Auto sales drop may just be a hiccup

After two record-breaking years of auto sales, are the latest numbers a sign of concern?

According to the latest statistics from Autodata Corp., U.S. light vehicle sales in March totaled 16.6 million annualized units. This was a decrease of 5.5 percent when compared with the sales total from February.

Vehicle sales in the first quarter averaged 17.3 million annualized units, a drop of more than 4 percent when compared with the average of 18.1 million from the final three months of 2016.

The March decline was larger than most analysts expected. As is often the case when there is a surprising deviation from the trend, it now has many pundits wondering whether this is the beginning of a significant trend downward. There was even a report that this drop in vehicle sales is a harbinger of a decline in the stock market.

Such macroeconomic implications notwithstanding, the trends in the auto industry carry a lot of weight in my outlook for the domestic plastics industry. So any abrupt or unexpected changes in demand for light vehicles will always capture my attention. But to be honest, the March data does not have me concerned just yet.

I started the year with a forecast for a moderate decline of 2 to 4 percent in the auto sector in 2017, and I have not changed it. I can't guarantee that it is not the beginning of a precipitous drop, but let's put this March figure in context before we do anything rash.

First, the number of vehicles sold in March may have been down sharply on an annualized basis from the previous month, but it represented only a slight decline from the same month of a year ago. I do not know why March was such a weak month for auto sales in 2016. Perhaps it had something to do with weather or the incentive programs in February. But whatever the reason for the March hiccup, the sales totals bounced back strongly in the second half of last year and the annual total for 2016 set an all-time record.

So we should not get too worried about one bad month. There were also some weather issues this year that may have impeded sales in March, and there were fewer incentives offered than there were in February. So I am inclined to believe that most of the drop last month can be attributed to noise in the data and not a large shift in market demand.

This belief is bolstered by the strong divergence in the trends in the types of vehicles sold. The decline in the total sales so far this year is entirely due to a sharp drop in market demand for passenger cars. The number of light trucks (SUVs, minivans and pickups) sold continued to rise in March. For the year to date, the number of passenger cars sold is surprisingly down almost 12 percent from last year, while the number of light trucks sold is up a solid 6 percent.

So the unit total is down about 2 percent, but since sales of the larger, more expensive vehicles are substantially higher, I suspect that the total amount of money that Americans are spending on vehicles continues to climb. This suspicion is corroborated by the fact that sales of almost all brands of luxury vehicles (BMW, Mercedes-Benz, Jaguar, Porsche and Maserati) are higher than a year ago.

We have just come off of two consecutive record-breaking years for auto sales in the United States. This means that there are also a lot of used cars on the market. It seems only reasonable to me that the number of units sold might decline in 2017, but it is unlikely that they will fall too far. The labor market is tightening and the pace of wage growth is accelerating, so the economic fundamentals for strong demand remain intact.

I use data on vehicle assemblies because it is relevant to domestic suppliers of parts, tooling and equipment. The sales data that I referenced above is a good indicator of overall demand, but it includes imported cars made somewhere else. Assemblies are a better indicator of demand for domestically produced plastic parts.

As the accompanying chart indicates, the industry hit a plateau in 2016 after six years of very healthy gains. When this data hit the 12 million units per year, the trend flattened out. That's a historically significant number because that is the level at which the industry operated when it was going full bore just before the Great Recession. So during the past two years when total sales were at record highs, the number of assembles came in just a bit stronger than 12 million units.

So far this year, the assemblies data is running about 4 percent below the comparable period in 2016. That is not enough to start a panic, but the pressure on suppliers will definitely start to increase. This is a crucial trend, and I cannot emphasize enough the fact that you will need to monitor it closely this year.

For 2017, I expect this data to drift back down to just below the 12 million line, so it will still be a good year by historical standards. But I confess that I do have some questions about what that means for the expectations of the automakers and how those expectations will affect the demand for new employees, plants and equipment.

For instance, there is evidence that the inventory-to-sales ratio for automobiles is rising. Automakers are very sensitive to inventory levels, so they may be inclined to increase sales incentives to keep their inventory at acceptable levels. This will lower profit, which will have a negative effect on demand for equipment, parts and tooling. We have seen this movie many times before, and suppliers always seem to get it in the end.

The only remedy is the same one I have been preaching for years — stay lean, stay innovative and stay competitive. It will not get easier, and your customers may well try to use this latest decline in the sales data against you. A small drop in the trend may result in a disproportionately large increase in the amount of complaining.