Manheim Steamroller

I’m fed up with all this reading! You’re a Wormwood, you start acting like one! Now sit up and look at the TV.

Matilda (1996)

A couple weekends ago I visited a car dealership to buy a new car.

Like most people, I look forward to this as much as I look forward to, say, going to the dentist or watching the Oscars. And like most people, I suspect you look forward to hearing someone complain about a car dealership experience about as much as you look forward to reading a rant about a bad airline experience.

Don’t worry – this is not that kind of story. But it is an unusual story.

I went to buy a car for a very ordinary reason. My wife is 8 months pregnant with our third child. Since my pickup truck can’t really accommodate three car seats, it was the obvious choice to take one for the team. So it is that I am now officially “regularly googling Korean-made three-row SUVs” years old.

Now, the whole car-buying experience is something I have more familiarity with than I’d like, having previously served in a professional capacity setting sub-prime auto loan pricing for one of the largest non-captive lenders in the space. Buy Rate shenanigans in the finance manager’s office, the economics of trade-ins, the loss severity impact of repossessed collateral – all of this garbage lives in the career-only skills section of my brain, next to dynamic named ranges, Black-Scholes formula components, state regulatory requirements for investment advisers and banking confidential information memorandum templates. In probably 90% of my life, I operate with barely enough knowledge to be dangerous. Lamentably, the world of purchasing an automobile is part of the other 10% where I have real knowledge – even if it is decidedly cursed knowledge.

All this, and still I left without a car. Which is not very interesting.

What IS interesting is why I left without a car. It wasn’t because of lack of inventory or credit availability or too much “cargo net and window tint” lagniappe or some guy pushing the undercoating option like he was $1,000 away from topping the monthly sales leader board. It wasn’t even because they wouldn’t honor the deal their internet sales manager had agreed to before I walked in the door.

It was because they couldn’t.

You have probably heard or read that used car prices are up this year.

You may not know how much used car prices have risen. For a variety of reasons (e.g. rental car company activity, some pent-up consumer demand, and yes, semi-conductor supply constraints), used vehicle values have skyrocketed since the early 2020 COVID trough. Manheim, Cox Automotive’s wholesale auction and consulting platform, publishes an index of these values.

As it happens, some auto segments are experiencing this pricing pressure more acutely than others. These are, to put it bluntly, extraordinary times for this particular good.

When yours truly rolled into a dealership with a detailed late model Toyota pickup with fewer than 15,000 miles on it for trade, it was already higher-than-average value collateral. Add to that the general price pressure on used vehicles and the particular spike in pickup prices, and you had an odd situation: wholesale, private sale and trade comps at other dealers were telling them that the vehicle I brought in was worth such a high percentage of a new version of the same auto that it broke their model.

The used car guy knew what the trade was ‘worth’, in the commoditized sense of what it had been getting at wholesale and the sky-high prices other area dealers were asking for at retail. But when you’ve spent 30 years taking trades with an expectation of netting a couple grand turning it around and now you’re being asked to price terrifyingly close to new inventory to approach that margin, you can start to see why he would balk. Consider as well that there is no certainty about how long this pricing pressure will last, and the risk that the dealership won’t be able to turn over its high-priced used car inventory in time starts to loom very large.

I could have accepted a lower value, of course, but all it took was one other dealership who was willing to bet on their ability to continue to pass through record, unprecedented used car pricing.

OK, interesting anecdote, but what’s the bigger story here?

Common knowledge among investors, allocators and business operators nearly always frames the proper response to inflation in terms of price direction. We want to know which assets will win if prices begin a steady rise upward, or if prices of a particular good, commodity or service are likely to spike. We want to know which businesses have pricing power, which can pass on input and labor costs without loss of demand.

And those are all good questions.

What that narrative misses, however, is the importance of sensitivity to price volatility in a path-dependent world. If you think that what’s happening in auto supply/demand and pricing is generally good for auto dealerships and the related industry infrastructure, you are probably right. But there will also be leveraged dealerships who participate heavily in inventory acquisition at prices and quantities that they can’t turn over before the pricing environment flips back. There will also be winners who figure out how to accommodate and navigate higher used price expectations in trades for new vehicles.

So it will be for every asset class, industry and business being identified as a ‘beneficiary’ of an inflationary regime or a ‘transitory inflationary spike’ in our ongoing collective dialogue. Even within a space likely to benefit from the direction of prices, expect the volatility of prices to transform some assets into steamrollers – and some into the steamrolled.

If there’s one thing I feel confident telling you simply because it is nearly always true, there are going to be a lot of investors and business owners who get the inflation trade 100% right. They will nail the timing, duration, direction and causes, whatever those things end up looking like. And for all that rightness, they won’t make a dime from it.

I think this will be a big reason why.