Kurt Ernst is the U.S. auto industry's best hope--and greatest uncertainty. This spring, he and his wife, Kate, bought a 2002 Volkswagen Jetta wagon, lured in part by cheap financing. The Jetta shares the garage with a 2001 VW Passat purchased two years ago. The 37-year-old Oak Ridge (N.J.) sales exec figures he'll trade in his 1993 Mazda Miata next, but cautions that before he buys again, "we need the economy to get better."
Therein lies Motown's dilemma: Will folks like Ernst keep trading in old cars for new, or are economic worries going to stifle the incentive-inspired bonanza? News on Oct. 1 of a sharp drop in September auto sales gave new credence to nagging fears that the U.S. market can't sustain its sizzling pace. Although September sales were up 3% from a year earlier, when terror attacks kept buyers home, the seasonally adjusted pace of 16.3 million vehicles a year was a far cry from August's torrid 18.7 million clip. "I think we're living on the edge," frets veteran auto analyst Maryann Keller.
This year, auto sales have defied gravity, thanks largely to rock-bottom interest rates and financing deals. But lately they look vulnerable to a host of factors: the possibility of a war with Iraq, a slowing of consumer spending as unemployment rises and stocks sink, and an eventual end to the mortgage refinancings that have given car buyers extra liquidity.
Mounting risks have some economists predicting that auto sales are heading into a downturn that, at least temporarily, could send annual sales tumbling well below the roughly 17 million units the industry has tallied since 1999. Warning that recent stratospheric sales may be a bubble, Diane C. Swonk, chief economist at Bank One Corp. in Chicago, figures 2003 auto sales could fall to 15.4 million. "When everyone starts saying the sky's the limit, that's when you look for the sky to start falling."
Not surprisingly, auto execs disagree. They're sticking with more bullish forecasts, such as the one from researchers DRI-WEFA, which predicts that car sales will hover near 17 million units again this year and next, then climb to 17.5 million by 2004. Carmakers contend that the September results were temporarily distorted because dealers ran out of incentive-laden 2002 models. Says Paul Ballew, GM's chief market analyst: "It's a one-month aberration."
So why are bears worried? Many of the factors driving record auto sales are ephemeral. "Low interest rates and a home-mortgage bubble are propping up" consumer spending, especially on autos, Goldman, Sachs & Co. analyst Gary Lapidus wrote in a recent report. "A spending slowdown should hit autos hard, since the need to buy cars is low."
In a nutshell, trading in a car every couple of years is a discretionary practice--and one that happened more and more frequently lately. Lured by bargains, dealers say, consumers have been coming in often to swap cars. But that habit could cease overnight, especially if carmakers can't afford to keep ratcheting up rebates that now average $3,633 per vehicle--more than triple the $1,194 of a decade earlier. "Consumers don't need to buy a new car," says Arthur M. Spinella, general manager of CNW Marketing/Research Inc. in Bandon, Ore. "What they're driving now is good enough until the next round of incentives comes out."
Of course, few expect auto makers to cut back on cheap financing voluntarily anytime soon: They're too dependent on it. Every time they try to phase out 0% financing and other incentives, as they did again in September, car sales tank. So to avoid getting stuck with excess inventory, manufacturers again reward patient buyers with more hot deals, as General Motors Corp. and Ford Motor Co. both did on Oct. 1.
The question, though, is whether they can afford to continue being so generous. Already, auto makers have paid a stiff price. "Sales may be high, but there's a recession on the income statement," says Ford sales analyst George Pipas. Combined Big Three profits fell from $18.3 billion in 1999 to last year's collective loss of $9.6 billion. That toll, added to worries about pension-fund shortfalls and lingering concerns about the risks in the credit portfolios of the carmakers' financing units, has kept a lid on auto stocks.
There's another reason for concern. Used-car prices--a leading indicator for a weakening new-car market--are down 5% this year, according to Manheim Auctions, an Atlanta auto-auction company. Used cars are considered a predictor because when their prices dip low enough, budget-conscious consumers snap them up instead of new models. Moreover, the used-car supply has ballooned. An influx of trade-ins, combined with a flood of vehicles now being returned as leases signed several years ago expire, have used-car lots stuffed.
Why, given all the reasons for concern, does optimism persist in Detroit? Because even the most bearish economists and analysts see strong reasons for long-term sales growth, meaning any slowdown will be no more than a temporary "pause" before auto sales resume their ascent beyond 17 million annually. Demographics tell a big part of the story. Combine population growth of 1% a year, the fact that a large number of Baby Boomers are entering their peak spending years, and the driving needs of a new cohort of twentysomethings now entering the market, and continued strong sales are just about guaranteed, they say.
Moreover, while it may seem like everyone has fresh wheels, Americans aren't any more loaded up on new cars than they were a decade ago. The average age of cars and trucks on the road has remained just over eight years since the early '90s, according to auto analyst R.L. Polk & Co. That implies there will be plenty of room for replacement purchases in the future.
The relative affordability of cars will help, too. Credit the combination of rising incomes and falling auto prices. Even as incomes surged nearly $800 per capita this year, for example, auto prices dropped an average of $200, says Comerica Bank, which tracks auto prices. The result: Car prices hit a 24-year high in affordability. Buyers can probably afford to dig a bit deeper. Spending on new cars shrank from 2.1% of disposable income in 1990 to 1.3% by mid-2002, according to the Commerce Dept.
Besides, Americans like the Ernst family have been gradually increasing the number of vehicles they own. Auto-registration data compiled by Polk shows that the average number of vehicles per household crept up to 2.05 by last year, from 1.95 a decade earlier. As Americans add a sports car for weekend drives and extra cars for teenage children, says Chrysler Group sales chief Gary Dilts, "two-car garages are going to three-car garages, and three-car garages are going to four."
Still, the heady environment leaves even auto-sales bulls such as DRI-WEFA forecaster Rebecca Lindland worried about forecasting in uncharted territory. "We're so far out of range we don't have any benchmarks anymore," she says. "It's nerve-wracking." Auto makers can only hope that, by combining Americans' love affair with the car and their appetite for a good deal, they can keep the good times rolling.
By Kathleen Kerwin in Detroit, with Peter Coy in New York, and bureau