Tesla's struggle to lure buyers paints a grim economic picture

Thinning profits at Tesla Inc. and signs of broader weakness in the US auto industry are sending ominous signals for the US economic outlook.

Tesla’s troubles are no secret as Elon Musk’s company has repeatedly cut prices to lure reluctant buyers. But the problem goes beyond the high-profile electric-vehicle maker: Auto-lending giant Ally Financial Inc.’s first-quarter profit took a hit as it made fewer loans and set aside money for defaults, and dealers AutoNation Inc. and Lithia Motors Inc. sold fewer cars, trucks and SUVs. Meanwhile, auto loan delinquencies are rising.

The trend is troubling because auto companies typically struggle during downturns when people balk at making big-ticket purchases. This time could be even worse as businesses and consumers are also grappling with stubbornly high inflation and steeper borrowing costs. Retail sales slid in March by the most in four months, and a slowdown at auto dealers played a big part.

“Auto demand and pricing dynamics are a canary in the coal mine for the consumer,” said Matthew Tuttle, the chief executive officer of Tuttle Capital Management. It’s a sobering lesson for investors broadly, as even the “recent demand for mega-cap technology stocks is a flight to relative safety from fully invested portfolio managers.”

Auto stocks, especially car manufacturers, retailers and parts suppliers, have nosedived this week. The S&P Composite 1500 Automobiles & Components Index (S15AUCO) is down about 10% through Thursday’s close, while the S&P Composite 1500 Automotive Parts & Equipment Index (S15AUTP) has lost about 2%. Both gauges fell in early trading Friday.

Tesla shares have also slumped this week, losing about 10% through Thursday’s close. It lowered prices of two higher-volume models right ahead of its results Wednesday. Then it raised the price on two higher-end offerings, although the cost for both is still lower than at the end of the first quarter.

“The recession scenario is on,” New Street Research analyst and long-time Tesla bull Pierre Ferragu wrote in a note Thursday. He said he expected the company’s margins to decline further this quarter, before recovering slowly in the second half of the year, and noted a “steep drop” in auto demand in China and signs of economic weakness globally.

Demand Swings

The pandemic years have generated sharp swings in demand for autos. Right after the initial Covid outbreak and related production stoppages, prices of cars shot up amid a severe supply crunch. Even when auto factories gradually reopened, the companies faced intense supply-chain delays and shortages, driving vehicle prices even higher and feeding into inflation economy-wide.

“The broader, high-level issue is that, in the last couple of years, people took out very high-cost loans on cars that were also overpriced because of lack of inventory,” said Will Rhind, chief executive officer of GraniteShares. “It’s similar to what happened with housing.”

The latest developments show the outlook is darkening for autos. The Federal Reserve’s move to ratchet up interest rates has made already-expensive car loans even pricier and is starting to weigh on demand.

Meanwhile, data this week added to signs that the labor market, which has been resilient in the face of the Fed’s rate hikes, is starting to lose momentum. Still, the relative tightness in that area so far has some analysts reluctant to read too much into the auto industry’s cooling.

“Everyone is looking for a sign the economy is falling off a cliff; we are heading toward the cliff but I don’t see it yet,” said Bill Zox, portfolio manager at Brandywine Global Investment Management. “It is pretty hard to draw any firm conclusions on the broader economy based on what we have seen so far in autos.”

While Zox says the economy may tip into a recession later this year, he recommends monitoring the labor market for a clearer signal.