Automotive Inflation: More than Meets the Eye
Vehicles are a focus in CPI, but other auto services/goods added in makes “autos” almost as large as Food in the CPI index.
As we dig deeper into CPI, specifically at the role played by automotive sector line items in the total mix, we find inflation numbers for new and used vehicles come with more add-ons than are typically highlighted in monthly CPI discussions.
When you roll up the various services, i.e., insurance, maintenance/repair, aftermarket parts, and fees, the automotive sector is almost the size of the “Food All” line—well before you put gas in the tank.
New and used vehicles catch the headlines for good reason, but the cost creep in maintenance and insurance, and the forecast for higher borrowing costs, all make the “driver experience” a lot more costly for households as budgets get squeezed broadly.
At over 12% weight in the CPI index, these automotive line items materially exceed Energy (8.2%), Rent (Primary Residence) at 7.3%, and Medical Care Services (6.9%).
In this commentary, we try to give some context to the broader picture around where the automotive sector fits in the inflation picture, i.e., within the “material to components to OEM to dealer to services chain.” Broadly, the auto sector has always been one of those high-multiplier-effect industries like housing. As a broad sector, autos flows into everything from materials (lithium is a new addition to the upper tiers of the list) to freight and transport to manufacturing, retail, and finance.
Over the last 40 years (or longer), the auto industry multiplier checklist has been adding more tech and software to the mix than at any other time in history. The electronics and software role just keeps on climbing. The impetus to transition to EV will keep the auto industry as critical as any in the next wave of investment and job creation. That said, geopolitics is a rising threat given how many OEMs and Tier 1 suppliers have grown dependent on China for their supplies, well beyond the Taiwan chip connection that flows into the US and China supplier base for systems integration. Headlines are spooky on what this could mean for disruption risk.
In the chart above we highlight a few key line items that are part of the broader auto-related story, but vehicles get lumped under the Transportation Commodities category (new and used vehicles, parts and equipment). The separate Transportation Services bucket (motor vehicle maintenance and repair, motor vehicle insurance, motor vehicle fees) does not draw as much attention.
The main point: A lot more than new and used vehicle costs flow into the inflation impact of the automotive sector. For reference, below we also provide the Energy and Shelter categories. A slice of that Energy inflation ends up in the tank of the car and truck, adding to the cost of ownership.
That auto CPI chart also drops in the other four categories of the Big 5 of inflation buckets (Shelter, Food, Energy, and Medical Services). If we roll up autos in this format, the Big 5 (including this pro forma auto lineup) account for just under three fourths of the CPI index weighting. Energy is more self-explanatory than the Shelter group, where Owners’ Equivalent Rent (“OER”) deserves its own commentary. That OER line tends to create a commotion for what it means in substance for more homeowners with high home equity and freshly refinanced mortgages with low coupons locked in. In contrast to the OER, the replacement cycle for autos is much shorter in years while the need to do auto maintenance is less predictable. In addition, the demographics of families (the echo boom) or drivers coming of age can factor into the new or used car market (and the related insurance and repair/maintenance) with almost 40 million transactions a year in the used space. With 285 million vehicles on the road, the usual estimates of 13 to 16 million new vehicles sales, and 40 million used vehicle transactions, it is a busy mix of subsectors.
The supply-demand balance story still rules…
Vehicle inflation has been a headline item across 2021 and 2022 for both new and used vehicles, so that is not news. The supply-demand imbalances come with plenty of explanations as COVID brought some major disruptions in production and replacement cycle distortions. Auto demand soared with the vaccines in fall 2020 and comfort around employment and consumer credit. Inventory availability soon rose to the top of the list as a factor driving auto sector inflation. For OEMs and dealers, pricing power was clearly in evidence, and it was freely exercised as detailed in the bullets below.
The theme of supply-demand imbalances broadly was part of the post-COVID demand spike in many industries across goods and services alike, but the problems were especially acute for auto inventories—new and used. Regardless, the need to pass through much higher operating costs was a big contributor to pricing strategies. The operating cost base included all the freight and logistics issues we hear about given the global supplier chain profiles, but materials and wages were also a big part.
Who eats the costs? OEMs vs. suppliers…
The cost pressures are not as straightforward here as in some industries with suppliers bearing a disproportionate amount of the pain in materials costs and disruptions along the suppliers chain (Tiers 1, 2, and 3), including from freight and logistics disruptions. Suppliers are almost always on the disadvantaged side of the cost risk story even if there are some exceptions for the most tech-intensive suppliers who have the ability to push back. As EVs become a bigger factor in fleets, that balance could shift unless the OEMs build more of their own captive supplier chain capacity (notably batteries and/or chips via JVs, equity stakes, or long-term contractual commitments for building in the US). We see some of the largest Tier 1 suppliers investing heavily in chip expansion (e.g., Bosch) but the more common theme is the chip suppliers seeking to add greenfield capacity in the US (Taiwan Semi, SK Group, Intel, etc.)
The semiconductor challenges have been extensively covered in the trade press for how that stalled production and in turn cost the OEMs a lot of sales opportunities. We will look at more of the broad auto sector trends in a separate commentary. We recap some of those key drivers below, but the focus here is on the range of inflation effects that goes beyond the vehicle costs.
Key Takeaways
Something new or used or whatever is on the lot: High inflation in new and used vehicles has been a fact of life in 2021-2022. Used cars have captured a lot of the headlines as prices on used cars soared for a number of extraordinary reasons. We say “extraordinary” rather than “nonrecurring” since the COVID pandemic, Europe’s largest land war since 1945, and the sacking of the US Capitol arguably has outlawed the concept of nonrecurring. I hope “extraordinary” still applies in a few years and not “recurring.” The idea of buying a used car at a price higher than the sticker price on a new car of the same model was one of a range of exceptional developments in the automotive market. The auto sector is also going through a massive propulsion transition process with tens of billions of capex pouring into the EV markets every year from lithium to finished vehicles, from assembly plant and battery plant construction to component supplier chains to charging stations. Toss in widespread moves to digital transformation from new to used vehicles and in remarketing by fleets directly to consumers and you also have a real chowder of evolutionary trends in auto retail (new and used) and fleet management.
The battle for inventory: The demand for inventory, the supply-demand imbalances in integrated mobility from consumers to ride share and car share, and the migration to EV all are part of the mobility evolution themes that gets discussed daily in the trade rags and across the subsectors of transportation. For all the currents of change, the main economic story line is still some retail buyer making a decision about the need for a new or used car, looking for financing if needed, the vehicle buyer meeting the requirement for insurance, and paying whatever related fees are attached to that purchase. Then that owner gets repair and maintenance if needed whether under warranty or otherwise. If repair and maintenance costs rise, the costs of warranties sold at the dealer level also sees prices rise.
The inventory challenge has created plenty of distortions in what constitutes a normal supply-demand relationship, and in this case the demand outstrips the supply. Used cars have been hard for dealers to source with trade-ins less available due to a combination of new car affordability and supply (i.e., impaired production rates) and weaker sales. Rising interest rates also can limit used car supply if replacement cycles remain stalled by household budgets getting squeezed from inflation.
There is ample commentary from the industry of late on the building of inventory back to more acceptable levels and well ahead of the prior year’s depleted levels that drove major sales volume problems. The rebuilding of inventories shows inventories back up to around 42 inventory days (still below normal) at recent selling rates in early October. The lower inflation school of thought on new autos is that a significant erosion in demand will be the outcome of high inflation broadly and higher rates on loans. The idea is that will help bring new and used car demand back into better balance. There is also the omnipresent threat of a recession and shifts from 50-year lows in unemployment. More joblessness means less demand although used cars benefit in theory during tough times vs. new vehicles. Less pressure on the new car supply-demand balance with less demand and higher inventories (or even a rare incentive program) could help on price and would also boost used car inventory on trade-ins.
New vehicle transaction prices breaking records: Average transaction prices should have a hard time sustaining the pace of growth with an average transaction price (ATPs) over $48,094 in September 2022 (Source: Kelley Blue Book) or just down from the record price achieved in August at $48,240. Dealers have often annoyed OEMs with markups from the sticker price that some OEMs did not want to see—in part due concerns of longer-term customer loyalty. Dealers will do whatever they can to make more money. That is not likely to change if demand vs. supply remains favorable to pricing flex. The ATP has in fact exceeded the MSRP (aka sticker price or Manufacturers Suggested Retail Price) for 16 straight months according to Kelley Blue Book. That is a fairly stunning stat.
The retail mix is somewhat distorted by a high luxury share (18% of total), but non-luxury ATP was also transacting above average MSRP. During the summer, Automotive News did an analysis that showed how the prior 15 years saw only two years with double-digit ATP % increases—2021 and 2022. Luxury ATPs were $65,775 in Sept 2022 and non-luxury $44,215. Looking at the CPI new vehicle increase in the BLS data, we see +9.4%, but that includes a new car component of +10.5% for a CPI line with trucks at +9.1%.
The highest ATP growth prior to 2012 was 6.1% in 2020. Prior to 2020 and all the way back to 2008, those 12 years saw 11 years with 3% handles or less. Of those 11 years at 3% handles or less, 9 years were 2% or less. Only one year—the economic rally year of 2010—posted a 5% year. The last 2 years 2021-2022 have clearly been exceptional by any standard. The new vehicle inflation is likely to move lower in 2023 and notably in non-luxury tiers. Geopolitics is the main threat (supplier chain nightmares in a Taiwan conflict scenario) or a fresh deadlier bout of vaccine-resistant COVID. These double-digit numbers for vehicles are not sustainable under remotely normal conditions. Insurance and repair/maintenance are a different story.
New car cycle chipped but not broken: The outlook for sales remains muted on supply challenges and the same sort of problems experienced in the supplier chain across 2021 and 2022. For some context on volume impact, Cox Automotive recently updated its forecast again and lowered its 2022 sales forecast in the US to 13.8 million or the lowest in a decade (Source: Automotive News, Cox). The semiconductor challenges and the slowdown tied to chip shortages have been picked over with regularity. That topic deserves its own commentary with China/Taiwan tensions and massive capex plans underway to expand domestic capacity in leading auto markets such as the US and Germany. The recent news flow is that numerous major OEMs are already lowering their forecasts for 2023 from earlier plans. These changes are regularly tracked in the trade rags.
Will used cars move (slowly) toward reversion in the new-used pricing relationship?: The bottom line in the trends as they are unfolding is that used vehicle inflation should ease as supply-demand balances improve and the distorting effects of COVID on used cars eases. The retail lease roll-offs and rental fleet remarketing will take a while to be felt but soaring travel and rebuilding rental fleets will help as 2023 proceeds. Before COVID, the steady rise in new car prices was growing the differentials between new and used vehicles (on a same-vehicle basis) to historically high levels. The logical outcome was going to be a secular shift toward more demand for late model used cars on relative value and affordability.
The talk of a negative effect from an off-lease “tsunami” of used vehicles was dialed back in the industry as demand for used cars grew. When COVID struck, the differentials quickly collapsed with some used car prices going higher than new just on inventory scarcity. The purchase of late model used vehicles at lofty prices (sometime higher than new) was like the old adage on “Why did you climb that mountain?” (“Because it was there.”) The pricing dynamic for buying a used car was simply the fact that the car was available. Then to make matters worse, the used car lots started to empty out.
The role of EVs in pricing strategies by OEMs: If the OEMs can still push pricing higher on new cars, there is every expectation that they will. The financial logic is that the transition to EVs, the need to invest in battery capacity, the high raw materials costs, and the new capacity and retooling needs all point toward higher ATPs. That will allow the OEMs and suppliers to meet the broader consolidated financial pressure to invest in new tech at a record pace. If the OEMs can “stick” the supplier chain with most of the rising cost of materials or freight and logistics in 2022-2023, I assume most OEMs will do that. Those topics come up in industry literature.
The supplier chain stress is not just about the Tier 1 supplier chain players familiar to the public markets. There remains a long tail of suppliers on a global scale in the Tier 2 and Tier 3 level that will be under duress. Those also could be swept up in geopolitics (notably in China). There will be much to unpack on those risks (on a different day). The reality is the OEMs will need to focus on maximum cash generation to the meet the transition demands from new EV models and plan construction to investment in battery capacity whether captive or through joint ventures. The OEMs themselves will also face massive uncertainty ahead in how China trade stress will play out.
Auto finance and the rising interest rates: Auto finance is a tough sector to make generalizations about with captive finance, banks, consumer finance companies, credit unions, dealer F&I operations, and leasing/rental companies in the transaction chain in some fashion. The inherent risk of rising interest rates is that the monthly payments on car loans will be going higher. That in turn can slow down some replacement cycle timing decisions for households getting pummeled by the rest of the inflation going on in their life (Energy and Food at the top of the list). That is the same dynamic as rising mortgage payments for new borrowing, but with a lot less pain.
The headlines around the rising share of $1,000-a-month payments on auto loans has been making the rounds. The idea that the OEMs might step in to offer financing incentives is always there on slow moving-models, but that makes assumptions about “new car” supply-demand balances that may not come to pass. In used vehicles, there is always the chance that the lenders will take more risk for less premium than is merited. These are going to be trends to watch.
The role of dealers, retail, maintenance/service, and aftermarket inflation: With the perennial focus on new and used car sales and much higher visibility in recent years to the used car business, it is often easy to lose sight of how pervasive the auto sector is outside those two CPI line items. It is understandable since the need for mobility usually makes the car/truck (or 2 or 3) in the family driveway the second largest investment (including replacement cycles) that a household will make. For many, that cash outlay will even exceed tuition and especially with tuition making college out of reach for many as well.
As a frame of reference for the broader economic picture, motor vehicles and parts manufacturing showed a payroll count of 1.0 million people in the September 2022 BLS numbers. Motor vehicles parts retail and dealers was almost twice that number at 1.97 million. That payroll count does not include those focused totally or in part at financial intermediaries that make auto loans, lease vehicles, or deal in insurance focused on autos.
The franchised and independent dealers in vehicles and parts supply (including tires) are major players in the auto food chain. The auto dealer industry has also gained a lot of visibility in the capital markets in recent years as the public dealers have grown (AutoNation, Penske, Lithia, Sonic, Group1, Asbury, CarMax etc.). They have the same manpower challenges as most industries but even more so for skill sets that are required in an increasing technology-intensive process from vehicle sales to vehicle services. I read a lot of the trade rags for autos, and the coverage of personnel needs and employee retention gets more column space than ever. I recall one public dealer earlier in the shale boom say he was losing potential auto repair and maintenance hires to the shale oil sector given the computer skill needs in E&P and how those same skills were needed in automotive diagnostics. It often comes down to pay. The inflation line for the subcategory of Motor Vehicle Repair was 15.0% and for Body Work was 12.6%. The new days are not the old days for Mr. Goodwrench.
Other challenges cited include getting sales and marketing personnel up to speed on new auto tech as they cite the need to bring in the next generation to educate customers on the auto interior tech and “gadget heavy” products of today. That costs money in a tight labor market as the wage inflation theme comes back. That cost must get recovered by markups and F&I products among other revenue strategies.
For dealers, the investment demands of the transition to EV also comes with stricter requirements from the OEMs if they want product. The dealers have high capex and upgrade requirements set by the OEM. Then the demands for skilled personnel with knowledge in the space moves the bar higher again on wages and benefits. That also tightens local labor markets independent of the cycle. Those investment will need to be made even in a recession.
In the end, there is a reason many industry watchers are saying the auto sector is a very hard one to forecast at this stage. Inflation, geopolitics, recession questions, the secular need to invest in EV and related supplier chains, and a mix of macro variables from currencies to potential trade battles all make for a wide range of outcomes.