Four Reasons the Auto Industry Is in Big Trouble

Good luck finding a new car... Four reasons the auto industry is in big trouble... Everyone suddenly needs more semiconductors... The market thinks everything is still going great... How to bet against this indebted automaker...

Stephen Wade is having trouble selling trucks...

Pickups are the ride of choice for many Americans, and that's especially true out West.

That's why Wade used to stock 200 new pickups in his Ram dealership in St. George, Utah. But these days, his inventory is down to barely a tenth of that number.

Wade owns eight dealerships across southern Utah and said it's not just Ram. He recently told the Wall Street Journal that his Chevrolet dealership was down to just four Silverado pickups, and he wasn't sure when that would change...

We seemed to have reasonable inventory at the end of last year. But it's just gotten shorter and shorter.

It's not that Wade wants to stock fewer trucks. It's not that Ram and Chevrolet don't want to ship him more. And it's not that customers have lost interest.

Instead, the inventory issue relates to a tiny but critical component of modern vehicles...

I (Bill McGilton) am talking about semiconductors. They're the microchips that make electronics work.

Modern cars are full of electronics, requiring hundreds of semiconductors in every new vehicle... But with everyone needing computing power these days, and with COVID-19 upsetting supply chains last year, there aren't enough of these chips to go around.

This shortage is reverberating throughout the entire automotive industry, idling auto factories and leaving some carmakers with stockpiles of nearly built vehicles – waiting only for the semiconductors before they can reach eager dealerships and would-be customers.

Chad Wilson, the general manager of two Ford dealerships in Michigan, has a similar issue to Wade's. As he told the Detroit Free Press...

Cars are 2021's version of toilet paper in 2020... Normally, between our two stores, we'd have 150-180 F-series in stock. I think right now there might be 10.

You may have even heard about the semiconductor shortage already, especially if you've tried to buy a new car in recent months. But unfortunately, the problems don't stop there...

As I'll explain in today's Digest, this is just the first of four headwinds facing the auto industry today. I'll describe how all of these problems will crimp both supply and demand for new cars while also driving up automakers' costs.

I'll also show how the euphoric markets haven't factored these concerns into automakers' valuations. And finally, I'll discuss the unique strategy I use to take advantage of market conditions like this one...

I recently detailed the semiconductor shortage to my Stansberry's Big Trade subscribers...

The problem began when manufacturing facilities around the world shut down to limit the spread of the COVID-19 virus. This disruption caused a kink in the semiconductor supply chain.

At the same time, automakers around the world closed their factories in an attempt to protect their workers and "flatten the curve" of COVID-19 infections.

With production disrupted and the economy in turmoil, auto executives decided to hunker down for an extended economic depression. They would conserve resources and reduce costs as they waited it out.

They canceled orders for materials, parts, and electronics across the board. Some automakers even invoked force majeure – unforeseen, extreme events – clauses to get out of contracts with suppliers. They planned to see what happened next, and get back to business as usual whenever they were ready.

At first, this decision was a blow for the semiconductor industry...

In 2019, the auto industry purchased around one out of every 10 semiconductors that were made – spending roughly $43 billion, according to consulting firm Bain & Company.

Today's vehicles use semiconductors in almost everything... including the engine, transmission, brakes, cruise control, steering wheel, power seats, air bags, sensors, front and rear cameras, side mirrors, driver-assistance features, entertainment system, and more. In all, new vehicles have around 200 to 400 semiconductors apiece.

So when the auto industry went dark at the onset of the COVID-19 pandemic last year, semiconductors experienced a sharp drop-off in orders.

Here's what happened instead... While automakers were waiting to see how the pandemic would shake out, the world moved on to the "home economy."

Most folks were under some form of quarantine – working and learning from their houses. They needed new computers, smartphones, and modems. Demand for at-home entertainment products like TVs, tablets, and video-game consoles went through the roof as well.

Semiconductor makers saw the opportunity. As the auto industry cut back orders, chipmakers shifted their production capacity toward consumer electronics.

This wasn't the only source of demand...

China has been stockpiling semiconductors for fear of trade restrictions... The new fifth-generation telecom standard, 5G, requires lots of electronics equipment and is encouraging folks to upgrade their mobile devices... And cryptocurrency miners are snapping up powerful chips to create increasingly valuable quantities of bitcoin and other cryptos.

And demand for cars didn't dry up after all...

Thanks to record amounts of federal stimulus, the economy – including demand for new vehicles – proved more resilient than automakers had expected.

But as they started to increase production toward normal levels, they found it difficult to source semiconductors...

Now, there's so much demand for semiconductors that factories can't churn the chips out fast enough. The entire world is suffering from a massive shortage. And there's no quick fix...

You see, semiconductors have a long build time to begin with – roughly 26 weeks. There's an intense design process and complicated manufacturing process.

Older factories slated for closure are now staying open to keep up with demand. Major chipmaker Taiwan Semiconductor Manufacturing (TSM) said it will invest in new production facilities. But that won't help in the short term... New semiconductor manufacturing plants require multibillion-dollar investments and often take years to complete.

It's not an industry that can simply institute a quicker turnaround.

So the shortage is not going to end anytime soon...

Automakers rely on just-in-time inventory management – they buy components from part manufacturers as needed and keep minimal inventory.

In normal times, when supply is readily available, it's the most cost-effective way to manage the production process so that automakers don't get stuck with old inventory.

But in a supply crunch, having a limited stockpile of assembly parts creates a gap in the production process – which can lead to shutdowns.

That's exactly what we're seeing now...

Most major automakers worldwide are now having trouble sourcing semiconductors – to the point that they're cutting production and idling plants.

On February 9, General Motors (GM) announced it was cutting production at several North American plants for multiple weeks. The production cuts at many of these plants were originally slated to last through mid-March, but have since been extended through at least April. At this point, it's not clear when several of GM's plants will resume full operations.

GM's international operations have taken a hit as well... The company halved production at its plant in Bupyeong, South Korea and plans to take downtime at its Gravataí plant in Brazil in April and May.

GM has also started building some vehicles with fewer features... For instance, the 2021 Chevrolet Silverado and GMC Sierra pickups will be made without a certain fuel-management module, which will lower their fuel efficiency.

GM estimates the lost production could hurt its pretax profits by as much as $2 billion this year.

On March 18, Ford Motor (F) announced that the company would cut shifts and will only partially build some vehicles – like its top-selling F-150 trucks. Ford plans to finish assembling them in "a number of weeks" when semiconductors become available.

On March 31, Ford said it was scheduling additional downtime at several U.S. factories. The automaker has since extended shutdowns into at least May.

Ford estimates the lost production could hurt pretax profits by as much as $1 billion to $2.5 billion this year.

Stellantis (STLA) – whose U.S. brands include Chrysler, Jeep, and Ram – initially cut production at five of its North American factories through mid-April because of the lack of semiconductors and has since extended the production cuts into May. Honda Motor (HMC), Nissan Motor (NSANY), and most other automakers have cut production as well.

At this point, automakers expect the semiconductor shortage to continue into at least the second half of the year. We're looking at around 1.5 million to 5 million fewer vehicles being made in 2021, according to estimates from research firm AlixPartners – which expects the shortage to cost the auto industry roughly $61 billion in sales over the course of the year.

Some industry officials are even more pessimistic... They expect the shortages to run into 2022. German chipmaker Infineon and auto-parts maker Robert Bosch expect shortages to worsen through the year.

And there's another problem that will increase automakers' chip costs...

Automakers typically use old safety-tested chip designs. These designs have limited use and generate smaller profits for semiconductor companies... so they're not thrilled at the prospect of making them. As semiconductor factories gear up to make these older chips, they'll make them at much higher prices.

Global automotive semiconductor makers, such as NXP Semiconductors (NXPI) in the Netherlands, are already increasing prices to match the high demand and low supply. This trend will continue.

By the time semiconductors are readily available again across the automobile industry, they're going to be a lot more expensive.

So any way you look it at, the global semiconductor shortage is going to hurt production and squeeze margins for the auto industry.

Plus, other vehicle components are rising in price as well...

Since May 2020, steel prices are up 182%. Hot-rolled steel was trading at $480 per ton at the start of that month. It's now up to $1,354 per ton – an all-time high. As with semiconductors, COVID-related supply constraints in steel have pushed prices higher.

And they'll likely keep rising from here... Industrial buyers are reporting extreme difficulty in being able to buy enough steel to meet customers' needs.

In a similar issue for automakers, aluminum is up 58%, from $1,458 per metric ton last May to $2,297 per metric ton today. And copper is up 83%, from $232 per 100 pounds to $424 per 100 pounds.

Prices of platinum and palladium are also soaring... These precious metals are crucial in making catalytic converters, which reduce exhaust emissions from cars.

Platinum is up 55% since last May – rising from $766 per ounce to $1,188 per ounce. Palladium is up 45% – rising from $1,918 per ounce to $2,787 per ounce.

You can see the rising costs for all of these materials in the following chart...

Money has gotten more expensive, too...

Since May 2020, yields on U.S. Treasurys have skyrocketed alongside commodity prices.

Investors are selling longer-dated U.S. Treasurys because they don't believe they're receiving enough of a return to compensate for rising inflation. As investors sell Treasurys, their prices fall and their yields rise inversely...

Since last May, the yield on the 10-year U.S. Treasury is up more than two and a half times, from 0.61% to 1.57%. This move higher has taken a breather since the end of March, but overall, the trend is still rising. The bond market is getting worried that inflation is running hot. Rates are still low, but that's a massive increase across the entire economy.

When the rate of "no risk" U.S. Treasurys rises, it reverberates through lending rates across the economy. A higher interest rate on government bonds means a higher interest rate on corporate debt, home mortgages... and of course, auto loans.

Most consumers don't buy vehicles outright. They get loans and make payments. Higher interest rates make vehicles less affordable.

When interest rates were falling, automakers had little trouble pushing their higher costs onto the consumer by raising prices. The pricier components – steel, palladium, and semiconductors – were offset by friendlier loan terms.

But increasing the vehicle price gets harder to disguise with rising interest rates. The monthly payment goes up – making the vehicle less affordable, and making it harder for prospective borrowers to qualify.

Consumers have been flush with cash lately – but it won't last...

Unemployment programs, the Federal Reserve's low-interest-rate policies, and direct stimulus checks have kept folks spending and helped them stay on top of their bills.

But despite all these efforts and the euphoria in the markets, consumers are struggling...

Unemployment remains at 6%. That's 70% higher than before the pandemic... And with the exception of last year, it's the highest it has been since 2014. There were 547,000 new weekly jobless claims in the week ending April 17. That's about two and a half times the 220,000-weekly average prior to the pandemic, and far above historical levels recorded over the past 50 years.

Consumer-debt levels are at an extreme. Household debt is at $14.6 trillion – its highest level ever. Delinquencies on debt like credit cards and car loans are near multiyear highs – with more than 9% of all credit-card debt and 4% of auto loans delinquent by 90 days or more.

The latest $1.9 trillion "American Rescue Plan" includes a third round of $1,400 stimulus checks and extended unemployment benefits. That will help folks who qualify to stay afloat.

But stimulus is losing its potency... Real personal income spiked 12% during the pandemic on the initial round of stimulus checks and extended unemployment programs. Even so, it fell toward historic levels within seven months...

In January, real personal income spiked again as the second round of $600 stimulus checks went out. But the effect of the second round largely dissipated within a few months.

Real personal income is set to spike again with the third round of stimulus payments that started going out in March. But as commodities and other costs rise throughout the economy, each successive round of stimulus will have less of a wealth-creating effect.

Unless stimulus checks are the new norm every six months or so, high unemployment levels combined with massive debt are going to catch up to the economy (and the stock market) in a nasty way when the checks run out.

And if the stimulus keeps flowing, then inflation is going to go much higher... and the checks will be less effective. Either way, it's not looking good for cash-strapped consumers going forward.

Let's not forget that the auto industry was already struggling before COVID-19...

In 2020, automakers sold 68 million units globally. That's 13% less than the 78 million units sold in 2019 and 20% less than in 2017, when global auto sales peaked at 85 million units.

This is an industry with extremely low margins that has been declining for years. The pandemic only worsened the situation. And now, semiconductor shortages, rising commodity prices, higher interest rates, and the loss of temporary stimulus effects only add to the mix.

But judging from automakers' stock prices, you would think everything is great...

GM, Ford, Stellantis, and Toyota Motor (TM) are all trading around multiyear or all-time highs – with market caps far greater than before the pandemic when their businesses were in better shape.

And EV companies like Tesla (TSLA) and NIO (NIO) have skyrocketed higher over the past year. EVs are the future of automobiles... But these companies' valuations have gotten way ahead of themselves.

It's part of the same distortions we're seeing across the market...

Investors lack fear and are willing to take on even greater risk. We've watched stocks get pumped up and come crashing down – from Reddit users driving up GameStop (GME) or professionals like Bill Hwang using huge leverage to bet big on ViacomCBS (VIAC), then wiping out the values of all his holdings (and his own fortune) when it didn't work out.

Automakers' share prices have also benefited from market froth – just to a lesser extent. But with the semiconductor shortage, rising costs, and increasing challenges for their customers, the odds are running against them.

If nothing else... be careful if you're holding shares of automakers in your portfolio.

You can also use this distorted market to your advantage...

You see, in Stansberry's Big Trade, I look for troubled companies that investors have overvalued... then bet against them by buying long-dated put options.

This strategy protects your portfolio against the inevitable end of the current market euphoria. When investors panicked last spring and stocks were plummeting, we booked a rapid succession of triple-digit winners.

In our most recent issue, I recommended a trade on an automaker that admits it could lose billions from the semiconductor shortage alone.

This company is heavily indebted, it will have to pay more for materials and components, and fewer customers can afford to pay more for its vehicles. Plus, because many of its existing customers are subprime borrowers, this company will lose money quickly when they stop making their car payments.

If you already subscribe to Stansberry's Big Trade or if you're a Stansberry Alliance member, you can read my full report about this company right here.

And if you're not already a subscriber, I encourage you to check out our latest special offer... Right now, you can gain instant access to all of my research and my complete model portfolio at a 40% discount. Get all the details right here.

New 52-week highs (as of 4/21/21): Automatic Data Processing (ADP), American Financial (AFG), American Homes 4 Rent (AMH), Axis Capital (AXS), Berkshire Hathaway (BRK-B), Brown & Brown (BRO), Corteva (CTVA), CVS Health (CVS), W.W. Grainger (GWW), Hershey (HSY), IQVIA (IQV), Ingersoll Rand (IR), 3M (MMM), Oshkosh (OSK), S&P Global (SPGI), Seagate Technology (STX), United States Commodity Index Fund (USCI), Visa (V), Westlake Chemical Partners (WLKP), Waste Management (WM), Consumer Staples Select Sector SPDR Fund (XLP), Health Care Select Sector SPDR Fund (XLV), Alleghany (Y), and Zimmer Biomet (ZBH).

In today's mailbag, feedback on the great debate about bitcoin and gold between Michael Saylor and Frank Giustra (which is now live)... and more feedback on lithium-ion batteries that we wrote about yesterday. What's on your mind? As always, you can tell us at feedback@stansberryresearch.com.

"As debaters, Michael Saylor and Frank Giustra were well matched. They were intense believers in their subject but kept their cool with each other. The presentation made me think and answered some questions. It was worth my time. Thanks to Daniela Cambone for a good job as moderator." – Paid-up subscriber Donie D.

"Excellent debate and Daniela was a great Moderator!" – Paid-up subscriber Alain D.

Corey McLaughlin comment: We agree. Both guys came in well prepared, and Daniela kept them on track to hit all the big points about bitcoin and gold. It's well worth the time.

The debate is also totally free to watch... So if you haven't done so yet and want to, just enter your e-mail address at DanielaCambone.com, and you will get a link to the video in your inbox.

"As EV becomes more popular, there will be escalating incidents of these problematic fires. That will also generate governmental costs. I don't think this will end well.

"It should also be pointed out that cars are not the only place where large lithium batteries are being used. Those who have made the move to solar panels on the roof, with battery backup, are often using Tesla batteries. So if the case of the battery in that situation should somehow get damaged and the innards exposed to the air, a flaming hard-to-extinguish mass attached to the side of your house could become a big problem.

"I have a BSEE (Electrical Engineering), and I was employed in a consulting firm for many years. The small batteries, such as in phones, we can probably live with, but my gut instinct is that the cost/benefit/risk of the large lithium batteries just won't work out favorably.

"We certainly need something better than the old lead/acid technology, and there is work being done on new technologies, but I don't believe that lithium is going to be the eventual answer." – Paid-up Flex subscriber P.E.S.

Regards,

Bill McGilton
Kyiv, Ukraine
April 22, 2021