Falling Car Prices May Slow Detroit's Profit Machine

For those who can pay in cash, conditions are gradually improving for buying a car. However, for companies that sell cars, conditions are getting worse.

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The Manheim Used Vehicle Value Index, which tracks wholesale auction values in the U.S., finished 2022 down 14.9%. This is its worst ever annual result and far worse than the 3% decline forecast at the start of the year by Cox Automotive, the data provider that crunches the numbers. Adjusted for mix, mileage and seasonality, the index did tick up in December, breaking a 12-month downward trend, but Cox said Monday that it doesn’t expect that to mark the bottom. It is forecasting a further 4.3% decline this year as interest-rate increases reduce buyers’ purchasing power, with the market reaching a more normal equilibrium in the second half.

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The Manheim index has been a useful early gauge of the underlying strength of the U.S. auto sector since the pandemic, when sales became an unreliable indicator. It posted rapid gains in the spring of 2020, signaling the start of a stimulus-backed boom in consumer demand that soon ran up against a shortage of vehicles for sale. First the lockdowns, then supply-chain challenges disrupted production, keeping prices rising. During 2021, the index made an unprecedented 47% gain.

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The lack of competition from secondhand products allowed General Motors and dealers to price new vehicles more aggressively, supporting a surprisingly profitable run of results despite a slump in unit sales. Strong used-vehicle pricing is also a tailwind for auto manufacturers’ lending operations, as it reduces credit risk and improves the math behind leasing.

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The peak in the Manheim index at the beginning of 2022 coincided with the peak in GM stock as investors started to anticipate the unwinding of the pricing bonanza. Detroit profits remained relatively robust last year as manufacturers and dealers clung on to their newfound negotiating leverage, supported by weaker-than-expected production, but signs of slippage are now emerging. Tesla, which has become a leading indicator with its unusually public real-time price changes, cut its U.S. prices twice in December. While rising interest rates have more impact at the secondhand end of the market, they still matter for manufacturers, not least because consumers often pay for new wheels by trading in old ones.

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This year is shaping up to be a tough one for auto manufacturers. Production is still struggling to recover from the pandemic, with Cox forecasting new-vehicle sales of just 14.1 million this year. That would be up from last year’s 13.7 million low, but still the second-worst result of the past decade. And while raw-material cost inflation is easing, the end of the current four-year contract between Detroit’s vehicle manufacturers and the United Auto Workers union this fall could spell an almighty fight. Last time round, GM workers went on strike, costing the company $3.6 billion.

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The question for investors is whether all the bad news is already priced in. GM stock fell 41% last year, but after a steady drip of earnings downgrades, it is now trading just below its 10-year average of seven times forward earnings. Ford's record is complicated by greater volatility in profit, but when comparing price to sales, its valuation is not far from the long-term average.

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Now is not the time to buy Detroit auto stocks. The best points in recent history to buy these stocks were March 2009 and April 2020. Another opportunity may be coming, but it isn't here yet.