European Auto Stocks: Why Interest Rate Cuts Won't Drive Immediate Gains
European auto stocks may not see an immediate boost following anticipated central bank interest rate cuts, despite hopes of increased vehicle affordability. In a detailed note to clients on Wednesday, Morgan Stanley analysts emphasized that the historical trends in the auto sector do not support quick reactions to rate reductions.
Key Points:
- Delayed Sector Response: Historically, the auto sector does not quickly respond to interest rate cuts. Weak underlying demand and deflation in new and used car prices usually take several quarters to improve.
- Limited Impact of Lower Rates: While lower interest rates can enhance car affordability, they are not a panacea for the sector. The underlying demand needs substantial time to recover.
- Margin Risks: Despite potential affordability improvements, European auto manufacturers (OEMs) face significant margin risks due to weak demand and price deflation.
- Federal Reserve's Moves: Morgan Stanley’s macro team predicts the Federal Reserve will introduce a 25-basis-point rate cut at the September FOMC meeting, with a total of three cuts expected by year-end. However, these cuts may not sufficiently counterbalance the pressures within the auto sector.
- Decreased ASPs: Lower rates often coincide with decreased average selling prices (ASPs) as OEMs defend their market share, potentially leading to a challenging margin environment.
- Bond Yields and Stock Performance: Lower bond yields, while improving affordability, often result from lower aggregate demand and do not always tighten spreads. European car stocks have historically underperformed during rapid yield drops.
- Risk-Reward Profile: For long-term investors, the risk-reward profile of the sector remains poor due to ongoing margin downgrades, weak demand environment, and high margin estimates.
- Inflation and Pricing: The auto sector had benefited from rising prices, but recent data indicates a deteriorating pricing backdrop, with new car price inflation in the U.S. turning negative and dealer incentives rising.
- Case Study - BMW: Bayerische Motoren Werke AG (BMW) recently issued a profit warning, highlighting weak demand, particularly in China, as a significant factor affecting margins.
Breaking It Down:
Imagine you're considering buying a new car. When interest rates drop, you might think it will be cheaper to finance your purchase. While that could be true, the carmakers themselves are struggling with larger issues. They have more cars than people want to buy, and the prices of both new and used cars are falling. This makes it tough for them to make a profit, even if they sell more cars.
Morgan Stanley analysts are saying that just lowering interest rates won't fix these bigger problems. It will take time for people to start buying more cars again, and during this period, car companies might not make as much money because they have to sell their cars for less to stay competitive.
Moreover, while interest rates are expected to drop, which could make borrowing cheaper, this might not be enough to make a significant difference for these companies. Lower interest rates often come with lower bond yields, which can signify reduced demand in the economy overall. This isn't always good news for carmakers, who might see their stock prices fall if bond yields drop quickly.
So, if you're thinking of investing in European auto stocks, be cautious. The sector is facing a lot of challenges, and it might not be the best place to put your money right now. The big takeaway here is that while lower interest rates might make it easier for you to get a loan for a new car, they won't necessarily help car companies in the short term.