectable gross margins."

Meanwhile, Kontos expressed a similar assessment. "I am more optimistic that firming in wholesale prices that I've already noted since the market tanked in May and June will continue," he highlighted.

"As we approach year-end, we should begin to see prices flat to modestly up over year-ago levels," he added. "I'm less bullish about the prospects for a significant improvement in retail sales until after the election and into the new year. As retail sales improve, we should start seeing more excess trades start flowing to auction, but again this will be a while in coming."

At the same time, Kontos and Webb also appeared to be pleased that wholesale values for full-size trucks and SUVs have begun to improve.

According to both, taking into account mix, mileage and seasonal trends, prices on these larger vehicles increased in both August and September, and for some models and age categories, the improvement has been "quite significant."

Looking back at what took place when gas prices skyrocketed in May and June, Kontos said he believed the market overcorrected and that he expected pickup trucks to rebound faster and stronger than SUVs.

On the other hand, many dealers were willing to pay higher prices in the lanes on smaller, more fuel-efficient units in order to stock their lots with vehicles in high demand, the executives said.

On a positive note, however, Webb pointed out that dealers were still able to subsequently retail those units quickly and at "nice grosses."

"With gas prices back below $4 a gallon and with the prospect of greater stability in those prices going forward, we expect that vehicle valuations in the wholesale market will exhibit greater stability with less diversion between market classes," he continued.

Kontos agreed. "Wholesale prices have stabilized since May and June, though I believe that even with ‘lower' gas prices, shifts in consumer tastes will continue to favor small vehicles versus SUVs," he said. "Pickup trucks are somewhat shielded from significant declines in demand because of their unique capability to fill specific vocational and recreational towing and hauling needs."

Meanwhile, gauging macroeconomic conditions and the impact on the wholesale and retail markets, Silver said he expected gasoline prices to remain lower as world economic growth slows and effort to increase supply increase. For example, he pointed to the fact that the moratorium against offshore drilling off the Atlantic and Pacific coasts has just been repealed.

"With the fear of gasoline prices reaching $5 or even $6 per gallon no longer in the consumer's mind, the retail and wholesale market for larger vehicles will begin to improve while the premium put on more gas-efficient vehicles will inch down," Silver said.

Projected Wholesale Volumes

In evaluating yearly wholesale volumes, the three economists varied a little on how many total vehicles they expected to be wholesaled through NAAA auctions this year.

Silver said he anticipated unit volume to decrease about 2 percent for the year to 9.35 units, compared with 9.54 million in 2007.

Kontos was a tad more bullish. He estimated about 9.5 million units will be sold by year's end, "plus or minus 1 percent."

On the other hand, Webb expected that total auction volume in 2008 will come in at a similar level to 2007.

"The volume of repossessions, off-lease and rental risk vehicles is up. Off-rental program cars are down significantly and quite naturally, given the reduction in retail activity, dealer consignment volumes are also lower," he concluded.

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