On May 11, BMO Private Wealth held the first of a three-part series for automotive owners. Focused on economic trends affecting the industry, the hour-long conversation was hosted by Sal Albano, Vice President and Market Leader.
Albano kicked off the conversation on a positive note, hailing Stellantis’ recent investment in the Windsor region (the heart of the automotive industry) of nearly $4 billion as part of its vehicle electrification strategy. The microphone was then handed over to Robert Sadokierski, Senior Vice President and Head of Automotive Finance.
Here's to Resiliency
Reflecting on the past two tumultuous years – beset by Covid, lockdowns, human resource challenges, etc. –Sadokierski noted that the automotive industry wasn’t insulated from those realities. But BMO’s philosophy has proven effective in the past and will do so again, he added. “Acceleration is how we operate within the auto finance ecosystem,” he offered, adding that in his 25 years in the business, he’s witnessed many pivots. “Change is a constant.”
The industry is known for its resiliency and ability to adapt. “Its DNA is all about improving and evolving,” said Sadokierski. “And we are committed to it from an institutional perspective too.” During the financial crisis of 2008, for example, BMO was actively building the business, growing market share. By the end of the crisis, they had an office up and running in the U.S. And, today they have cross-border capacity in automotive finance that no bank can match.
A new national accounts team was also set up to support dealers with large debt/finance requirements and to offer cross-border assistance. “We are a true partner in good times and bad times – and everything in between,” Sadokierski concluded.
Navigating the Roller Coaster
That message of resilience was a perfect segue to the next speaker: Erik Johnson. Economist, BMO Capital Markets, Johnson knows well the ups and downs of the industry – and the importance of flexibility and fortitude in the face of challenge. To be sure, it’s a tumultuous period, and will remain so for a while, he shared in his opening remarks, calling to mind the well-known saying: “May you live in interesting times.”
Our current situation is particularly “interesting”, he said, due to compounded challenges impacting macroeconomic trends: global pandemic, geopolitical tension, high interest rates, etc. The Ukraine war is having the greater impact on our financial outlook, adding more pressure on the inflation side, particularly in Europe. We’re also seeing a downward trend in growth, growth risk and stagnation. despite a modest recent tailwind to the Canadian economy.
The shortage of metals and energy exports from Russia – particularly oil and gas – deserve special mention, said Johnson. For the automotive industry, the chip shortage is serious. Palladium and platinum are essential to catalytic convertors, while aluminum metal is vital to production. Volatility will continue until there’s resolution to the conflict, he said.
Labour Market Tensions
Unemployment rates in both Canada and the U.S are mostly back to pre-pandemic levels, which may influence the Bank of Canada (“BoC”) and U.S. Federal Reserve (“the Fed”) to raise rates and tamp down on excessive demand. The CPI in the U.S. is down a couple of ticks, reinforcing the need to step on the brakes to bring demand under control and put more downward pressure on prices.
Retail sales are nowhere near pre-pandemic levels and that’s not just a result of supply issues. People weren’t spending as much on restaurants or entertainment for two years and much of that demand rotated into goods, impacting the runup in prices. Effectively, it’s goods not services that are pushing higher inflation pressure.
Some of that will ease as supply issues unwind. “We’ll probably also see a moderation in consumer demand and some rotation back into services,” Johnson predicted, adding that industrial production, particularly in the U.S., is above its pre-pandemic levels. It simply can’t keep up with aggressive demand, alongside monetary and fiscal supports.
Rising Rates
We’re witnessing significant rising interest rate cycles, Johnson said, and they’ve upgraded their 2022-2023 outlooks accordingly. For the U.S., the prediction is 20 and 10 basis points higher at the end of 2022 and 2023, respectively. Canada’s outlook includes a 10-basis points increase in 2022 and 2023.
In Canada, we’re currently at 100 bps and the expectation is for the BoC and the Fed to quickly ramp up to neutral interest-rate range of two to three percent. There will likely be a hike of 50 bps and another 25 bps increase until it reaches 2.75 percent, while the U.S will return to a 2.25/2.50 range.
Automotive Predictions
“We’re quite bullish on the sector this year,” Johnson said of big assumptions that inform his view. Sales have been stuck in neutral since semi-conductor shortages began last spring. The retail market is mostly keeping pace this year, while up-and-down swings are largely seasonal. For those reasons, he’s predicting a healthy recovery.
There have been some positive trends in North American production since March. According to Johnson, we’ve seen the bottom and are now heading up. “During the second half of this year, we will probably see an improvement.”
Still, challenges remain. For example, the auto industry represents only a tenth of the semi-conductor market and when the sector took a step back, other industries stepped up their chip inventory. All that to say, the semi-conductor shortage is still looming large.
We will also continue to witness volatility depending on the make and model of cars. Supply can take anywhere between three and 100 days, the latter for less popular, non-luxury passenger products. And used car prices have probably peaked (prices have been rising 40 percent year-over-year). New vehicles are more impacted by the supply-chain issue and cost of logistics moving across borders. But prices are continuing to ramp up.
From a dealer perspective, we’re seeing higher margins, Johnson shared, but inventory is holding back volumes. Still, a recovery seems imminent.
Changes in the Average Buyer
A lot of the market pivoted to higher incomes, Johnson said, particularly in the U.S., a trend strengthened by the type of vehicles available. We may see a regression, but high prices are certainly reinforcing the view that this trend will persist for a while.
What about the effect on credit quality and delinquency rates? It’s been one of best periods for delinquency from a market health perspective because of broad monetary and policy supports. But delinquency rates probably leveled off and will head upward from here.
As for auto loans, Johnson believes we’ve seen the bottom in Canada. Hopefully loan growth will get up to more normal levels in Canada and the U.S. soon.
Read Part 2 of the series: Tax and Insurance Planning Strategies for Automotive Business Transition
Read Part 3 of the series: Transition Planning Considerations, the Transaction Process and the Value of your Automotive Business
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