As we move ever closer to the fiscal cliff, U.S. auto manufacturers, including both Ford (NYSE:F) and General Motors (NYSE:GM) are set to finish off 2012 with the strongest sales numbers the industry has posted since 2007, before the financial meltdown. The impressive showing includes a rise in December sales of 9%.
It is against this backdrop, however, that we must consider whether the potential impact of going over the fiscal cliff should make us buyers or sellers of these stocks in preparation. Ultimately, I believe that both U.S. automakers have enough pent-up value in their shares to overcome the potential concerns created by Congress' seeming inability to resolve the fiscal cliff issues.
The fiscal cliff
In a letter to Congress, Treasury Secretary Tim Geithner wrote: "'I am writing to inform you that the statutory debt limit will be reached on December 31, 2012, and to notify you that the Treasury Department will shortly begin taking certain extraordinary measures authorized by law to temporarily postpone the date that the United States would otherwise default on its legal obligations."' While the debt ceiling does not precisely relate to the fiscal cliff, the issue acts as an overriding concern and a backdrop against which other issues are considered.
The fiscal cliff references each of the scheduled tax increases and spending reductions that are in place to go into effect in 2013; Congress still has time to avoid this eventuality, but time is quickly running out. The Congressional Budget Office, as well as many other economists, project that if no resolution is reached, the fallout from these measures will cause a recession with the potential to cost around 2 million jobs. Critical areas include the expiration of various tax abatement initiatives, and the commencement of sequestration reductions.
Beginning in January, several tax-easing measures will end. The so-called Bush tax cuts, the extended unemployment benefits, and the payroll-tax holiday will each be affected. The sequestration measures refer to previously defined spending cuts that were accepted as a self-imposed motivator for Congress to find bipartisan support for some needed budget reductions. With no agreement reached, the reductions are set to take effect.
A central element of an individual's willingness to buy a new car is one's general level of confidence in the state of the economy -- specifically, one's personal prospects. A recent Reuters report highlights that "U.S. consumer confidence fell to a four-month low in December on worries over the $600 billion in automatic spending cuts and tax increases that take effect unless Congress acts to stop them." Despite this decline, the sales numbers for December are expected to be quite strong. This apparent disconnect highlights how strong demand may really be in the segment.
Brian Johnson of Barclay's Capital explains: "Given relative strength in consumer sentiment post last month's election -- even in spite of the fiscal cliff -- and improvements in labor data, we expect healthy retail demand to spur a strong month." December is supposed to help 2012 finish the year with a total of 14.5 million vehicles sales; that represents a 13% increase over a year ago and the third straight year of double-digit growth for the industry. While growth is expected to fall below 10% for 2013, the question becomes whether pressures from the fiscal cliff will drive down demand sufficiently to disrupt this strong growth trend.
The role of the fiscal cliff
There are two countervailing forces at work within the auto industry in this scenario that will affect 2013 sales. On one hand, the average U.S. car on the road is now more than 11 years old. Demand should thus be strong, as consumers have been waiting for the right time to buy. Stronger home prices are one area cited as spurring auto demand: When consumers feel more secure in the value of their homes, they are more likely to buy a car.
The other side of the coin is that if going over the fiscal cliff leads to another recession, unemployment is likely to rise and home prices are likely to fall. The mere threat of these eventualities may be sufficient to encourage car buyers to continue to wait until they feel more secure in the future. It's not necessary for the actual recessionary effects to go into place for consumers to change their behavior -- often the expectation is sufficient. While the data is not there yet, this should be a real concern for 2013.
Still a good value
Despite these concerns, both Ford and GM look to be solid values from an investment prospective. GM is currently trading at a forward P/E of 7.2, and Ford is trading at a forward P/E of 8.7. To put that into some perspective, Toyota (NYSE:TM) is at 11.7 and Honda (NYSE:HMC) trades at 10.3. Both U.S. companies are also attractive across multiple other fundamental metrics.
Overall, while it doesn't appear that the threat of the fiscal cliff is a justification for selling either automaker, it will be important to carefully follow consumer confidence, sales data, and unemployment on the other side of the cliff. Any significant weakening in these figures should be viewed as a catalyst to move to the sidelines and find greener pastures. At current levels, wait-and-see seems prudent for anyone without an existing position.
Fool contributor Doug Ehrman has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.