You might have heard the news of auto sector slowdown in the news in India recently. The government is providing various explanations for the same and the industry is crying. One thing, however, is for sure, that there is a decline in the number of units sold in auto sector. While ups and downs are part of every business, but let us see the implications of this on equity markets. For the purpose of this post we shall restrict it to four wheelers.
Who purchases automobiles and repurchase cycle?
Around 11-15% of Indian households have at least 1 four wheeler. A significant proportion of car owners are either business owners or professionals (like lawyers, doctors etc. who have their own practice). The other proportion is of salaried people.
Typically, the repurchase cycle of business owners and professionals are smaller than salaried people. The reason is as follows. When business owners and professionals purchase a car, more often than not, they purchase in the name of their company. The advantage is that since car is a depreciating asset, the company gets to pay lower tax (as depreciation amount is removed from income). Because of this, the same car that a business owner or professional buys costs them cheaper than it does to a salaried person. And hence, their repurchase cycle is also smaller than it is for a salaried person.
When does the repurchase cycle of a business owner increase?
As a business owner, if your business is going through a downturn what would you do? Reduce un-necessary expenses, reduce investment in assets like property, plant and equipment and defer purchase of the new car. Since business is going through a downturn, the net income of a business owner decreases. For a salaried class person, the income does not decrease or decreases marginally (bonuses are reduced), unless of course, the downturn is so massive that ultimately salaried people start losing jobs. However, the loss of jobs is typically the last thing to happen. The first indicator is always businesses making less money. Hence, they defer purchase of a new car.
Impact of auto sector slowdown on market or leading indicators?
One impact is the direct impact which is for the auto sector. The sector loses money and people employed are losing jobs. From the market perspective, auto sector stocks are going down. And it might not be a bad thing, as a lot of auto sector stocks are over-valued. In fact, it might be a good time to consider stocks of auto companies if they fall to levels that they become undervalued. You may want to look at my post of picking best stocks to figure out if stocks are undervalued or not.
But it also impacts the larger market. If our hypothesis is true that auto sector sales are declining because business owners have stopped or deferred the purchase of a car, then it means businesses in general are in slow-down. Which in turn means that stock markets would go lower.
Should I stop investing and wait for markets to bottom?
That is usually investors first instinct. Because, somehow we think that we know when would markets crash, bottom out and peak. But in reality, markets are more intelligent than an individual. Timing the market is a zero-sum game, some will win others will lose (to sell, one needs a buyer and vice-versa). Hence, the best way to to systematically keep investing and let things average out. Remember, long term is what pays out in equity investment.