Episode 25: Jonathan Smoke, Chief Economist at Cox Automotive

For our 25th Episode of Full Throttle, we are joined by Jonathan Smoke, Chief Economist at Cox Automotive. Topics of discussion include the recent CDK shutdown and its impact on dealers, consumer demand for automobiles, the Fed and rate cuts, EVs, and much more. 

0:00 Intro 
2:38 The CDK Shutdown 
5:15 Dealer Resiliency 
7:10 Consumer Demand has been Sluggish 
12:10 Pent Up Demand 
13:12 Rate Cuts 
17:05 The Impact of EVs on Pricing 
21:46 China’s Impact on the US Auto Industry

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Transcript

Welcome to the fifth episode of season two of Full Throttle, the Presidio Group's automotive industry podcast. I'm your host, Jason Stein, Director of multimedia and events at Presidio. On a regular basis full throttle serves as the industry's meeting point. For great conversations with leaders across the automotive world. 

I would say largely what has happened so far this year. And we're, we're almost halfway through that the year has turned out very close to what we expected to be the case because we expected this to be a difficult, challenging year with rates beginning to come down, that's the one part that hasn't come to reality. And I think it adds to the hesitancy and and the lackluster results, particularly that we had more in the used car market in the spring, I think was a bit more of a disappointment than what I would say we were expecting on the on the new vehicle side.

Reading the economic winds in this industry can be a day to day challenge. If inventory isn't tipping the scales, then it's interest rates. If affordability isn't climbing too quickly, then it's a crisis at CDK, for example, or maybe it's all four of those factors. So how to read the winds of change? Which direction from where and why? Today, we get to listen to the insights of someone who has emerged as a leading voice in the industry. As the chief economist at Cox Automotive, Jonathan smoke has his finger on the pulse of so much that's happening. And for more than 24 years, he's been focused on translating data and trends into relevant actionable insights for the industries that represent the biggest purchases that consumers make in their lifetimes, real estate and automotive. Prior to joining Cox automotive smoke served as realtor.com chief economist before that he was the chief economist for Hanley Wood, a media and market intelligence company and also served in a variety of roles at Beazer Homes, including Senior Vice President of Strategy and Innovation. It's Jonathan Smoke Today on Full throttle.

Hi, this is Jonathan Smoke, and this is Presidio's podcast, Full Throttle.

Well, if you want to know what's going on, I know that I always turn to the one guy here on the other end of the microphone, and that is Jonathan Smoke. He's got his finger on the pulse. He is fully immersed as a full automotive guy now forget the past that he had. And it's a pleasure to have him on the program. It's good to have you back. 

Yeah, it's always good to talk to you, Jason. 

Same here, we have to start with the inevitable discussion that's circulating, although it's a moving target from a news perspective. But we'll we'll just start off with what, you know, your view on the CDK effect, the effect of of the shutdown and a situation that obviously has created all kinds of turmoil at the dealership level, but I know you have a very specific view on this. so fire away. 

Well, yes, I'm almost immediately when it was clear that this was going to last more than 24 hours, people were asking me what's the impact going to be on the market. And basically, I view this much like a weather event occurring. Yes, it's impacting 1000s of stores. But what is most important here is that it's really not changing the fundamental demand for vehicles and and or put another way, consumers in need of transportation are not passing on buying a vehicle because of software issues at some stores. So I think what we will see if we give it enough time, is that disruption will happen in the sales that are occurring in June. You know, so we're going to have a week, two weeks, maybe longer. But eventually those sales that would have would have taken place would have will occur. I do think it adds another factor of inconvenience to what I would call a lackluster amount of demand right now. Because I think in general, consumers are hesitant to make purchases any kind of big ticket purchase this summer, because of the perception that rates will be coming down and prices are likely to be lower as well. And so it just adds to the challenge that dealers are facing to convince consumers that now is a good time to buy. So you know, if I'm a dealer, I wouldn't be worried too much about losing those sales over the longer term, but I would be preparing not just how am I going to do sales if this persists, but you know, how do I get consumers believing again, that it's actually a good time to buy, and and creating some sense of urgency in the market that I think is is suffering from a lack thereof.

It's also proving the resiliency of the dealer network, isn't it? I know that's been talked about a lot during this whole issue. But if we go back to the bankruptcies if we go to COVID, now we go to this. 

I mean, I look back and think of the resiliency that dealers displayed when they were not allowed to be operating in 2020. In many places, and dealers more than survived in COVID. They, they thrived. So I will, I would never bet against dealers, I think they will triumph over this. Clearly, there's some lessons learned that this was an Achiles heel, and there's probably going to be better solutions that prevent something like this from from happening again, in the future. It's impacted us, we do see evidence of the disruptions in some of our most timely data. In particular, I've seen credit applications that are off the trend that we had pre-disruption, we're seeing a pretty substantial change on X time in service appointments. That one was a bit of a surprise to me. And I think actually, what's missing in the data may be more a reflection of what's not being recorded, as opposed to what's not happening. Because I'm quite sure, in what I'm hearing, I'm curious what you're hearing, but I think most dealers are finding a way to work around this. And we just may have some records that are slow to be updated. But you know.

Exactly the same thing I just, from the folks who we've talked to over the course of the last week, it's it's back to basics, you know, and that's, and that's what a fairly prominent South Florida group told me last week, like, look, it's pen and paper, and we might be a while to catch up. You know, not not to mention all of the other issues that could pop up litigation. You're reading all about that now. But yeah, service. And also, I want to hit on something that you just said, it's not going to change consumer demand, but consumer demand has been sluggish. Give me your read on consumer demand. And is there still pent up demand for vehicles lingering from the pandemic? Or is that over?

Well, yeah, that's that's two big important questions, I would say largely what has happened so far this year, and we're, we're almost halfway through that the year has turned out very close to what we expected to be the case, because we expected this to be a difficult, challenging year with rates beginning to come down, that's the one part that hasn't come to reality. And I think it adds to the hesitancy and and the lackluster results, particularly that we had more in the used car market in the spring, I think was a bit more of a disappointment than what I would say we were expecting on the on the new vehicle side. You know, so far, we think the way June is going to end we're going to end up with a year to date SAR of about 15.6 million, which would be up about 3% year over year. And used has also seen growth because last last spring and last summer were were bad. And you know, in the most recent weeks, we've been tracking used retail sales up 8%, year over year. So we're definitely seeing growth, it's just constrained growth. What I am most concerned about is more about the next couple of months, because we're getting research survey data that that are indicating that consumers are feeling a very high degree of uncertainty about the election. And they have the perception that rates are going to be lower inflation is going to be lower almost immediately when the election is done. And you know, as an economist, my first reaction to that was laughing, saying that, you know, who occupies the White House, especially given the choice between these two, it's not going to change interest rates. But if enough people believe that and that changes their behavior about purchasing because hey, if you gave me that as as the condition that rates are going to be lower in a few months time, and I could put a high degree to confidence, then the wise move is to postpone making any any big purchases and the problem in an in an economy is if too many people do that, it starts to create slowing economic activity and it impacts businesses which in turn have to cut back and and that unleashes you know the beginning stages of of a recession. I'm not saying that we're gonna go through that, because I think what what we've seen this year is essentially we're having a struggling time to get above the growth that we enjoyed last year in the new market. Thankfully, the used market has stopped declining, and we're up off of the bottom there. But in an environment where auto loan rates are at the highest they've been in 24 years, it is really tough, especially with evidence that consumers are not only struggling with affordability, like literally how many people can afford to transact and buy a new vehicle today. But they're also they have a heightened sense of price sensitivity. There's some great research that Morning Consult does, and it shows autos not alone in this category. But consumers are basically just more price sensitive. So technically, I can show you the math, that affordability has actually improved this year, for both new and used vehicles because there are four main metrics that influence affordability, and three of the four have moved in the right direction. It's only the interest rate component that has moved in the wrong direction. But if you can afford more, but now you really want to see a price that's even lower to compel you to move, which is basically how the consumer is is acting in auto and in many other sectors, it essentially means that affordability is not enough or put another way, pricing has to come down a little bit more and consumers have to feel like they're getting a deal in order to you know, make them transact. And I think that adds to the lack of lack of launch that that we've seen in further improvement on on the new vehicles SAR.

Is that just the wave of information related to inflationary pressures over the course of the last couple of years that people become sort of heightened to this sense of, am I paying too much generally, all the way from fast food to cars?

Well, I Yeah. And I think it contributes to an overall fatigue, that that sort of builds on that. But I also back to your second part of your question on pent up demand, I think at today's prices and rates, and who's capable of transacting, we've exhausted the pent up demand. But if you were to hypothetically say we would have the prices we would have had had we not had the pandemic today, and we'd have interest rates that were closer to what they were in 2019, as opposed to the unnatural high level of rates that the Fed has pushed rates into, then I think we would, you know, have more demand. And you can kind of see that in the vehicle market this year. The segments that are up year over year are the more affordable segments, compact cars, compact crossovers. It's definitely got a value orientation. And you take a step back and you look at the broader economy, and in this economy, Walmart is doing well, but target is not. And and I think we're seeing a bit of that in the vehicle market too.

Jonathan, at the beginning of the year, it was widely believed the Fed would cut the federal funds rate at least three times during this year. That story has changed a lot.

That stories, yeah, has changed the most and I would say is the factor that has turned out to be most different than expectations. You know, at the end of last year, the financial markets were actually betting on six rate cuts by the end of the year, and we've had none. The last rate increase was July of last year. So we're almost lapping that. So effectively, the Fed hasn't moved. But their rhetoric has swung from being dovish to hawkish, which is caused the tenure to move up and down pretty dramatically through the year. But net net the tenure is higher by 40-50 basis points now and it's even though it's come down at roughly 40 basis points. So that influences consumer rates really more than the Feds official policy does. And we also see that yield spreads have widened again, because lenders see a lot of uncertainty and they also see warning flags on delinquencies and that has caused them to be more risk averse, which means that they you know, among many factors, they have widened their yield spreads to make sure they can handle more more losses more defaults on the on their books. And so that produces a double double whammy that auto loan rates have actually increased even more than the 10 year has increased and and actually, it has continued into June, June, month to date and Seeing the average new rate cross 10%. And that is officially a 24 year high. And we didn't we came very close to it last fall, but we never crossed 10%. But we have so far in June.

What do you now see to be the most likely scenario for interest rates being cut either this year or next?

So I think the most conservative scenario sticking to the latest latest projections from the Fed officials is that we'll have one cut and that cut will come in December, post the election results. So effectively, it's not going to change what consumers are seeing in the near term. But once that cut goes into place, it likely sets us up for at least a full percentage point if not a point and a half in cuts, transpiring fairly regularly in quarter point, doses next year. And then on top of that, I think that amount of uncertainty, and and what should be some improving momentum for consumers buying not just cars, but homes and reinvigorating really important sectors in the economy should help to remove uncertainty about how, where the economy is going, which will help lenders feel that they can get at least back to a more normal yield spread. And so consumers could see 2% improvement in rates, and then you're starting to talk about rates that are more normal, and I think would would really compel some people to get back into the market, with all the other variables going well, too. And those other variables are incentives being higher incomes growing at a very healthy pace. But obviously, vehicle prices coming down which are happening in both the new and used market as well.

How about the impact of the pendulum shift on EVs to pricing?  I have to believe that we're just going to become or that the levels will again normalize.

Yeah, EVs are clearly in a situation that have been over supplied for about two years now. The gap on the inventory levels, and day supply being so far out of whack with with the overall industry is narrowing. So that's because sales are up modestly. They're not in they're not up dramatically. But we we think we're in for some growth this year and in evey sales, but we you've had some very high profile cuts in in production postponement of of launches. And perhaps most importantly, what's really hurting EV sales growth is a surge in hybrids and plug in hybrids, because those vehicles are really the natural stepping stone to get particularly plug in hybrids, to get consumers feeling more comfortable, while we see infrastructure and battery technology and just have the facts that consumers can have more confidence that these vehicles will retain their value and will will be capable of performing over over the longer term. So you know, I think the next couple of years are likely to be the most challenging for for selling EVs, I have no doubt we're gonna see growth because they're, even though there's launched delays and reductions and in sales plans by virtually every every brand, every brand still has plans, and some still have very aggressive global plans of of getting to 100% or certainly the majority of the vehicles that they're offering being electrified within the next five, five to 10 years. So it's it's an inevitable path. We think the demand research suggests that the most challenging years are this and the next two, and by that point, consumers, more consumers will go from being skeptics to be considerers and we you know, you know, I take a very sort of back of the envelope, skeptical view of what the total demand is going to be longer term. And I drew this very simple conclusion look, based on what we've seen, where there has been success in the US what it has come down to are households that have more than one vehicle in their household. So our multi vehicle In a household, they have the ability to charge the vehicle at home at night and play and pay residential rates. So there really isn't a convenience factor. And the use case for that vehicle is mainly urban driving, commuting, commuting to work. In that scenario, an EV is a homerun and if we were able to do that, you would basically sell at least a half of half an EV for every household in the country, which gets you to about 65 million EVs when today we have three and a half million. So that's a huge growth opportunity that again, from a pure economic standpoint is a no brainer. I drive a plug in hybrid today, it's been five months since I put any gasoline in that vehicle it fits. So you know, it has taught me that yes, I can handle even the, you know, the low end range on an electric vehicle for for my day to day usage. And so I think more and more consumers are going to see that with the pricing dynamics we're seeing in the Evie market. It makes me even more confident that in two to three years time, the most affordable vehicles are likely to be EVs and multiple EVs, you know, with great choices. So I'm, I'm optimistic. I just think that, you know, the part there's too much KoolAid being passed around at the party for how quickly we're going to get there without actually convincing people. This is good for them and good for the climate and, and good for the country overall.

Yeah, well said. Final thing. As you look further out, how are you thinking about China and the possible impact of Chinese manufacturers on the US auto industry? Even with Biden's tariffs on China-made EVs? And could this be a disruptive force on the US industry?

Yeah, I think it's, I think, is a disruptive force. Regardless of whether or not it actual actually comes to fruition, meaning, you know, right now, it looks like both Trump and Biden would be greatly resistant. And it's not a factor that we should consider to be material, materially likely over the next couple of couple of years. But if you look at affordability, and you look at what BYD for example, is doing in in Europe, and in South America, there is no question that there is a giant vacuum of space that if you can really deliver a sub 20,000 vehicle, even if that vehicle is fully electric, I think you would create demand opportunities. And so it totally depends on who the stakeholder is. But as an economist thinking about what dealers need, and thinking about most of the of the ecosystem for the automotive market in the US, we all benefit by having more cars in operation and having affordability addressed. So I think what what the Chinese manufacturers have managed to do has proven that you can do this profitably. Is there a role that the Chinese government and other special circumstances have enable that to happen? Possibly, but does that force some changes and thinking and, and really push our manufacturers to really address it rather than completely abandoning affordable price points? There's, there's enormous opportunities, I think, in the marketplace. And I think and if we were to have Chinese entrants, either directly, or because they set up factories in the US or in Mexico or something like that, we could easily see an 18 million SAR, but I'm the first to tell you, I'm skeptical about reaching 17 million with today's dynamics, and what's what's really much more expensive vehicles coming from North America and and Europe and and Asia.

Wonderful. Always great to catch up with you always so insightful. And we'll check, we'll check back in with you again at a later time to to get a full update.

Yeah, we'll have to see what the election outcome really is and what that's gonna mean for the year year ahead.

I agree. I agree. We'll have you back. Thank you, Jonathan. Thanks again to my guest, Jonathan Smoke, Chief Economist, Cox automotive, and thanks for listening to Full Throttle. Come back to us later in the month for our next interview on this platform. Email me with suggestions JStein@thePresidioGroup.com Or go to the website, ThePresidioGroup.com. Follow us as well on LinkedIn. Thanks again for listening to the program. We'll see you next time.