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Auto sales in U.S. have a tough road ahead

Edward Niedermeyer
Bloomberg News

Having enjoyed a roaring comeback from the depths of the global financial crisis, the auto industry is shifting back into cruise control. Though European auto sales appear to have staged a mini comeback in September (up 6 percent), growth has slowed more dramatically in China than anyone expected (up just 3 percent). With the bottom falling out of Russian demand, India stuck in neutral and South America dipping again, automakers are facing renewed pressure to make up for that weakness with sales in the U.S. market.

The burning question: Can the U.S. market sustain the growth automakers need to keep rolling along? According to forecasts by J.D. Power, AutoNation Chief Executive Officer Mike Jackson and others, there's nothing to worry about: Sales in the U.S. will rise to nearly 17 million units next year. But history is littered with such optimistic forecasts, subsequently abandoned when growth slows. And there's plenty of evidence to suggest that auto sales have gone as high as they can go.

The case for optimism is pretty straightforward: Car sales and transaction prices have been growing relentlessly since 2010, as new fuel-saving and infotainment technologies coax buyers out of older cars into pricier rides. With gas prices likely to remain low for the foreseeable future, consumers are likely to continue upgrading to higher-margin trucks and SUVs, too.

Despite these trends, the potential for a slowing in U.S. auto demand cannot be ignored: The U.S. never had sustained sales above the level of 16.5 million units per year. Indeed, IHS Automotive sees the market topping out at 16.7 million units in 2016 and 2017 before dropping back to below 16.5 million by 2020.

Another major cause for concern is the fact that the U.S. auto market's recovery was driven by expanding auto credit, which is now reaching the limit of its stimulant effects. The subprime auto loan boom has attracted widespread media and regulatory concerns, and lenders are pulling back as delinquencies rise. Increasing loan terms are pushing consumers underwater on new cars. Though fears of systemic risk caused by an auto loan "bubble" are overblown, such a credit expansion has risked pushing future demand forward. Unless the Federal Reserve maintains its quantitative easing policy indefinitely (or expands it to buy asset-backed securities, as the European Central Bank might), it seems unlikely that demand for asset-backed securities will persist, cutting off the macro-level support for expanded auto credit.

The broader macro policy debate will also determine whether the U.S. car market will continue to grow: If central bank policies hold steady, car sales will continue to improve. But that perspective overlooks the potential for secular impacts on new-car demand. Improving car quality and changing consumer perspectives on auto ownership (specifically, urbanization and the rise of smartphones and car-sharing apps) may exert downward pressure on U.S. car sales. And while the average age of a vehicle remains at a high of 11 years, rather than indicating pent-up demand, consumers may simply be realizing that quality improvements allow them to keep their cars longer. Additionally, the raging success of car sales over the last five years has rebuilt the stocks (and lowered the price) of used cars, once again making them viable alternatives.

In short, secular pressures indicate that the new-car market could well be facing downside risk unless central bank policies remain aggressive. It's also worth noting that this risk may not affect all automakers equally. Due to extreme exposure to the U.S. market, Detroit's Big Three automakers — General Motors, Ford and Chrysler — are most likely to be affected by a slowdown, especially if weakened credit markets prevent consumers from upgrading to the trucks and SUVs the companies rely on for profits. Moreover, relatively weak brands such as Dodge and Cadillac have already seen sales decline through the first three quarters of 2014 over a year earlier. As slowing volume ramps up the competition, expect marginal players to feel the squeeze the most.

How and when the U.S. market reaches maturity may be up for debate, but there's no question that the days are over when rising global demand lifted all players. The next several years will see intensifying competition and huge expenditures by the major players, who hope to gain some room for growth by knocking out smaller and weaker manufacturers. Anyone hoping to survive the coming endgame will have to fight for every sale going forward.