The Resilient U.S. Economy

If the stock market is the pulse of the American economy, the outlook might be better than expected.

In a conversation I had with noted Wall Street analyst and international trader James Vena, he asked a very interesting question: “Where was the Dow a year ago?” Answer: About 12,000. “And where is the Dow today?” About 12,000.

Vena pointed out that the economy has withstood some serious challenges this year, including:

• A debt crisis that would threaten the European economy and the Euro currency itself.
• A significant cheapening of the U. S. dollar.
• A disruption in oil supply from Libya caused by a series of uprisings in the Middle East and a corresponding spike in fuel prices.
• An earthquake and tsunami in Japan that would disrupt world trade including components for global auto production.
• Flooding in Southeast Asia that further disrupts the global supply chain.
• An attempt by a U.S. political party to hold a lifting of the country’s debt ceiling resulting in a lowering of the credit rating.
• The bankruptcy of a major legacy U.S. airline.
• Continuing U.S. housing foreclosures and a further decline in home values.

The U.S. economy is far from out of the woods. But it has withstood a serious assault in the past year and not slipped into a double-dip recession. Will the upcoming election year bring about new challenges, or will the economy get a break?

Mike Smitka as devil's advocate: but it's housing prices that are weighing down household balance sheets, not the stock market. Until you get into fairly high incomes shareholdings are primarily indirect, through retirement plans -- are Americans really going to cut back on their contributions further in order to buy a new car???? And sitting at 9%-plus unemployment for 2 years is "resilient"?

The Ford-GM Stock Equation

As with the economy, the stock market will continue to evolve. So far this year, though, auto stocks, specifically, have hit some hard times.

Surprising to many is the fact that the stock of General Motors has dropped to about $21 per share from its $35-per-share post-IPO high a year ago. Even more surprising is that Ford’s stock has dropped to about $11 per share from $18 in the same time frame. This decline, despite impressive sales gains and profits, and improved fixed costs, now that both companies' VEBAs have capped legacy costs while their UAW contracts have removed the threat of strikes and wage hikes.

Of course, in the past year there have been headwinds: high oil prices, the Japanese tsunami, and the debt crisis debacle, to name a few. Both companies have taken hits on quality, with GM experiencing bad PR due to some Chevy Volts that burst into flames during crash testing and Ford being slammed in a J.D. Power quality survey.

Despite these obstacles, the two companies have stood firm. GM announced the reopening of the old Saturn plant in Spring Hill, Tenn., to build the Chevy Equinox. Both companies continue to increase volume, marketshare, and profits. They have both been reducing incentives while maintaining sales momentum.

Once GM’s stock price gets to a certain level, expect the Treasury Department to sell quantities of the taxpayer’s GM stock. The outcome: a somewhat depressed price.

So what is your prognostication for the upcoming year? Buy? Sell? Hold?

GM recently began paying a dividend on preferred stock while Ford just announced a 5 cent per quarter dividend, its first since 2006.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs here at blogspot and writes regular columns for several publications.

From whence will they come? -- profits, that is.

In North America the pricing umbrella created by the need of the Detroit Three to fund retiree health care is unwinding, while the Europeans are fleeing the Euro to add capacity here; the Japanese began diversifying out of their yen cost base 15 years ago. In the short run, that may improve profits for the Detroit Three and the Germans at the expense of the Japanese, but will ultimatlely enhance rivalry and lower profits for the industry as a whole. Europe remains in the doldrums, and the excess capacity in China will become more apparent as sales slow to a merely torrid pace. Ditto India. Brazil? South Africa? Sure, there will be markets that grow, but will they grow faster than new capacity is added? I can't think of an exception.

That pressure is obscured by shifts among market segments, particularly in the move away from small cars in the US and China that boosted profits for some firms. It is also obscured by exit, the role of which is inadequately recognized. In Europe VW snapped up SEAT, Skoda and others while Ford and GM consolidated formerly autonomous UK and German operations. In Japan Toyota absorbed Hino, Isuzu, and Daihatsu and now has a large though not yet controlling stake in Fuji Heavy Industries, Subaru's parent. Meanwhile foreign partners have unloaded their stakes in Mazda and Mitsubishi, which face a shrinking domestic market and a yen whose value makes exports unprofitable. No one is likely to value them solely for their engineering capabilities; their demise is only a matter of time. The US looks different partly because of large capacity adjustments by the Detroit Three, but we've also seen the demise of AMC, Suzuki, Isuzu, and Mazda while Mitsubishi's plant continues to run at unsustainably low capacity. If we include the elimination of brands such as Saturn and the cessation of exports by various firms, exit is significant. Inside Korea, Hyundai gobbled up Kia while GM purchased Daewoo and Renault picked up Ssangyong. The survival of brand names makes it hard to know what operations remain. Ditto Australia, where the Ford and GM affiliates were at one time stand-alone companies.

You might say "but China." Few outsiders are aware that there were 120 firms in that market, which was dominated by a host of minuscule operations owned by the governments of provinces and large cities. They had captive markets -- the models made in Shanghai couldn't be found on the streets of Beijing, and vice-versa. Of course some of these firms and subsequent private entrants (Geely, Chery and BYD) continue in business. But the market is dominated by those Chinese firms that poured their efforts into joint ventures; they've created jobs and been able to keep a slice (as a first approximation, half) of the profits, and some of them have quietly gobbled up failing regional firms. That's important because, while the central government in Beijing has been able to eliminate the domestic trade barriers in industry after industry that impeded the creation of a national economy, the legacy of local fiefdoms remains visible in the vehicle market. VW and GM, strongest in Shanghai, have done very well. Who will "own" Sichuan Province, with a population of over 100 million? It won't be a local firm, because their exit continues.

So as I look across the world (OK, on a good day I can only see 40 miles from my mountain ridge home), well, what strikes me is the likelihood that in the aggregate profits will continue to erode. Consumer preference for choice offsets that, allowing an amazing diversity of product to survive in the marketplace. From time to time individual firms will themselves with the right vehicle in the right place, and do quite well. But that will be offset by poor profits elsewhere. In the background, there's the pressure to invest in new technologies. No one can risk not pouring resources into R&D, as regulatory pressure for safer products, lower emissions and higher fuel efficiency keeps raising the technology bar. But with expensive new and less expensive old technologies continuing side-by-side in the marketplace (and typically the dealership), it won't be possible to raise prices sufficiently to generate generate commensurate profits.

With lower industry profits, the losses for those firms that fail to hit a sweet spot will be worse. It will thus be much harder for firms that find themselves on left tail of the distribution of profits to survive. Chances are Saab won't be the last manufacturer to fold in the 21st century's second decade.

Followup: For a story focusing on this issue from that standpoint of one product, see"Toyota Threatened..." by Alan Ohnsman at Bloomberg.

Mike Smitka

Where are the French?

...they must have all the love they need at home...

Mike Smitka

First it was the Japanese. Then a couple Germans and the Koreans. Now the rest of the Germans. The Italians have one foot in the water. But except for a fleeting presence through American Motors, both with Simca as a subsidiary and later with Renault as an owner, the French -- who dominated the global industry in its formative years in the 19th century -- are nowhere to be found. Why?

Now it may be that Renault's control of Nissan represents de facto entry. Certainly purchasing is handled on a global basis, and there's cooperation in engineering. It may be that some Nissan products currently on sale in fact use a Renault platform (Perhaps one of my readers can fill in the gap.) But the absence is puzzling.

That's even more true of PSA (Peugeot-Citroen). The last time I looked (I'm probably showing my years!) they were doing well in Europe and solidly profitable. They keep up with technology, as seen in the customer base of the winners of the PACE Supplier of the Year innovation award for which I'm a judge. They're simply not here.

So what is their strategy? Do they believe that sufficient technology resides in the supplier base that they do not need sheer size to fund the R&D for tomorrow's products? Are they making enough money in small cars that they've chosen to "stick to their knitting" -- not venture into segments with which they have no experience -- and are therefore passing up the US market with its cheap gas and penchange for fuel guzzlers?

I don't know, but I've started to think about the variance in such "macro" strategy across the top vehicle assemblers. Suzuki strikes me as the closest analog, but they have a strong base in India, though it's probably no longer accurate to say that they dominate the market through their joint venture Maruti. Then there's Daihatsu, but they were gobbled up by Toyota and so, for better or for worse, are shackled to the small vehicle niche. Daihatsu long ago exited the US market; Suzuki seems likely to. So maybe PSA made a sensible strategic decision, and refused to join the herd in entering (and now exiting) the US.

My curiosity is piqued, but I have no answers.