The auto industry is cyclical, and this year is showing the end of years of growth. In this segment from Industry Focus: Industrials, analyst Sarah Priestley and senior auto specialist John Rosevear talk about the state of the auto industry, and how it got to where it is today.

Find out what special factors in particular might be contributing to the decline in the industry; how a glut of used car sales affects profit margins for big automakers like Ford (NYSE:F) and GM (NYSE:GM); how Hurricane Harvey impacted the industry; why some auto companies try to juice up sales with discounts and incentives, and how that affects the entire industry; and more.

A full transcript follows the video.

This video was recorded on Sept. 21, 2017.

Sarah Priestley: So, we're going to talk about the auto industry today. After posting record sales in 2016, selling 17.6 million units, automakers are starting to see a slowdown. Sales of automobiles are down 2.1% for the first six months of this year, and the Detroit 3 -- Ford, GM and Fiat Chrysler -- all posted declines for the first half of the year. GM sales down 1.8%, Ford 3.8%, and Fiat Chrysler almost 7%. So, John, this year looks likely to end the two years streak of record sales. The narrative in the press right now is very much on the wider debate of, have we reached peak auto? You've been in the industry for 20 years, commentating and being an analyst, so I wondered if you could give us the long-term view on this?

John Rosevear: Auto sales are cyclical. They're somewhat of a leading indicator, we say, because when consumer confidence starts to fade, people don't buy new cars. Business is also don't buy new cars, and commercial sales are very important for some automakers, in particular Ford and GM. But, looking a little bigger picture, we've been in a rising cycle since late 2009. We all know the economy and auto sales blew up in 2008, and they stumbled around in 2009. But if we had a graph of this, and Sarah and I did earlier so you'll just have to play along by audio, you'd see the pace of auto sales picking up steadily from about the end of 2009 through about the end of 2015. And it went up and down last year, just enough to eke out a record over 2015, but then it's been coming down in 2017. You look at that, and the obvious conclusion that suggests itself is, we're past the peak of the auto cycle, and that has some implications.

Priestley: Absolutely. Just to play devil's advocate for one moment, some people are suggesting that there's currently issues at the minute that are different and more stressful for the industry that we haven't seen before. For example, the glut of used vehicles. In 2014, 3.3 million vehicles were leased, which was 23% of auto sales that year. The suggestion that we're seeing is that this is going to create an overall glut in the market and pressure prices down. We haven't seen that yet in new car sales. What do you make of this? Do you think that's going to happen?

Rosevear: When you have a glut of used car sales, we point to a couple of things that happen right away. First of all, the prices of used cars, nice, lightly used cars, the kind of cars you get off lease, are under some pressure. They're slipping. That has a couple of impacts on the automakers from an investor's perspective. First of all, a lot of these leases are underwritten by captive finance units. Ford has an in-house bank, Ford Motor Company Credit. Ford Credit is bringing these leased vehicles from 2013 and 2014, whatever, to auction, and they're getting less than they expected. That impacts the profitability of those lease deals they did two or three years ago, whatever it was. It also makes it a little harder for them to lease now, because of course, leases are priced on what we call residual value, which is the predicted value of the car at the end of the lease. Values are coming down now, that means the analysts who rate residual values for the automakers are going to bring values down. And that means they have to either price to leases higher to the consumer, the monthly payments have to be higher, or the profits get squeezed if they're going to hold the levels. That makes it a little harder to lease. You see some automakers actually backing away from leasing somewhat because of this, because the profitability is not what it was. So, there's that too.

Impact on new car sales, we haven't seen a lot of that yet, but if the economy starts to slide, you will. You sure will. And that supply will get bought up. When consumers are feeling pricing pressure, they postpone new car purchases that are optional many times. But if they need a car, they may limit their spending and say, "I'm just going to get a used one now and I'll replace it when things improve." There are a good number of people, not so much business is, but individuals who do that, and that'll suck up some of that excess inventory if it starts to happen soon. If not, used car prices will be under pressure.

Priestley: Yeah, I think they've slipped 6% so far this year, but dealers are maintaining that discipline in terms of not slashing prices indiscriminately that we have seen before. There are the longest term loan offers in the industry's history. Is that carried by the dealer, or is that carried by the automakers themselves?

Rosevear: The automaker's captive finance unit makes a percentage of the loans that their dealers make. The dealers often work with independent companies as well. For instance, to go back to the Ford example, Ford has an optimal credit profile, and folks who come in with lower quality credit, the dealer may know other financing companies that will work with them if Ford would rather not have that deal or won't offer it at a competitive interest rate. But, what we see going back to the way we framed all this, with the cycle in decline, the pace of sales slowing, what happens is, to show growth, some of the automakers will resort to jacking up discounts. Generally speaking, historically, this is what has happened. You see incentives go up. Those incentives, the cash back or 0% financing or price cuts, those are financed by the automakers. And the higher they go, the bigger the squeeze on profit margins that comes out of their profit margins. We have seen, we've heard a lot of talk over the last five to eight years, really since 2009, about how we're going to resist the temptation to boost our discounts, we're going to cut production rather than discount in order to keep sales up. We would rather lose the incremental sales and maintain our profit margins. Mostly, we're seeing that. This was notably the talk of, former Ford CEO Alan Mulally was famous for this. We'll match supply to demand, we'll match our production capacity to demand, meaning that will move it up and down to keep inventories from getting out of hand. GM has been doing it for the most part. Their incentives haven't come up too far. Ford's haven't come out much at all. Some other automakers are discounting more aggressively. Whether that puts further pressure on companies like Ford that are trying to hold the line over time, we'll see what they think the optimal business decisions are. But so far, the discounts aren't skyrocketing. Ford would rather come in and say, "Sales were down 2% last month," than say, "We gave away some profit so we could show a gain."

Priestley: I think it really shows that they must have a finger on the pulse for the market, if they can respond that quickly. I know manufacturing cycles probably aren't that long, but they are long enough that they would really have to be ahead of the game.

Rosevear: They mostly are. I mean, obviously, they talk to their dealers all the time. There are people at Ford whose job it is to talk to dealers and get the sense of this. And all the other automakers, as well. And that turn feeds into production decision. It doesn't quite move that quickly, like, "Trucks are off this week, let's cut trucks next week." It's not quite like that. It's more quarter-by-quarter. But, yeah, it's fairly quick. It's quicker than it used to be.

Priestley: I mentioned a little in the intro about the first six months of this year. August results show that cars and trucks declined to 2%. Some of this can be attributed, interestingly, to Hurricane Harvey which has affected auto sales to the tune of about 20,000 cars, Houston being the ninth-largest vehicle market in the nation. I gather, John, this is a double-edged sword, given that the storm can boost sales, unfortunately, as people replace flooded vehicles. What do you make of that?

Rosevear: It's hard to say how this will play out. I saw one estimate that said 200,000 vehicles had been lost as a result of Hurricane Harvey flooding. Houston area is a big market in particular for Ford, for trucks and so forth. General Motors, the GMC brand is very strong in the Houston area, as well. Ford's truck sales weren't bad last month. But there is a sense that their dealers have lost some inventory, although less than a lot of people expected. So, Ford and GM and the other companies will replace that, and that'll give them a little boost, and those cars will go on to be sold and drive up auto sales generally. It's hard to say right now. The impact is not dramatic, though, I think. Of course, we got more hurricanes out in the Gulf, so who knows?

Priestley: Yeah, I know, who knows. It's awful if you live there. But a lot of these automakers really need a boon. If you look at the numbers for a Hyundai, sales were down 25% in August. Nissan, 13%. Fiat Chrysler, 11%. Some bright spots in the August numbers -- GM sales were up 7.5% year-over-year. Toyota, 7%. Volkswagen, 9%.

John Rosevear owns shares of Ford and General Motors. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ford. The Motley Fool has a disclosure policy.