‘Is it gloomy in here?’ joked a speaker at last week’s JD Power Automotive Forecasting Conference. She was partly referring to the overenthusiastic use of the dimmer switch at the posh London hotel that served as venue. But the question could also have applied to the mood in the hall. Dave Leggett was there and this is the first instalment of a three-part report.
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Throughout the day there had been confirmation that things are bad. We knew that, of course. But there was also the scary notion that things won’t get back to the way they were anytime soon.
A stock cycle based upturn is not very far away and it will bring some relief, but that won’t quite mean all’s right with the world. Things are relative. The best that we can hope for is a gradual uplift that proves sustainable. But even with a fair wind and without any further nasty economic shocks, we’re talking about getting back to 2007 market levels in the middle of the next decade.
Synchronised economic downturn
The global economic situation is at the heart of this industry’s difficulties, so we began the day with an assessment of what’s happening and where we’re headed from Adrian Cooper of Oxford Economics. This time last year we were treated to a rather upbeat address from one of his colleagues. The bottom line then was that the ‘credit crunch’ adjustment taking place in the global economy was manageable because the slowdown in the West was counterbalanced by still strong growth elsewhere – most notably in Asia and Russia.
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By GlobalDataA lot can change in a year. The international financial crisis that deepened late last year has plunged the whole world into an unprecedented and synchronised downturn. The decline to world industrial production in this recession is actually sharper than that which occurred during late 1929 and 1930. Those countries – like China and Russia – whose economies were growing strongly last year have not been able to escape the recession, either through reduced exports or through financial linkages which have reduced credit pretty well everywhere.
To make things worse, risk aversion and liquidity demand have led to the withdrawal of funds from emerging markets. As business confidence globally has waned, so firms everywhere are moving to cut costs and conserve cash in the same way as banks did earlier in the downturn.
‘Deleveraging’ will keep things weak. Asset prices are set to stay low. Households are not in the mood to spend and won’t be for some time. Unemployment – a lagging variable – will be climbing well into next year.
On the plus side, the authorities have acted swiftly to lower interest rates and initiate fiscal stimulus packages. And commodity prices have fallen back sharply since the highs of last year.
And here’s where it gets interesting. After the sheer depth of the contraction to the world economy this year, an apparent recovery based on restocking could actually be pretty fast to get going in 2010. It will be led by the US economy and when it comes it may even look like a sharp rebound, too.
But the underlying problems that have caused this recession will not have gone away, giving rise to the risk of a deeper or more prolonged downturn. Credit remains in short supply, with the banks far from ‘fixed’. Other dangers include the risk of price deflation and growing protectionism that could hit world trade. Past experience suggests that banks are slow to resume lending after banking crises.
Mr Cooper also reminded us that a combination of increased regulation of the financial sector and the need to unwind the current economic stimulus measures will weigh on economic growth in the medium term.
Oxford Economics is couching its economic forecasts in terms of broad scenarios. A particularly ugly scenario in which things continue to get worse in 2010 with the world’s economy shrinking still further, comes with a 20% probability. Oxford Economics own central forecast, in which things slowly get better in 2010 only comes with a 40% probability. When the professionals are hedging their bets with ifs and buts, showing reluctance to stick their necks out and commit with confidence to a view of how the world will be, that says it all.
I guess it could be worse. At least the bottom is in sight and some stock cycle support to activity should be evident later this year and into 2010. It will be a fragile up-tick from a low base. For economic recovery to be sustainable in the longer term the root causes of this recession need to be fixed so that banks are lending again, asset prices have stopped falling, confidence comes back and economic activity picks up. And, even assuming that relatively benign scenario, the experience of this recession will leave its mark for some time to come as governments struggle to balance national accounts and many households spend less than they did and save more.
Scrappage incentives mean jam today, but not tomorrow
As the economic storm has blown in, vehicle markets and the automotive industry have faced a severe buffeting. One clear policy response from governments in Europe has been to introduce scrappage schemes in order to lift markets. For policy makers, the appeal is obvious. Temporary subsidies for car purchase tempt buyers in and through extra sales they help to support manufacturing industry, suppliers and retailers. And there’s that cloak of environmental responsibility that comes with the notion of replacing old clunkers with new cars that are cleaner.
Is it working? The short answer to that is yes, especially in Germany, where the €2,500 subsidy has been topped up with additional discounts. The German car market in March was 40% up on last year. But JD Power analyst Pete Kelly also revealed that a scrappage incentive in Spain hasn’t made much difference there, such is the severe state of that country’s economy.
JD Power calculates that the scrappage incentives announced in Europe will add 1.2m units to the West European car market, taking it to around 12.4m units. But here’s the rub. More brought forward sales this year means fewer next year. The experience in France in the 1990s was precisely that. Governments can come under pressure to extend scrappage incentives, but there’s a diminishing benefit. Eventually, the market catches up with artificial boosts and there’s a compensatory pause in sales.
How much will the UK market benefit from the recently announced scheme? The sterling-euro exchange rate leaves little room for manufacturers to add discounts on top. Margins are slim to start with and especially on small cars. Manufacturers with hot selling products – like Ford with its Fiesta – may be reluctant to stump up ‘their’ GBP1,000 share of the GBP2,000 scrappage discount). The boost to the market this year is forecast at about 100,000 units. A Q1 rush ahead of expiry could mean 2010’s market is 50,000 ahead of where it would otherwise be.
Will there be political pressure to extend scrappage incentives further next year? Yes, there’s bound to be. But the psychological button-pressing nature of these schemes means that any extensions come in the last minute.
The ‘payback’ effect means that JD Power is forecasting a decline to Germany’s car market approaching 30% in 2010 following this year’s boost approaching 20%.
Kelly also made a more fundamental point about the demand cycles in developed markets. Each time there’s an economic recession and a downturn in vehicle sales, the market takes longer to recover. The reason for that is increasing market saturation which means underlying or trend market growth is becoming lower over time. Back in the 1970s and early 1980s we were still motorising. Each time there’s a market dip, the recovery period becomes longer.
And that’s why emerging markets will recover more quickly than developed markets this time around. But it is also a reason why this recovery to demand in Western Europe will be a long haul. Overlay that with incentives and some payback weakness further out and it could be 2014 or later before Western Europe’s car market gets back to where it was in 2007.
Scrappage boosts small cars
JD Power analyst Jonathan Poskitt pointed out that the segmentation impact from scrappage is strongest at the small car end of the market where the scrappage voucher accounts for a bigger proportion of the purchase price. Small cars in Germany are selling like hotcakes.
He cited some Q1 sales gains in the ‘basic’ and ‘small car’ segments (otherwise known as Segment A/City cars and Segment B/ Superminis) in Germany:
- Basic segment volume up from 44k units in 2008q1 to 93k units in 2009q1 (+111%): Fiat Panda (+360%); Ford Ka (+490%); Fiat 500 (+100%); Hyundai i10 (+660%); Opel Agila (+470%); Toyota Aygo (+160%)
- Small segment volume up from 154k units in 2008q1 to 258k units in 2009q1 (+67%): Fiat Gr Punto (+150%); Ford Fiesta (+150%); Opel Corsa (+35%); Peugeot 207 (+50%); Skoda Fabia (+130%); Toyota Yaris (+60%); VW Polo (+80%)
One curious side effect of the gain to small cars in Germany – diesel share of the car market is declining this year. It has gone from over 40% at the end of last year to under 30% by March.
And, next year is payback time, so some of those small cars enjoying a boom in orders this year will see much thinner times when their share of Western Europe’s car market drops around 10% points from the current peak of 46%.
European production rise later this year could be a false dawn
JD Power analyst Arthur Maher explained the relationship between sales and production in Europe. It’s a picture this year of slashed build levels and destocking. Not only has the market collapsed in Europe, but major export markets – like North America – have headed south at the same time. European light build this year will turn out close to 20% down on 2008. It would be even worse without that hectic small car activity due to scrappage incentives.
By the time we get to the fourth quarter of this year, year-on-year comparisons are against already collapsed volumes and there is some recovery to build levels now that stocks are wound down. JD Power forecasts that Q4 light vehicle production could be over 20% above last year.
Maher does not expect the extensive Christmas shutdown of 2008 to be repeated again
in 2009.
But he is cautious about the outlook thereafter and especially about the transition to a post scrapping incentive environment. Light vehicle build in Europe in 2010 is forecast to be around 2% down on 2009. A recovery to volumes is expected to take hold in 2011.
Where does that leave Europe’s auto industry? Facing rationalisation. JD Power estimates that capacity utilisation at Europe’s car plants stands at around 50% – versus 80% in 2007. JD Power’s baseline forecast has a return to an 80% capacity utilisation ‘norm’ in 2016. “We can expect further resizing,” Maher says.
A rule of thumb is that car plants break even at 60-65% capacity utilisation. There won’t be much recovery to capacity utilisation from the current 50% this year or next on current market assumptions. Conditions are clearly right for structural change.
Coming tomorrow….Part 2: North America.
And in Part 3 later this week: Eastern Europe and Asia
