FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 27, 2021

IN THIS ISSUE:

1. Shortage of Tiny But Critical Auto Component

2. Here's What Surprisingly Happened Instead

3. Shortage is Not Going Away Anytime Soon

4. Semiconductor Shortages = Higher Prices

5. Consider Reducing Exposure to Automakers

Overview: Automakers Are in Big, Big Trouble

Pickup trucks are the ride of choice for many Americans, and that's especially true out West (I drive one). That's why most large dealerships usually stock 200 or more new pickups on their lots. But these days, pickup inventories at most dealerships are down to barely a tenth of that number or even less.

It's not that car dealers want to stock fewer trucks. It's not that Ford, Chevrolet, Ram and others don't want to ship dealers more vehicles. And it's certainly not that customers have lost interest. No, it’s none of that.

The main reason is there is a critical shortage of semiconductors which make auto electronics work. This shortage is bad and may (likely will) get worse before it gets better, as I will discuss below.

The fact that there is a severe shortage of auto semiconductors means automakers are sitting on millions of nearly-finished vehicles they can’t complete and send on to the dealerships. We haven’t seen such a global phenomenon in decades, if ever.

Losses in the tens of billions of profits are facing all major automakers. General Motors expects pretax profits to plunge by $2 billion this year alone. Ford expects a drop of $2.5 billion this year, and the company which owns Chrysler, Jeep and Ram expects similar losses for 2021. Ditto for Honda and Nissan.

Yet the shocker in all this is the fact that most automaker share prices have soared in the last year, with some at or near all-time highs. This is simply unbelievable, and that’s why I want to warn you about it today!

Automaker stocks are widely-held among many mutual funds and ETFs, pension funds and most “index” funds. You may want to reduce your exposure to auto-heavy investment funds ASAP, as the bottom could fall out just ahead. Here’s the story.

Shortage of Tiny But Critical Auto Component

Modern cars are full of electronics, requiring hundreds of semiconductors in every new vehicle. But with everyone needing computing power these days, and with COVID-19 upsetting supply chains last year, there aren't enough of these chips to go around.

Today's vehicles use semiconductors in almost everything – including the engine, transmission, brakes, cruise control, steering wheel, power seats, air bags, sensors, front and rear cameras, side mirrors, driver-assistance features, entertainment system, and more. In all, new vehicles have around 200 to 400 semiconductors apiece.

This semiconductor shortage is reverberating throughout the entire automotive industry, idling auto factories and leaving some carmakers with stockpiles of nearly built vehicles – waiting only for the semiconductors before they can be delivered to eager dealerships and would-be customers.

You may have even heard about the semiconductor shortage already, especially if you've tried to buy a new car in recent months. Automakers around the world closed their factories last year not only because of the COVID crisis but, more importantly, the critical shortage of semiconductors.

With production disrupted and the economy in turmoil, auto executives decided to hunker down for a likely economic depression, as some were predicting. This, they calculated, would conserve resources and reduce costs as they waited it out.

Many canceled critical orders for materials, parts, electronics, etc. across the board. Some automakers even invoked “force majeure” clauses (unforeseen, extreme events) to get out of contracts with suppliers. They planned to see what happened next and get back to business as usual whenever they were ready, thus leaving millions of vehicles unfinished.

In 2019, the auto industry purchased around one out of every 10 semiconductors that were made worldwide – spending roughly $43 billion, according to consulting firm Bain & Company. So, when the auto industry went dark at the onset of the COVID-19 pandemic last year, semiconductors experienced a sharp drop-off in orders.

Here's What Surprisingly Happened Instead

While automakers were waiting to see how the pandemic would shake out, the world moved on to the "home-work economy." Most folks were under some form of quarantine – working and learning from their houses. They needed new computers, smartphones, modems, etc. Meanwhile, demand for at-home entertainment products like TVs, tablets, and video-game consoles went through the roof as a result.

Struggling semiconductor makers saw an opportunity. As the auto industry cut back orders, chipmakers shifted their production capacity toward consumer electronics. And this wasn't the only source of new demand they found for their products.

The new fifth-generation telecom standard, 5G, requires lots of electronics equipment and is encouraging folks to upgrade their mobile devices. And cryptocurrency “miners” are snapping up powerful chips to create increasingly valuable quantities of bitcoin and other cryptos.

Thanks to record amounts of federal stimulus, the economy – including demand for new vehicles – proved more resilient than automakers had expected. But as they started to increase production toward normal levels, they found it difficult to source semiconductors.

Now, there's so much demand for semiconductors that factories can't churn the chips out fast enough. The entire world is suffering from a massive shortage. And there's no quick fix. You see, semiconductors have a long build time to begin with – roughly 26 weeks on average. There's an intense design process and manufacturing is complicated.

Older factories slated for closure are now staying open to keep up with demand. Major chipmaker Taiwan Semiconductor Manufacturing (TSM) said it will invest in new production facilities. But that won't help things in the short term.

New semiconductor manufacturing plants require multibillion-dollar investments and often take years to complete. It's not an industry that can simply institute a quick turnaround.

The Shortage is Not Going Away Anytime Soon

Automakers rely on “just-in-time” inventory management – they buy components from part manufacturers only as needed and keep minimal inventory. In normal times, when supply is readily available, it's the most cost-effective way to manage the production process.

But in a supply crunch, having a limited stockpile of assembly parts can create a gap in the production process – which can lead to shutdowns – as we saw last year. Most major automakers worldwide are having trouble sourcing semiconductors, as we witnessed in 2020 and this year – to the point they've been cutting production and idling more plants.

On February 9, General Motors (GM) announced it was cutting production at more North American plants for multiple weeks. The production cuts at many of these plants were originally slated to last through mid-March but have since been extended through at least April. At this point, it's not clear when several of GM's plants will resume full operations.

On March 18, Ford Motor announced that the company would cut shifts and will only partially build some vehicles – like its top-selling F-150 pickup trucks. Ford plans to finish assembling them when semiconductors become available.

On March 31, Ford said it was scheduling additional downtime at several US factories. The automaker has since extended shutdowns into at least May. Ford estimates the lost production could hurt pretax profits by as much as $2.5 billion this year.

Stellantis (STLA) – whose US brands include Chrysler, Jeep, and Ram – initially cut production at five of its North American factories through mid-April because of the lack of semiconductors and has since extended the production cuts into May. Honda Motor, Nissan Motor and most other automakers have cut production as well.

At this point, automakers expect the semiconductor shortage to continue into at least the second half of the year. “We're looking at around 1.5 million to 5 million fewer vehicles being made in 2021,” according to estimates from research firm AlixPartners – which expects the shortage to cost the auto industry roughly $61 billion in sales this year. Some industry officials are even more pessimistic.

Semiconductor Shortages = Higher Prices Overall

By the time semiconductors are readily available again across the automobile industry, they're going to be a lot more expensive. So any way you look at it, the global semiconductor shortage is going to hurt production and squeeze margins for the auto industry. That means higher prices.

Since May 2020, steel prices are up 182%. Hot-rolled steel was trading at $480 per ton at the start of that month. It's now up to $1,354 per ton – an all-time high. As with semiconductors, COVID-related supply constraints in steel have pushed prices wildly higher.

In a similar issue for automakers, aluminum is up 58%, from $1,458 per metric ton last May to $2,297 per metric ton today. And copper is up 83%, from $232 per 100 pounds to $424 per 100 pounds.

I could go on with other examples, but you can see the rising costs for these and other materials in the following chart.

Finally, I should note that rising short-term interest rates further weaken the auto industry. Not only does the rising cost of borrowing affect automakers’ cost of servicing their bloated debt, it also weakens consumer demand due to higher monthly car payments.

Conclusions: Consider Reducing Exposure to Automakers

This is an industry with extremely low margins which have been declining for years. In 2020, automakers sold 68 million units globally. That's 13% less than the 78 million units sold in 2019 and 20% less than in 2017, when global auto sales peaked at 85 million units.

The pandemic only worsened the situation. And now, semiconductor shortages, rising commodity prices, higher interest rates and the loss of temporary stimulus effects only add to the mix. Things look very bad for the automakers now and going forward.

Yet GM, Ford, Stellantis, and Toyota are all trading around multiyear or all-time highs – with market caps far greater than before the pandemic when their businesses were in much better shape. Electric vehicle (EV) companies like Tesla and NIO are even more outrageously overvalued, in my opinion.

In conclusion, now may be an opportune time to reduce your exposure to automakers. These companies are widely held by stock index funds, ETFs, etc. Check your exposure now and act while prices are still at or near record highs.

This is one of the most misvalued market occurrences I have ever seen. Hope this helps!

Wishing you profits,

Gary D. Halbert

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Forecasts & Trends E-Letter is published by Halbert Wealth Management, Inc., a Registered Investment Adviser under the Investment Advisers Act of 1940. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of the named author and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific advice. Readers are urged to check with their financial counselors before making any decisions. This does not constitute an offer of sale of any securities. Halbert Wealth Management, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have their own money in markets or programs mentioned herein. Past results are not necessarily indicative of future results. All investments have a risk of loss. Be sure to read all offering materials and disclosures before making a decision to invest. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.