Slowing Down

With US dealership inventories at 88 days on February 1st – 60 days is healthy – we are seeing a possible mismatch of sales relative to production. Yes, there's been bad weather across much of the US, and that kept shoppers away. This past week, though, I visited a half-dozen dealers while car shopping and used that as an opportunity to listen to them. What I heard suggests this is not a temporary blip.

...deals are on the way: if I could put off buying a car, I would...

First, the factory is hiking dealers' sales targets, and getting pushback: late 2013 is as good as it's going to get, and no, we aren't likely to do better. Of course every dealer wants a lower target, and they rightly fear the "ratchet effect" of overperforming leading to higher targets, even if their success was a result of idiosyncratic factors, such as hiccups at a local competitor or a sales blitz that worked in volume terms but not in profitability so won't be repeated. Still, my reading is that dealers aren't seeing the same sort of foot traffic, and they don't think it's just the weather. Furthermore, that is consistent with other macroeconomic indicators such as wage growth, interest rates and housing. Growth is anemic.

Second, supply is up both because new capacity is coming onstream (Honda and Mazda in Mexico, for example) or is available because of the weak yen (Toyota is again making money on exports from Japan, and has a lot of capacity there relative to the current size of the domestic Japanese market, which is also facing a big hike in sales taxes). That's bad news if there's in fact a slowdown, or at least not an increase, in sales. Oh, and neither Honda nor Toyota has seen any uptick in their market share this past year.

...[other indicators likewise show] growth is anemic...

Then there are new models, with incentives to make way for the old. As a result a quick scan of Automotive News headlines suggests a number of OEMs in that position. That's an argument for part of this rise in inventories reflecting model changeovers, but that will vary from firm to firm and ought to ease quickly.

Overall, though, my sense is that firms will have to either trim their production plans, and soon, or really beef up the inventories. And if we start seeing more vehicles coming off-lease and out of fleets, then tradein values will make moving the metal a bit more difficult.

So deals are on the way: if I could put off buying a car, I would. Now in my own case I can't, and what I'm seeing suggests I'll opt for a new vehicle over a used one. Yes, if I wanted to spend $23K there are many attractive larger cars out there, lots of BMWs and Volvos and the like at Carmax. But all I need is a car to get me to and from work, and my wife has nixed a relatively inexpensive Porsche Boxster that would do the trick, or even a coupe: with a 2-week-old granddaughter a couple miles away the ruling decree is that I need the option of putting in a car seat...

Federal Agency Should Stop Playing Guessing Games

David Ruggles

Here I'm posting a few points I made in "Federal Agency Should Stop Playing Guessing Games" published February 21st in WardsAuto.com. You can read the full article on Wards.

The Consumer Financial Protection Bureau has socked Ally Bank with $98 million in penalties and restitution requirements as part of a consent agreement stemming from unintended discrimination involving dealer-assisted car loans.

Ally facilitated discrimination, according to a CFPB analysis using “proxy methodology” that presumes to determine who is and isn’t a member of a government-designated “protected class” by means of a borrower’s first name, last name, zip code and other variables.

....

So here’s a solution.

First, the CFPB should provide access to their proxy methodology so dealers can analytically determine up front who is and isn’t a member of a protected class.

....

Second, the CFPB should prescribe exactly what special treatment it wants protected- class members to receive. It can be business as usual for everyone else.

Absent this, the CFPB should leave the current system of indirect lending alone with the understanding that the bureau’s inaccurate proxy methodology has only turned up the possibility of the miniscule potential rate markup overcharge of a third of a percent. That certainly is within the margin of error for so imperfect a system designed to identify protected-class borrowers.

If the CFPB wants to institute a protected-class database, it should do so using actual data, rather than the guesswork it has been employing so far.

A line that got lost in editing:

"I can't wait to get my "protected class" membership card for being 65 and being bald." Another deletion included a reference to "SWAG," a term not deemed appropriate for a trade publication.

Comments Welcome! There will be a lot more published on this issue in the coming days.

Talking Macro: WREL show February 20, 2014

Here are notes from my weekly radio show on WREL Lexington, Virginia. The actual show seldom covers all of the topics I prepare, as what I discuss depends in part on questions from the host, Jim Bresnahan. What follows is thus expands on what I said or prepared to say.

The Economy

The Fed released its January minutes that suggests a pragmatic approach to policy targets. As I've discussed in previous shows, you can't capture the dynamics of the US labor market in a single number. The economists at the Fed of course know that, and so the headline item is that the Fed is revising its guidance that it will keep interest rates low unless inflation picks up or unemployment falls below 6.5%. That latter item is what is more flexible because jobs growth is not moving in parallel with the drop in unemployment.

First, the latest CPI (Consumer Price Index) report came out just after the show, and indicates no uptick inflation; prices are up a mere 1.6% over the past year once volatile food and energy prices are excluded (and as it happens, when they are included). That is consistent with the PPI (Producer Price Index) report released yesterday, with a 1.2% rise over the previous year. Both are far below historic levels, and the CPI remains well below the 2% target level with no indication that the rate is rising.

Back to employment. At present we have 145 million people employed in the US, below the 154 million level consist with population growth – a gap of 8.5 million. Worse, while my population growth number incorporates baby boomer retirement, in fact the baby boomers are not retiring at the same rate as in the past. For people aged 60-64, today 52% are employed, in 2005 only 50% were. For the older 65-69 bracket, in 2005 only 30% were working but today it's 35%. That's bad news for those at the younger end of the age bracket. In 2005 some 68% of those age 20-24 were working, but today only 62% have jobs. So the Fed is sensibly treating the unemployment number as just one more indicator, and not tying policy to a single number.

Other indicators likewise suggest muted growth. Housing starts were 880,000 in January, seasonally adjusted to reflect normal winter weather. Obviously this year's not been normal. So perhaps we'll see things pick up in Spring, but the pre-bubble level was more like 1.6 million starts (the bubble level peaked at over 2 million). But the level remains far below what we need for robust growth, and of course bad weather means that construction workers and the stores that sell to them are having a very bad start in 2014.

Finally, there's a Bloomberg story on divorce rates rising from a 40-year low in 2009. The story claims that's good news, but I'm not so sure. Yes, hard times make it more challenging for spouses to find the jobs that enable survival after a break-up. But long-term unemployment is a destroyer of families, something observed in the Great Depression of the 1930s, which left many mothers single when their men hit the road in search of work and didn't come back. But more consistent of the "economy is better" interpretation is that new household formation is rising.

That's consistent with what I've seen of my son and his friends. None of them have girlfriends, and the reason they give is that without stable jobs, it's just not a responsible thing to do. For all the decrying by their elders of today's youth, other indicators suggest the same, including a drop in children born to single mothers and in abortions.

United Way of Rockbridge update

Let me close with an update on the local United Way of Rockbridge annual campaign. While the website calendar isn't yet updated, and the thermometer outside Walmart remains on its side with the new sign blown off, we are now just shy of $220,000 or 88% of our $250,000 goal with results from Mohawk, one major employer workplace campaign, still pending. We still very much need those in our residential campaign who have procrastinated to contribute – a check to UWR at 218 S Main in Lexington (zip 24450) would be very much appreciated, and we should have a "click and contribute" button added to our web site within the next week, as we no longer want to be given credit card numbers. [Next week I will talk about our Community Leaders program, recognizing small businesses who support us.]

We also held our Annual Meeting yesterday, with reports from 16 agencies. It was both heartening and sobering to hear their reports, heartening because of the dedication of the volunteers and staff of these local community-oriented non-profits, and sobering because they too report slower contributions amidst increased demands for their services. Since we want to keep pushing ahead with our Community Impact program, Rockbridge Reads!, without cutting back on our assistance to these agencies, we really need to hit our fundraising goal.

Over the next weeks I will introduce the groups to which we contribute. One is RAOC, the Rockbridge Area Occupation Center headquartered in Buena Vista, which provides jobs to physically able but mentally challenged individuals. Now others in the area do this, Kroger and Food Lion for example employ individuals as do others, working in conjunction with the Community Services Board. So RAOC complements other efforts, running yard care and cleaning services, providing supervised work environments for individuals referred to them by the Virginia Department of Rehabilitative Services. Some of their workers are capable of using chainsaws, others are good at mowing. If you might be able to use their skills, please contact RAOC! – I provided their website link above.

Mike Smitka

Toyota's Profits, Nissan's Lack

One year ago – 2012Q4 that is – Toyota lost money in North America, and made only modest amounts of money in Japan. Today is much different, in contrast to Nissan. Bloomberg nails the source: the yen boom.

Yes, the Japanese economy and the US economy are both doing better, and so therefore should Toyota. But others were profitable in the US in late 2012, and Toyota has not gained market share. My scan of Toyota's financial statements (with glances at those of Ford and GM) suggest the entire gain is due to a more favorable exchange rate. (I have yet to look at the reports of stock analysts to see their take.)

From Toyota's perspective this should be a cautionary tale. They now are rolling in profits, and have the opportunity to continue a restructuring pushed by Akio Toyoda, the firm's near-eponymous chairman. But it does suggest two big problems.

The first is that Toyota is not making substantial money on its North American operations – otherwise it would not have lost money last year. Yes, they have a good market share, but they face competition in key segments and are weak in light trucks (and then there's the failure of their full-sized pickup to gain sales commensurate with investment). Their lack of profits suggests these are major, not minor issues.

Do Toyota's vaunted cost controls no long provide them a competitive advantage?

The second is that Lexus remains their cash cow – which is primarily a US story – but the vehicles themselves come from Japan. When the yen was strong, Lexus lost money. With the weaker yen, that shifted dramatically (though not immediately since Toyota hedges their dollar receipts).

So Toyota needs to improve the bottom line on their US operations. That's surprising, suggesting that their vaunted cost controls are no long providing them a competitive advantage. Second, they need to move away from the yen cost basis on their most profitable products. Otherwise when the yen next strengthens profitability will again collapse. Given that the "cycle time" in the auto industry for realigning what is made where is measured in 4-6 year increments, they had better get moving.

Mike Smitka

Oh, and I did put Nissan in the title, but haven't looked at their financials. But as a quick cut, reverse the above logic: they're not booming because they've successfully aligned their cost base with their revenue base. Instead Nissan's profits will reflect markets strengths, not forex swings.

Interest Rates and Employment: The Taper's Well Camouflaged

Protect Tapirs: http://www.tapirs.org

Tapirs are well-camouflaged. So's the taper: you have to look for it. That should not be surprising to anyone who lets their view of the world be affected by data, rather than the pop version of a simplistic model.

...the taper's well-camouflaged...

First, the data; I present 1 month, and 1-, 5-, 10- and 30-year interest rates, pulled from the Treasury's Daily Yield Curve web page. Interest rates are certainly up over the nadir of 2012, but casual reading of the graph suggests at best a modest impact (see the Wikipedia entry on the three US rounds of "quantitative easing", or the analysis of economist's such as that of James Bullard at the St. Louis Fed). In the background of course is the continued slow growth of the economy, which at its current pace of job creation will take until 2019 to bring us back to normal. Meanwhile, there are no signs of an uptick in inflation (and in Europe, a few whiffs of deflation).

This is of course in tension with the naive MV = PY monetarist frameword, most clearly developed by Irving Fisher but used as well by JM Keynes and Milton Friedman. In practice, given the ongoing evolution of financial systems around the globe, defining "money" and then measuring it is problematic, and "velocity" is volatile – and QE isn't directly affecting money, only providing an enabler for banks to create additional credit, and thus the bank deposits that we actually use. Meanwhile, at low levels of nominal GDP growth the split between prices and output is sufficiently uncertain that the conceptual link between money growth and prices is empirically useless – if somehow we overcome measurement errors in "M" and can predict V to give us a prediction of the growth of PY – nominal GDP – of 3%, we don't know whether we get real GDP of 3% and no inflation, or 3% inflation and no growth.

So there is no simple link between QE3 and growth. Indeed, there's no simple link with interest rates. At longer maturities interest rates reflect arbitrage opportunities: if we want to hold bonds through (say) 2019 we can for example choose between a 5-year bond and rolling over a series of 1-year bonds. What that tradeoff looks like thus reflects our expectations of future interest rates. If we expect slow growth to continue for most of the next 5 years, then we would expect the Fed to hold short-term interest rates to a low level, with or without QE3 – that is, whether we taper or not. If so, then a 5-year bond should carry an interest rate little different from today's short-term rate. If in 2018 we expect to be back to "normal" with 2% growth and 2% inflation, then we might think that come 2018 one-year rates could be around 4%. In that case 5-year rates (as an average of 1-year rates each year from now to then) would be lower than 4% – using annual rates of .1%, 1%, 2%, 4% and 4% gives a (compounded) 5-year return of 2.2% – but 10-year rates should be sharply higher (assuming rates after 2018 stay a constant 4% gives a 10-year return of 3.1%), and 30-year rates very close to 4% (keeping post-2018 rates at 4% would suggest 3.7%).

...the Fed may taper but interest rate's aren't going to move much...

Now the current rate of employment growth suggests that we won't be back to trend employment levels until 2019. Because of the retirement of the baby boomers employment growth need not be as stront as in the past (a naive projection gives the light blue line, 2.7 million above an estimated based on Census population projections and age-specific employment rates). Unfortunately we're still a long ways from normal. And guess what? My back-of-the-envelope calculations suggests interest rates are consistent with the employment story. The Fed may taper, but absent stronger growth, interest rates aren't going to move much.

...interest rates are consistent with employment growth (or its lack) rather than the taper

Mike Smitka

Mitsubishi Motors: Going, going ... gone?

Mitsubishi Motors Corporation (MMC) is trumpeting record profits. I'm not convinced things are so rosy: they've also just restructured debt, with its four main creditors – and largest shareholders – taking an average 25% haircut on their preferred shares, to the tune of ¥95 billion (US$950 million), something made clear only in its Japanese-language filings. Perhaps they want a tax writeoff and figure their last bailout won't be recouped. But it also provides MMC with a clean ownership structure that would make a sale easier. Whether anyone would want to buy them is less clear: the company has a stormy history that includes 2 failed sales and an unenviable strategic position. They aren't unique in this; many other small firms have failed or changed hands in the past half dozen years. But they're more likely to be a Saab story than any of the other Japanese bit players.

...they're more likely to be a Saab story than other Japanese bit players...

Mitsubishi Motors' origins saddled it with an inefficient structure. During World War II Mitsubishi Heavy Industries (MHI) made munitions ranging from warships to the Zero fighter. After 1945 the US Occupation split up the firm into 3 pieces, each of which made different sorts of motor vehicles – three-wheeled cars, scooters, commercial trucks – as they struggled to find things to sell in the grim 1940s and early 1950s. After the Occupation ended MHI's former pieces merged. The end result was the Mizushima plant in western Japan producing minicars ("kei" cars), Okazaki in central Japan making passenger cars, and Maruko in Tokyo (eastern Japan) making trucks, all within the larger MHI with its industrial machinery, shipbuilding and heavy equipment operations.

Then along came Chrysler, wanting to source small cars in Japan to provide dealers with something to compete against the VW Beetle, which in 1968 sold 600,000 units. (Ford and GM did the same thing, eventually ending up with controlling stakes in Toyo Kogyo – renamed Mazda to echo its brand – and Isuzu.) So in 1970 MHI bundled together the three automotive pieces into MMC and set it up as an independent company, with Chrysler to take a 35% stakeholding (which under Japanese corporate law would give them veto rights and hence potentially de facto control). But Chrysler entered one of its periodic crises and couldn't raise the cash, leaving it with a 15% stake in an unwieldy company. MHI and its bankers remained as the dominant shareholders. While MMC and Chrysler set up Diamond-Star, a joint venture assembly plant in Illinois that opened in 1988, by 1991 Chrysler had sold its share in MMC and various joint ventures.

[An aside: Chrysler purchased its stake in direct contravention to MITI's industrial policy of preventing foreign ownership in the industry – when push came to shove they lacked the clout to make such policies stick, cf. IBM's operations in Japan.]

Then in 2000 DaimlerChrysler bought into MMC, eventually holding 37.5% of the company. But MMC performed poorly, not helped by Daimler's management, and by 2004 that stake was sold off, with Daimler keeping MMC's truck division, Fuso, the one piece that made strategic sense for its Asian production base and array of drivetrains.

In the background is a rollercoaster history of a piece with Chrysler. The initial spinoff from MHI coincided with the success of the Galant passenger car in Japan. MMC then entered the US market, as did the partners in the other Detroit Three alliances. Unlike Isuzu and Mazda, both of which ceased production in the US, MMC never shuttered its plant in Illinois, despite low capacity utilization and poor North American sales. Inside Japan sales did well during Japan's bubble, with MMC introducing new brands, including the luxury Diamante. Again, given the bubble context, that didn't go well. Next MMC rode the sport utility boom with the Pajero, its Jeep-like product. It was the first firm to do so in Japan, and until rivals entered it earned a lot of money. Meanwhile it expanded overseas, with assembly plants not just in the US but also NedCar in Europe, Chrysler's old operation in Australia, a tie-up with Proton in Malaysia, and stand-alone operations in Thailand.

Most fared poorly. Its bubble-era brands are gone, as are its European and Australian operations. Domestically it turned out a bit over 500,000 vehicles in 2013, but 60% of those were exported. With the yen weak (today at ¥101 per US$) exports are far now profitable. Exports are also the focus of their US operations, which currently turn out 70,000 SUVs a year. Butexports are an expedient, not a strategy, only grasping at a short-term profit source. Meanwhile, 60% of domestic sales are of minicars. That's good news, because sales of that segment are rising (up 10% over the last year) but it's also bad news, because low-priced cars cannot possibly generate the profits needed to keep the company going.

...exports are an expedient, not a strategy...

International operations, centered in Thailand and with joint ventures in China and Russia, look better. In terms of production they are the same order of magnitude as MMC's domestic operations. But because most of domestic production is exported, the international-to-domestic sales mix is closer to 90:10 than 50:50. What has tided the company over were one-off OEM deals with Nissan, Honda and others, and its pickups in Thailand and SUVs in other developing markets such as Russia and China.

In Japan, Europe and North American its dealership networks remain weak. For example, in Japan it was late to expand into urban areas, and so had poor locations and poor franchisees. In order to finance its urban presence MMC resorted equity stakes, and then dispatched managers from the manufacturing side who seldom proved adept at running dealerships. In North America and Europe it is hampered by years of poor sales and an uncertain product strategy. Inside Japan contract production arrangements with several manufacturers have been cancelled; it has exited the "kei" (minicar) segment. Only repeated infusions of equity from the Mitsubishi family of companies kept it afloat.

Thus MMC is a firm with a strong presence in Southeast Asia. It has modest operations in China, though as typical of late entrants its factories are scattered from Manchuria to Guangzhou. Then there's a production base in Japan. Its product lineup is good for the developing world, but in 3 of the 4 largest markets – North America, Europe and Japan – its product mix is weak. The company is thus claiming it will ride emerging market dynamism to success. Elsewhere its focus is electric vehicles, to me a dim idea. But where will it be able to generate profits sufficient to sustain its engineering operations and factories in Japan? And without a steady stream of new products, all facing the expensive engineering challenges of increasing demands for fuel efficiency, low emissions, safety and connectivity, it can't survive.

So selling the firm strikes me as their last straw. For whom would a purchase make sense? Its current alliances with Nissan-Renault make that a possible option, as they can potentially use MMC's plants (though not its dealers in the US, Japan and Europe). Perhaps a Chinese company can be tempted, as with PSA and Volvo. But as I see it, Chrysler is the one global player with a footprint in North America and Europe that lacks a strong presence in China and developing Asia, the regions where MMC is least weak. If so, this would be the third attempt involving some iteration of Chrysler. But remember, three strikes and they're out. And that will be MMC's fate, if it can't sell itself before the yen again strengthens.

...three strikes and they're out...