The US auto industry faces an activist Trump White House
April 6, 2017
As the White House has begun to focus on its goal of igniting a US jobs renaissance in the manufacturing sector, the automobile industry has received particular attention early on from the administration. President Trump has publicly leaned on automakers to bring jobs back to the United States during an already delicate period for automakers, which continue to face pricing pressure in the market.
As risk-aware investors, we think the auto sector and the administration’s reactions to it bear watching, not least because of the number of unknowns involved. One of the unknowns is that President Trump, in his self-described role of disruptor, appears willing to insert himself into the middle of the private sector, seeking to provoke changes in both long-standing government policy and business practices. While the outcome is still far from certain, even in the near term, this can put investors in uncharted territory.
Is a balanced solution possible?
Another well-known characteristic of President Trump’s style is his inclination to develop deals and agreements. So, a compact between the administration and automakers could be in the works. If some type of negotiation is indeed developing, however, we believe it is likely to face substantial hurdles.
To begin with, auto executives would probably ask for relief from the federal government’s fuel economy regulations, which govern consumption standards for cars produced for sale in the US. Current standards (formally referred to as CAFE, or Corporate Average Fuel Economy, standards) require that each manufacturer’s fleet of cars achieves an average fuel economy of 54.5 miles per gallon by 2025, a level that automakers have objected to. What’s more, if consumer preference for larger cars continues to rise, meeting those goals will become increasingly expensive.
It follows, then, that automakers could very well lobby the government for a reduction in fuel economy standards that would be significant enough to offset the increased costs of bringing jobs back to the US. According to an analysis from Barclays, the US Environmental Protection Agency (EPA) has put the incremental cost of the 2025 fuel-economy target at $875 per car, while the difference between Mexican and US labor per-hour costs are estimated to be somewhere between $18 and $38. Viewed in that light, a rollback of regulatory standards could generate enough savings to support hundreds of thousands of US jobs, assuming that the price of cars remains unchanged.
All that glitters isn’t …
Still, an arrangement that seems good in theory may not be as fluid in practice, and we think a number of factors make such a compromise difficult. For instance:
- Any easing of environmental regulations would likely be received poorly by environmental groups, because the increased consumption of fossil fuels would continue to damage the environment.
- The administration will likely face particularly strong opposition in California, a state whose influence extends beyond state lines. Along with several other states, California has strict air-quality standards that surpass those of the EPA.
- Any cars produced in the US for sale abroad would have to meet emission standards in those countries as well, and major car-buying markets like Europe and parts of Asia have stricter emissions standards than the US. For some auto manufacturers, this higher threshold could render moot any rollback in US regulations.
- Automobile manufacturers would likely find any on-shoring initiative to be less than practical. They have already spent billions of dollars globally, establishing relationships with suppliers and maintaining production plants. Bringing those operations — or at least the attendant jobs — back to the US could drive capital costs higher as plants abroad are shuttered and those in the US are upgraded. Any prudent plan to bring auto jobs back to the US would have to take such costs into account.
In a fractious environment, the scrum could continue
In an environment in which the White House is outspoken and the industry is reluctant to give ground, we believe that a certain amount of bluster could continue. However, any measurable results — lowering of air-quality standards, for instance — could be quite small, in our view.
In the meantime, the pushing and pulling within the auto industry is also likely to continue, with all parties proposing their preferred ways of reaching a compromise that can achieve three things at once: (1) a reduction in carbon emissions, (2) retention of good jobs, and (3) preservation of reasonable car prices.
Staying the course amid possible upticks in political risk
The rhetorical tug-of-war in the auto industry is not provoking meaningful changes to sector positioning across the portfolios we oversee, although the ongoing scrimmage is reinforcing our sensitivity to political risk. We continue to maintain a meaningful allocation to the consumer discretionary sector, including modest positions in select auto manufacturers that we believe are dynamic enough to navigate changing political circumstances. As has long been our practice, each investment decision is made on a company-by-company basis, following an objective, evidence-based research process, one that takes political risk into account.
For manufacturers, a wage advantage in Mexico
Manufacturers around the world compete to deliver goods as efficiently and cost effectively as possible. When it comes to managing costs, few variables are as influential as wages, which helps explain why companies routinely set up operations outside of their home countries. US manufacturers, for instance, are increasingly turning their attention to Mexico; in December 2016, average hourly earnings in Mexico’s manufacturing sector were $2.50 (in US dollars), versus an average of $20.65 in the US (data: Bureau of Labor Statistics; Organization for Economic Cooperation and Development). This difference should of course wane in the future, but for the most part, Mexican wages appear likely to continue to stay low, growing at the anemic rate they’ve posted for approximately 15 years now (see chart below).
Data: Organization for Economic Cooperation and Development, via Federal Reserve Bank of St. Louis. Monthly observations, seasonally adjusted from January 1981 to February 2015.
Chart is for illustrative purposes only.
The views expressed represent the Manager's assessment of the market environment as of April 2017 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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