China's Car Sales Slump: When Will It End?

Vehicle sales in China slumped for the twelfth consecutive month in June, with unit sales of passenger cars and commercial vehicles declining by 9.6% in the month, and 12.4% for the first six months of the year. With the exception of electric vehicles (“EVs”), which increased by 80% in June and 49.6% year to date, all other categories of cars, trucks and buses registered declines. The unprecedented double-digit drop in auto sales has industry observers stumped, begging the question: When will it end?

Given the difficulty of analyzing events in China, it should come as no surprise that there are two schools of thought. On the one hand, Bernstein, a well-regarded securities research firm, is generally optimistic about auto sales for the balance of this year. On the other, John Murphy, the lead auto analyst at Bank of America Merrill Lynch, one of the world’s largest securities firms, recently told an audience in Detroit that the pace of sales declines in China is “still quite a bit shocking, and what’s equally shocking is a lot of companies are simplistically thinking this will stabilize in the second half of the year.” 

Auto sales in 2019 are particularly difficult to analyze due to the number of factors at work. From a macro-economic point of view, China’s deleveraging program has tightened credit for prospective auto buyers, and a slowing economy has hurt consumer sentiment, which is important for sales of big ticket items like autos. China’s economy slowed to 6.2% in the second quarter, its lowest quarterly growth rate in 27 years, and, after rebounding sharply in the first three months of the year, the Shanghai Stock Exchange Composite Index is off 10% from its April high and has been moving sideways since May.

Several structural changes are also impacting auto sales in 2019. On March 26, central government subsidies for EVs were slashed by 45% to 60%, and subsidies for EVs with a range of less than 250 miles were eliminated altogether. While EV sales are up year to date, it is questionable how much of the increase has been due to buying in advance of the subsidy cuts. Likewise, on July 1, new emission regulations kicked in with all vehicles sold in China being required to meet China 6 standards. The higher prices of China 6 vehicles gives rise to the same question: How many consumers pulled forward car purchases in order to buy lower priced China 5 cars?

Finally, overhanging the macro-economic and auto industry factors at work is the ongoing trade war between China and the U.S. Until early May, the dispute seemed to be on track to be resolved successfully by mid-year. Unfortunately, talks between the two countries broke off in early May, and while they have since restarted, many wonder whether an agreement will ultimately be reached. According to knowledgeable industry participants, the trade war is having a significant adverse impact on consumer sentiment and is one of the key reasons why auto sales are down this year.

In order to better understand what is happening at the retail consumer level, Bernstein’s analysts have been tracking first time auto insurance data, which they believe is the best indicator of retail sell-through. Bernstein’s more optimistic outlook for the second half of 2019 is partially based on the fact that the data for June showed industry insurance volume growing by 42% in the month, bringing 2019 retail sell growth for the first half of the year to 2.7%.

When the Bernstein analysts took to the road in early July to interview auto executives and dealers, they found several interesting, but inconclusive, trends. For example, dealers reported a dramatic upsurge in consumer foot traffic in June, much of which was ultimately converted to sales at the retail level, but which they were quick to point out may have been due to heavy promotional activity and discounts by dealers anxious to move inventory—including older models that couldn’t be sold after July 1. In fact, most dealers said that they had sold out their China 5 inventory by mid-June. However, dealers also reported a 40% drop in traffic in early July, which many attributed to a natural “hangover” following the surge in June.  Others said that the falloff in activity may be due to the higher prices of China 6 cars.

Despite these conflicting trends, strong retail sales in June had the positive effect of clearing out dealer inventories that had built up over the past several years, which may pave the way for higher wholesale sales in the remaining months of 2019. That, combined with the positive insurance data, are the principal reasons why Bernstein is optimistic for the rest of the year, while reduced inventories may be the reason why many OEM executives and dealers have also expressed optimism and believe that the “worst may be over.”