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The economy’s motor – Investors’ Chronicle

Suddenly, the price of second-hand cars is telling us a lot about the state of the economy; a point that applies as much to the US as it does to the UK. Not for nothing, the economics-research arm of the Brookings Institution, arguably the world’s best funded and perhaps most influential think tank, has just featured as its chart of the week changes in used car prices for the US.

Those who think prices of second-hand motors in the UK are silly have seen nothing. In the US, the annual rate of increase peaked at 45 per cent in mid-2021, moderated a touch, accelerated again to beyond 40 per cent and is now braking fairly hard. So the implicit point is that the latest dip in prices portends perhaps not an economy-wide recession in the US, but certainly a marked slowing.

Chartists might agree. They would take one look at the US graph and say the chart line forms a classic ‘double top’, where the second top peaks below the level of the first and gets to its highest point more laboriously. As such, they would explain that’s evidence a trend has run its course and a new one – of falling prices – is established. Not that used car price changes seem as if they are about to turn negative, as of March growth was still running at over 30 per cent.

Turn the focus to the UK and the price data are also revealing, although not necessarily in the way that might be expected. Compared with the US, the UK pattern is similar, though less spectacular. Average used car prices were running 26 per cent up on the year in the fourth quarter of 2021, which was by far the highest rate of increase in the 32 years of data provided by the Office for National Statistics.

First, though, it is important to recall the fact of life that used car prices fall rather than rise. In the chart, which juxtaposes changes in UK used car prices and in UK gross domestic product (GDP), the data for car prices are adjusted for inflation’s effects. As such, price changes are almost always in negative territory. In the 132 quarterly data points for the period 1989 to 2021, year-on-year used car prices fell 109 times. This is to be expected. After all, a car is a depreciating piece of capital with a useful life of, say, 15 to 20 years but a life as a desirable consumer good of much less than that.

Second, what matters, therefore, is not when car prices are falling, because that’s happening all the time, but the exceptional events – when they are rising. The table below quantifies this by taking the five discrete periods when used car prices rose year on year for at least two quarters running; the sixth period, which began in 2020 isn’t necessarily over so, as yet, there are no post-event data. It then contrasts GDP changes for the three quarters immediately preceding the periods of rising prices with the three periods immediately afterwards.

USED CARS MOVE GDP, NOT SHARES
Period of rising used car prices No. of quarters rise GDP change 3 quarters before* GDP change 3 quarters after* All-Share change 3 quarters before* All-Share change 3 quarters after*
1991-92 3 -1.4 1.8 12.5 17.6
1994 2 2.6 3.8 21.7 -3.6
1996-97 3 2.0 5.0 17.3 21.5
2009-10 4 -4.8 2.7 -29.6 8.5
2018 2 1.6 1.9 3.9 -1.0
2020-21 7 0.3 na -3.1 na
*Per cent per year. Source: Office for National Statistics

The results pretty well speak for themselves. Used car prices anticipated economy-wide growth. In each of the five completed periods GDP growth was stronger after car prices rose than before, sometimes markedly so. The output gap either side of the 2009-10 period that straddled the global financial crisis was 7.5 percentage points (a swing from a 4.8 per cent drop in GDP to a 2.7 per cent rise). It was 3.2 points either side of 1991’s Gulf War and the break-up of the Soviet empire and 3.0 points higher between the fade-out of John Major’s Conservative government and Tony Blair’s first Labour administration in 1996-97. For an economy that, on average, grows by just less than 2 per cent a year those may be significant differences – rising used car prices are telling us something.

This prompts the question: do second-hand car buyers know something the rest of us don’t? Instinctively, perhaps, they grasp the notion of the time value of money, which says money should be spent rather than saved when its future value is less than its present value discounted for risk. But that’s just a fancy way of saying anything can be worth buying if its price is low enough to outweigh the future benefits that might come from saving.

So maybe used car prices are an early mover in any economy-wide switch from saving to spending. This sounds logical to the extent that a high proportion of purchases are funded, somehow or other, with borrowed money, which will tend to be cheaper when GDP’s growth is low or non-existent.

What we make of the current unprecedented period of rising prices for seven quarters running and counting is something else. Sure, we could argue this is really two phases merged into one. The first phase, from mid 2020 to the second quarter of 2021, might be labelled “anticipating the recovery from Covid”. And, sure enough, it was followed by ridiculously high year-on-year growth rates in GDP. The second phase, from last year’s third quarter to the present, would be labelled “the supply-side squeeze” and is more problematic. It offers no happy ending but rolls together scary images of globalisation’s retreat, intense competition for scarce resources, tight labour markets, higher corporate costs, lower profits and the rest.

Miserably, however, there is no similar read-across between used car prices and the performance of shares in the UK. The table, which uses performance data of the FTSE All-Share index, is as inconclusive about the effect of rising car prices on share prices as it is conclusive about their effect on GDP growth. Still, it is easy to imagine that when UK used car prices eventually decelerate – and the anecdotal signs are already there – that will coincide with UK share prices going into a skid or worse.

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Meanwhile, more on cars – a  really odd thing happened last week. I renewed my car insurance with the same underwriter as the year just ended. Can’t remember the previous time that happened. It used to be a given that, with price-competitive insurance policies such as motor or home, it almost always pays to switch. Maybe last week’s renewal was a freak. More likely, it’s the result of new regulations that oblige insurers to offer existing customers renewal prices no more than those offered to new customers. And, sure enough, price-comparison provider Moneysupermarket.com (MONY) confirms that in 2022’s first quarter there was less switching, which meant revenue from its insurance services – the group’s biggest income generator – was the same as in 2021. Meanwhile – and predictably – its commission revenue from home services (ie, utilities) was almost wiped out, falling 65 per cent, as the effect of the energy price cap made switching pointless.

Granted, not everything was horrible. Consumers scrabbling for the least bad borrowing or savings rates meant strong growth in money services. Some revival in overseas tourism meant an eightfold rise in travel insurance income from almost nothing to £3mn. And there was a first-time contribution of £14mn from last autumn’s £87mn acquisition of cashback operator Quidco. Consequently, first-quarter revenue at £92mn was 8 per cent higher than in 2021, although without Quidco’s contribution it was 9 per cent lower.

Things will improve, say Moneysupermarket’s bosses, to the extent that they expect 2022’s operating cash profit (Ebitda) to be about the same as 2020’s £108mn; better than 2021’s £101mn but well short of 2019’s £142mn.

And therein lies the dilemma of holding the shares, as the Bearbull Income Portfolio does. When – if ever – will Moneysupermarket return to making the sort of money it made in the late 2010s? Even to justify the current share price – 180p and less than half its five-year high – would mean a regular Ebitda of approaching £120mn. Sure, there is a 6.5 per cent dividend yield on offer, which means the share price does not have to rise much to produce an acceptable total return, but it’s not clear where even a little extra growth will come from. It doesn’t help that a repeat of an 11.7p dividend this year may not be covered by earnings, although the balance sheet is under no strain.

So I could pocket the income and wait for something to happen; most likely that consolidation among price-comparison providers, which is much needed, will somehow benefit Moneysupermarket. But holding on would just be a form of buyer’s remorse. It is preferable to sell a holding I bought in a hurry 20 months ago and kept for too long. I have sold the portfolio’s holding at a fraction less than 180p each. This also means the income portfolio has about 15 per cent of its assets in cash, although by the time you read this a good chunk of that cash will have been spent on a holding in UK wind-farm investor Greencoat UK Wind (UKW), as explained last week.

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