Could Automakers Drive a GDP Rebound?

A production rebound at the Big Three carmakers in the third quarter may help start a U.S. economic expansion

By Michael Englund

"As goes General Motors (GM), so goes the U.S. economy." The old adage of the 1960s may have lost its luster, but unusual production cutbacks at GM and Chrysler in May and June—well ahead of typical late-June and July plant closings as automakers gear up their factories to churn out new models—will make a sizable dent in second-quarter U.S. factory data amid market hopes that the sector is seeing the first "green shoots" of recovery.

Beyond these disruptions, however, U.S. vehicle production should begin to rebound in July, helping make that month a candidate to see the start of the U.S. economic expansion.

Replacing Depleted Inventories

Vehicle assemblies plunged sharply in January when the Big Three bucked the usual seasonal pattern and extended the yearend plant shutdowns through January to preserve cash and to trim inventories. We are now seeing a partial repeat, as Chrysler's production cuts in the wake of its May 4 bankruptcy resulted in the loss of 27,000 hourly jobs and associated supplier cuts.

GM initiated some May plant closings in advance of its own potential June 1 bankruptcy filing and ahead of the usual July retooling. We should see an output cutback in seasonally adjusted terms in May and June, before a July-August bounce.

The production cutbacks may seem permanent to some, but it's important to note that production fell more sharply than sales through the last downturn, given the threat of Chrysler and GM bankruptcies. Though inventory-to-sales (I/S) ratios have remained elevated as sales weaken, retail auto inventories have fallen by 15% from their peak in August 2007, and the drop should reach 20% to 25% by the third quarter. The upshot: When sales finally bounce, inventories will need to be rebuilt.

Sales Trends

While the focus remains on the Troubled Two, and their less-stressed Detroit counterpart Ford Motor Co. (F), the vehicle sales slump over the past year has been more proportional across nameplates than many people may have realized. GM still consistently outsells Toyota (TM) in the U.S., and Ford actually exceeded its recent performance and outsold Toyota in April as well. Chrysler sales are generally comparable to Honda (HMC), and nearly double those for Nissan (NSANY).

If there are any notable "brand patterns" with the current vehicle demand pull-back, it is that sales for makers other than the "Big Six"—for example Hyundai—have proven more resilient than the industry overall.

The Big Three are suffering disproportionately because they have higher cost structures that leave profits more vulnerable to sales shortfalls, not because of vehicle design issues, such as size or mileage, as is often suggested in the media. Domestic content across nameplates is also more uniform than many appreciate, as Honda production and sales are now primarily in the U.S., making it largely Japanese in name only, while Toyota production in the U.S. has grown with sales. The implication is that U.S. vehicle assemblies will bounce with sales as we enter the next expansion, despite the woes at the Big Three.

Third-Quarter Rebound

Over the near term the big May and June hit to vehicle assemblies from the counter-seasonal plant closings should put a crimp in the various factory-sensitive reports (industrial production, durable goods, factory goods) as we saw in January. But a production rebound in the third-quarter—and the July-August period in particular—may help start a U.S. economic expansion.

In short, the current counter-seasonal vehicle assembly cut-backs, and likely third-quarter rebound, may well drive the timing of this recovery, as we see a comparable pattern not just in the vehicle assembly data but in the industrial production, durable goods, factory goods, capital goods, factory sentiment, trade, and inventory data as well. Gradual improvement in the economy will face some second-quarter headwinds from Chrysler and GM. But a third-quarter boost is likely, as production is gradually brought back in line with recovering sales.

With the U.S. auto industry in the driver's seat, the third quarter will likely show the first positive gross domestic product growth since the 2.8% growth clip in the second quarter of last year.

Englund is principal director and chief economist for Action Economics.

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