Saturday, February 07, 2009

Commodities, homebuilders and autos

Real estate and commodity stocks are similar - during boom times, both price and volume go up, and during the bear phase, both price and volume fall - creating huge swings in bottomlines and stock prices. So real estate is a commodity and a real estate investor can as well invest in steel.  

Real estate and auto are similar - they are the two biggest outlays in a consumer budget and are critically dependent on financing. So, both of them turn down when financing becomes tough.

Real estate and auto are dissimilar in one very important way - consumers view real estate as an investment item and auto as a consumption item. When I go and buy a house, my future outlook on home prices is one of the three most important factors driving my thought process - the other two being financing and my job/wage outlook. 

On the other hand, when I go and buy a car, I might try to time my car purchase to take advantage of some anticipated holiday discounts or tax reductions, but I will not bother to figure out what the price will be one year down the line. There are only two factors that drive consumer purchase decision - financing and job/wage outlook.

What all this suggests is that auto cycles are much more violent than real estate cycles. Globally, auto is in deep trouble because of flawed industry structure and mature demand. In India, where one can argue there is a lot of unmet demand, auto demand might bounce back quite sharply from depressed levels - I don't know what that depressed level is. 

Prices of cars doesn't vary as much as houses or steel year on year. So, in analyzing the auto industry, one needs to focus purely on volumes and market share. In commodities and homebuilders, one has to also focus on prices one year out - which is very hard to figure out. 

So, auto industry is relatively easier to analyse from supply demand perspective than the other two. What all this means is - there might be a lot of money to be made in the right Indian auto stocks by timing it right. 


Econlogic said...

"What all this suggests is that auto cycles are much more violent than real estate cycles."

It is not clear to me why this should be the case from your piece.

Also, are margins that easy to forecast given exposure to commodity prices on the cost side?

Autos will rebound just as the rest of the market will at some stage. But I remain sceptical of the sector's ability to beat the market sustainably.

The reason is mentioned in your analysis. The industry is global and in doldrums. Fierce competition in regions with unmet demand will be the end-game in my view. Sales will certainly be robust but what about margins? It will be great to know what you think about this.

Gaurav said...

Clearly auto stocks are not FMCG stocks that one buys and holds. But that doesn't mean money can't be made. Margins are dependent more on volumes than on commodity prices - I think the era of sharply rising commodity prices is over for a long time. Any gradual increase in commodity prices can be accomodated through productivity improvements.

Econlogic said...

Thanks for your reply.

1. I agree with you that money can be made. When markets move up, almost everything goes up. Yet the question for me always is: where is the best risk reward?

I agree with you that we won't see sharply rising commodity prices for a long time.

But there is a reason for it. We won't see the synchronous global upturn (2003-2007) for at least the next 5-years if not more.

By implication, this will be a period of slow employment and income growth and little support for spending from asset prices.

Stating the obvious, bank capital tends to be pro-cyclical. I am not sure how much of the short rate cuts will improve availability of credit in bank financed economies as the credit channel works as a constraining factor.

I am also not sure how this environment will be supportive for a huge upturn in consumer durables such as autos which involves chunky expenditure.

This slow growth environment superimposed by an industry in trouble and one where competition truly is global does not make for a pretty picture. Every market will be hard fought for with certainly some implications for margins.

High exit costs will also not help the competitive landscape in the industry.

2. I did not fully fathom your point about auto cycles being more violent than real estate cycles.

First, history is replete with housing and commercial real estate crashes and speculation. That is why your point came as surprise.

Second, the only extra factor working for real estate is price expectations. The key issue then is whether expectations are stabilizing or destabilizing - the standard momentum versus reversal debate in markets. From my limited reading, I have come to the conclusion that short-term expectations are often extrapolative -worsening the problem. Only over the long-term, prices play their allocative role leading to reversals.
So housing prices can continue to decline as people postpone purchases in order to get a better price in the future.

I thought that was your point about auto being better right now. But then are you also not saying that real estate cycles are more violent.