China's Auto Market: Speedbump

Around the Curve

China's Auto Market: Speedbump

Auto sales are a key barometer of global economic growth—and China has been the major growth engine. Can the world still rely on China’s auto demand to absorb the shock in the industry?

The global auto industry is hitting a speed bump with sales challenged in most major regions including China, the U.S., and Europe. Can the world still rely on China’s auto demand to absorb the shock in the industry?

As auto sales are key barometers of global economic growth—and China has been the growth engine—assessing what went wrong with the country’s auto sales should shed light upon the gloom. Examining the issue from a macro perspective, as well as from a cyclical and structural standpoint, can shed light, as well as offer guidance from an investment outlook point of view

Sources: CEIC, Macrobond. United States, Domestic Trade, Vehicle Sales & Registrations, Vehicle Sales, Motor Vehicle Units, Total, SA, AR.  China, Domestic Trade, Vehicle Sales & Registrations, Sales, Total. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


MACRO: China’s Auto Market Becomes the Largest in the World

In terms of car ownership, China overtook the U.S. to become the largest new car market in 2009, with the largest fleet of 240 million cars in 2018. In terms of market penetration, the U.S. has 910 cars per 1,000 people, whereas China only has 171 cars per 1,000 people, so China is still far from being a saturated market yet.

In terms of production, since 2009, the annual auto production in China has exceeded that of the European Union or the U.S. and Japan combined. In 2018, a third of the world's cars were manufactured in China, totaling 28 million, out of the total global production of 98 million. China is also a huge consumer of passenger cars, with annual sales exceeding that of the U.S.


Sources: CEIC, Macrobond. * See below for Note. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.


The Macro Drivers Behind the Slowdown

The escalation of the U.S.-China trade tensions has had a strong impact on auto buyer confidence and discretionary spending:

  • Tariffs: China announced a reduction of import tariffs for cars and parts in April 2018, which triggered a “wait and see” strategy for potential car buyers as they could buy at a lower price if tariffs were actually cut.
  • Local Stock Markets: The equity selloff also created headwind for auto demand in China. The sharp selloff in the A-share market was caused by the intensifying trade war in the second half of 2018. Weakness in the equity market was further compounded by the slowing Chinese economy.
  • Housing Markets: Property prices in lower-tier cities rose in 2018 given the increase in shantytown developments; however the result was weaker affordability due to lower income levels in lower-tier cities

These factors above are the main engines of much weaker car demand for mainland and mid-to-high brands, though demand for luxury brands is more resilient. Geographically, the weakness in the car market seems more concentrated in lower-tier cities.

CYCLICAL: Industry-Specific Cyclical Drivers

Property Prices and Taxes

In 2015-17, the major cyclical drivers behind the domestic auto industry were rising property sales and the purchase tax cuts on vehicles with small engines, which brought forward at least 3.2 million units of purchases into 2016-17, and propped up car prices in 2018 (Source: Citigroup). The combined effects of these drivers mostly benefited mainland brands and mid-to-high-end brands. In 2018, the purchase tax was normalized back to 10%, versus 7.5% in 2017, and 5% in 2016 and late 2015. Therefore, the front-loading of demand reversed in 2018. In addition, as the Chinese government tightens the cash reimbursement of shantytown developments in 2018, Citigroup estimated that the cuts in shantytown payouts will potentially remove another 3.5 million units of auto demand from 2017 through the first quarter of this year. Mainland brands and mid-to-high-end brands will split the pay-back. Both negative effects may come to an end in 2Q19.

Widespread Financial Deleveraging

The cooling of auto sales also coincides with financial deleveraging in China, which has led to tighter liquidity and credit tightening, which should squeeze consumer discretionary spending. However, the drag on car sales from credit in China is less severe. According to Goldman Sachs research, only about 40% of annual auto retail sales are financed, a penetration rate that’s still low compared with a global average of 70%. China’s car loans are concentrated in higher-end vehicles. A majority of loans are made by carmakers’ captive finance companies. The delinquency rate was around 0.1%. Chinese auto-financing products tend to have lower loan-to-value ratios and shorter terms than in other mature markets, indicating a lower default probability. Another dampening factor on sales came from a crackdown on peer-to-peer lending, which funded 10% of vehicle purchases in China’s smaller cities. Therefore, auto loans aren’t necessarily a major factor in the health of the overall industry.

Peak Demand for Sport Utility Vehicles (SUVs)

Sales for SUVs are no longer a growth engine in China. Based on JP Morgan data, China’s SUV penetration reached 44% as of December 2018, much higher than the peak level of 37% of other markets such as South Korea, Taiwan, and the U.S. Therefore, SUVs probably have reached the saturation point in China and will no longer grow as fast as sales have in the past several years.

STRUCTURAL: Four Structural Factors Within the Auto Industry

These four factors will continue to pose additional headwinds to new demand for internal combustion engine cars in China.

  1. Used Car Market: The used-car market rapidly increased in size after the government removed regulations that previously banned used cars sold in one city from being driven in another. A decade ago, China’s used-car market barely existed, but today, the ratio of used car sales to new car sales is 1:2. As the Chinese market matures, used cars are becoming an important part of the mix.
  2. Limited New Car License Plates: There has been growing popularity to limit new car license plates as a way to control traffic jams and air pollution. Beijing started the trend in 2010 with an annual quota of 240,000, which was cut to just 40,000 in 2017. So far seven other cities and one small province have implemented similar controls and more cities are likely to follow.
  3. New Energy Vehicles (NEVs): China already leads the world in demand for electric vehicles, with its share reaching 4.5% of total sales. The government has been subsidizing NEV manufacturers. Chinese demand for electric cars could eventually become an attractive market for foreign carmakers, but they must first retool their manufacturing process and technology and earn a foothold in the nascent market.
  4. Ride-Sharing Apps: One of the biggest structural challenges is the growing popularity of transformative technologies like ride-sharing apps. China’s version of Uber—Didi Chuxing—is already significantly larger with 550 million users making 11 billion rides in 2018. The structural decline in vehicle demand will only further accelerate once driverless, autonomous cars arrive around 2030. For automakers, that means declining demand and thinner margins.

CONCLUSION: Investment Implications

Given the above macro, cyclical, and structural drivers behind the auto sales slowdown, we see a risk that the Chinese car market could surprise investors with more prolonged weakness in demand before it picks back up in late 2019. The extended slowdown would be a result of the combined workings of near-term cyclical forces arising from the front-loading sales of 2015-17, and longer-term structural forces of alternative transportation options for consumers, and government policies of favoring clean energies. However, there are certain segments of the auto market that will continue to enjoy high growth, such as NEVs.

Auto sales growth could stabilize in the second half of 2019 with potential stimulus policies like rural auto purchase tax cuts that could temporarily boost auto buyer confidence, better seasonal factors in the fall/winter, and the base effect. We believe a sharp rebound is unlikely though, due to the more mature nature of China’s auto industry and the retooling process of transitioning from internal combustion engines to NEV vehicles.

Therefore, we believe China’s auto market is not likely to be a shock absorber to the challenging global auto market nor will it be a star performer to reverse China’s growth slowdown in the near term. We will be watching this industry and its related drivers closely in 2019.


* Note: United States, Domestic Trade, Vehicle Sales & Registrations, Vehicle Sales, Motor Vehicle Units, Total, SA, AR.  China, Domestic Trade, Vehicle Sales & Registrations, Sales, Total.


A shares, also known as domestic shares, are Chinese shares denominated in Renminbi and traded in the Shanghai and Shenzhen stock exchanges, as well as the National Equities Exchange and Quotations.


Important Information


All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People’s Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC’s commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC’s commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.