Chinese Growth Spurt

By John Mauldin


 

Economic reality isn’t black and white. At any given time, both good things and bad things are happening. Ignoring one side because it doesn’t fit your preferred outlook is an excellent way to go badly wrong.
 
So it is with China. We hear a lot about that vast country’s problems and challenges. They are very real and could have major consequences... which we will explore soon… but there’s good news, too. We reviewed some of it last week in China’s Command Innovation. Today, we’ll add a few more positive data points.
 
This letter will be a little different than most. Below you’ll read several short vignettes about positive events in China. They aren’t necessarily related and won’t build to any particular conclusion. My goal is simply to demonstrate that China has good news, and even some fabulously great news, much of it quite compelling. Whether it is enough to overcome the challenges is a different question we will address next time.
 
And frankly, the manner in which they are growing clearly makes Western countries uncomfortable, as it is not our usual playground.
 
First, a quick aside. We have been making an aggressive effort to keep the main body of this letter around 3,000 words, a length most people can read in a few minutes. We’ve had good feedback on it, too. Then in my personal section, I share a great story from Art Cashin from last Monday night. So you can read either part of this letter, or both, as you wish.

Now on with our China story.
 
 
Here in the US we are very excited at the prospect of seeing 3% real GDP growth this year. In China, that would represent an unprecedented crash. Here are the annual changes from 2010-2017, with IMF forecasts for 2018-2022.

Source: Statista
 
Now, you can fairly ask how reliable this data is. The numbers have a curious way of coming in at exactly the level Beijing expects. But I have no doubt that Chinese growth is far greater than the US or any other developed country has seen in the last decade. And I think the IMF is probably right that it will decline only gradually and remain impressive, by Western standards, well into the 2020s. Much, if not most, of this growth is debt driven, and eventually that debt has to come home to roost. But that doesn’t seem to bother them currently.
 
Yet I constantly hear predictions that China’s growth days are over. Often, this stems from a belief that China’s capital investment has been higher than it actually is, leaving excess capacity. And in some industries that is true—like steel production—but steel factories have been shutting down left and right. Axios reported recently:
 
By the end of the year, some 1.8 million Chinese coal and steel workers will lose their jobs, victims of the government's shift to cleaner industries and a shutdown of small enterprises. To put that in perspective, the two industries employ just 192,000 workers in the US.
 
That is in addition to the millions of coal and steel workers who have already lost their jobs in the last 15 years. The Chinese are ruthlessly eliminating excess capacity. Peterson Institute economist Nicholas Lardy argued last month that most of the “investment growth” we hear about is simply higher prices and real investment barely grew. If so, China may have less spare capacity than we think.
 
In a follow-up article, Lardy further explained that personal consumption data—which is much harder to manipulate—is more in line with economic growth. He says this is more meaningful than retail spending since China’s fast-growing middle class spends much of its income on services like education and healthcare.
 

 
 
If investment and consumption are both strong, as they appear to be, then the remaining threat to GDP growth would be falling exports. Trade tension might eventually bring that on, but it hasn’t happened yet and China is already working to replace any lost US sales.

Export Substitutes

I’ve talked before about Alibaba (BABA), China’s e-commerce juggernaut that is, if possible, even more dominant than Amazon.com (AMZN). One big question for both companies is how far outside their home countries they can expand.
 

Alibaba took a big step in that direction last week. On the sidelines of a Xi Jinping-Vladimir Putin summit in Vladivostok, Alibaba said it was buying a 10% stake in Russian internet giant Mail.Ru Group. They plan to use the latter’s Russian social networks to build an e-commerce platform. Aside from the benefits it brings to both companies, the platform will be a new conduit for Chinese exports to Russia.
 

 
 
Now, it will be a long time before Russian consumers buy enough online goods to replace what China will lose in US exports if the trade war heats up further.
 
The broader point is that Chinese businesses are not at the mercy of US trade policy.
 
They have other options and are actively pursuing them.
 
Combine this with China’s massive “One Belt, One Road” infrastructure initiative, and you can see where the game is going. Alibaba, Tencent, and Baidu will be following the yellow brick, I mean One Belt, One Road, as will other big Chinese companies. Beijing intends to dominate as much of the Asian economy as it can. North America and Western Europe aren’t going anywhere but we aren’t the world’s growth centers anymore.
 
Perhaps strangely, that thought doesn’t bother me. Who’s afraid of a little competition? I think we will do just fine, thank you very much.

AI Waves

Artificial Intelligence, or AI, is the new Space Race. This time the US faces China instead of the Soviet Union and the outcome is not nearly as certain. Beijing wants to win and is pouring resources into doing it.
 
A new book, AI Superpowers by Kai-Fu Lee, is a must-read assessment of this battlefield. My friend Peter Diamandis recently shared Lee’s concept of “Four Waves” in AI development. Chinese companies are giving Silicon Valley a run for its money.
 

First Wave: Internet AI. These are the now-ubiquitous online “recommendation engines,” like the products Amazon says you should want, or the “suggested videos” that keep you on YouTube for hours. Those recommendations come from the data we generate with our clicks and other online activity. Lee thinks China’s data advantage gives it a slight lead over US counterparts in this segment.
 
Second Wave: Business AI. This is where we see computers analyzing data to make judgements once reserved for humans: loan underwriting, cancer diagnoses, and so on. AI excels in considering far-flung datapoints that a human analyst would discount or miss completely. Lee says the US has a commanding lead for now but China’s lag may actually help by letting it leapfrog over legacy technologies. The country went straight from cash to mobile payments, for instance, bypassing the clunky credit card apparatus we have difficulty abandoning.
 
Third Wave: Perception AI. You’ve heard about the Internet of Things. The devices around us, once connected to each other, will merge the physical and online environments into one seamless world. China has the lead in sensor technology and is already using it in factories, retailing, and law enforcement. Already they have stores where you literally scan your face to pay the bill. No card, no device, just the face that’s always with you. That’s where we are all going and China is going there first.
 
Fourth Wave: Autonomous AI. Machines that can both make decisions and sense the world around them will eventually operate independently. Autonomous vehicles are the most familiar example but it won’t end there. Imagine drone swarms extinguishing forest fires or painting your house. Chinese scientists are working on such things.
 

These are controversial and sometimes risky capabilities. They will face opposition in the US but less so in China, if that is what the government wants. Hence, I think China will probably gain the lead and possibly hold it for a long time.

Automatic Automation

Even without AI, Chinese manufacturers are automating fast. This is partly out of necessity: the country lacks skilled workers, especially young ones who can work long hours. Competition from lower-cost Asian neighbors makes raising wages difficult. The best answer is to get more efficient via automation.
 
Increasingly, the same companies that once thrived by reverse-engineering and copying Western goods are building their own advanced products. The government’s “Made in China 2025” initiative helps with generous loans and subsidies.
 

For instance, The Wall Street Journal recently profiled a heavy machinery maker called Sany Group. Among other things, Sany makes the pump trucks that blast cement to the top of tall buildings, plus cranes and other equipment.
 

Source: Sany Global
 
 
It turns out, some 380,000 Sany-built construction machines are connected to the internet and constantly send data back to their maker. The company uses it to design better products, constantly adjusting production on the fly. That’s possible because the workers are robots who just need new software instructions, not lengthy retraining.
 
US and European companies make the same kind of equipment, of course. I suspect the quality is more than equal or better. Their problem is that even if a trade deal gives them full access to China, manufacturers like Sany are already way ahead, they don’t have shipping costs, and foreigners don’t get the kind of help from their governments that Sany gets from Beijing.
 

Now multiply this by thousands of other companies in many industries. Many are fully capable of competing anywhere on the globe, but they don’t have to. They have a giant market right there at home.

Some Random Bright Points

This next section comes from this short video on Facebook about some of China’s bright spots you might not know about. (The Science Nature Page has scores of other interesting videos, too, by the way.)

  • China has recently become the world’s largest solar power producer.

  • China is pouring $364 billion into renewable power generation.

  • At least 40 hospitals in China have deployed IBM’s Watson AI technology.

  • They are rolling out AI to improve healthcare and diagnoses at a prodigious rate.

  • Chinese scientists have invented rice that can grow in saltwater that will be able to feed over 200 million people. That will be a big deal.

  • At least 1 million Chinese could be using 5G mobile networks by 2023.

  • Most Chinese consumers are now using mobile payments instead of cash, even at local street vendors. That means Tencent knows your buying habits even down to the type of noodles you like. And again, the Chinese seemingly don’t care others have that data.

  • I don’t think they will beat Bezos or Musk or Allen to the moon, but China is teaming up with Europe to build a base on the moon. They are serious about it.

  • They just built the world’s largest telescope to study the universe. Basic research is the font from which new ideas and businesses grow.

  • The use of robots in China is growing at a prodigious rate. They actually have fully unmanned factories.

  • (A personal sore point): China will begin work on the world’s largest supercollider in 2020. It will be twice the size of the current Hadron collider. The US poured billions into what would’ve been the world’s largest superconducting supercollider south of Dallas. After digging the holes and tunnels, Congress decided it was wasted money and walked away.

  • China has the largest network of bullet trains in the world and they are expanding it to include all of those super cities I mentioned above.

  • China allows genetically modifying human embryos and stem cells, and will soon catch up with the research we have been doing in the US and Europe. Especially since we publish everything we do.

  • Rather than keeping things in the lab, the country allows CRISPR gene editing on humans. I can imagine all sorts of things that will go awry and it makes me cringe to use humans as guinea pigs, but it will speed up the invention of treatments for all sorts of diseases. And that’s a good thing for humanity. (Note: I think we should speed up the process but there still should be guidelines on gene editing in humans. Too much can go wrong.)

The Uncomfortable Nature of Chinese Growth

For years, China basically locked out certain US companies and let Chinese companies “copycat” foreign technology, often ignoring patents and ideas and so forth. It was a free-for-all but created Chinese “champions” in many industries. Think Baidu (tech holding company and second-largest search engine), Alibaba Group (huge diversified holding company—comparable to Amazon), Tencent (tech, internet, gaming, etc.), Xiaomi (phones and electronics).
 
Of course, now hundreds of American companies operate in China, but the Chinese government has a ring fence around certain segments. That’s one reason China has nine of the world’s top 20 tech companies. And now these companies are taking that local profit, creating state-of-the-art and often leading technology and using it to go global.
 

I showed this chart last week. Chinese venture capital is now over $50 billion and roughly at the US level.
 

Source: VentureBeat
 
 
This from my friend Peter Diamandis:
 

This astounding growth is part of China’s explosion in private equity. Currently, almost 16,000 limited partners have disclosed investments in private equity and VC funds totaling 6.1 trillion RMB.
 

But while many of these funds used to be poured into thousands of Chinese copycat companies and local tech startups, we’re seeing a dramatic outward shift in China’s biggest investments.
 

Let’s take a look at BAT-backed startups, for instance.
 

Source: CB Insights
 
 
As Baidu, Alibaba, and Tencent take on global leadership in AI, autonomous vehicles, and personalized medicine, China’s corporate VC targets are getting an even split between China and the rest of the world.
 

And this is just the VC expenditures of three companies, albeit big ones. Other Chinese corporations or state-owned enterprises (SOEs) are also pouring money into acquisitions and venture capital. They are all creating new technologies and buying whatever they need to compete, and they are all going to follow the One Belt, One Road as they expand. Count on it.
 

China is a growing competitive force and the rest of the world needs to step up its game. This is good from a strictly human perspective. Competition makes everybody improve their services and products. We believe that for US companies but it’s true on a world scale as well.
 

Do we have to like it? No. Nobody really likes having to compete aggressively in what they believe is “their” space, but that is reality now. And by the way, don’t dismiss South American or other Asian countries. I think over time we will see African companies competing at a high level as well. The world is going to look very different in 20 years.

Some Final Thoughts on China and Technology

An idea is circulating that the US should somehow rein in Xi’s and China’s drive for technological superiority. That is silly. First, it can’t be done; China won’t (and arguably can’t) stop progressing. Furthermore, if the US and other Western countries want to remain technologically superior, they need to devote resources to making that happen. As we saw last week, China now has more research, more scientists and engineers, and more capital. We are choosing to let that happen.
 
There is no reason China necessarily will surpass the West in technology, in artificial intelligence, autonomous cars, and a host of other technologies. We had an enormous advantage, but we have not kept up our drive. We call our entrepreneurs before congressional hearings to ask how they spend their capital, etc. We want to regulate one business initiative after another. We worry about monopolies. Cries to break up Amazon are part of that absurdity.
 
Consider what Chinese companies do with customer data. The average Westerner would blanch, maybe even run hysterically to their government, complaining about invasion of privacy. Most Chinese consumer purchases are on a small number of mobile systems like Tencent or Alibaba, which are using that data to improve and, admittedly, make more money. And you know what? The average Chinese person doesn’t care. That is just a foreign (literally) concept to the West and especially the US. It offends our notions of privacy.
 
Here is what you have to understand. Less than 40 years ago, most Chinese people lived at subsistence level, following an ox in a rice paddy, or its equivalent. Now they are living in megacities. They didn’t develop our Western privacy sensibilities over centuries as we did. This is all brand-new to them. They don’t understand why we would do it differently. Consider the vast cultural differences and leave your Western thinking behind when you try to understand China.
 
And with that, we will leave our bullish story behind, realizing that one could easily write several books about all the great things going on in China.

Houston, Dallas, Frankfurt, and Up in the Air

I’m in Houston tonight (Thursday) for a meeting at Rice University and dinner with the RISE committee (The Rice Initiative for the Study of Economics). This is an extraordinarily interesting group of people and it gives me a chance to get back to my old college stomping grounds. I will do some more business meetings Friday morning before I fly home in the early afternoon. I also know that I will have to make a few currently unplanned trips over the next month. The next actual trip I have scheduled is to Frankfurt in early November, and I know that Shane and I will have to get back to Puerto Rico at some point very soon. The schedule does seem to fill up.

 
I will be doing two presentations in Dallas on October 4 (my 69th birthday) at the Dallas Money Show, which is at the Hyatt Regency Dallas.
 

Normally when I have a dinner with Art Cashin the table gets crowded, and the conversations can get animated. Last Monday we went to the Friends of Fermentation gathering at Bobby Vans right next to the exchange. It wasn’t the usual group—just six of us in a private room. I found it special because two of the six had never met Art or heard his stories. And while we talked a little bit about the markets, I got us started and then the others chimed in with questions. Art held court, telling one story after another, many that I had never heard. Barry Habib had the presence of mind to pull out his phone and record it all, and Art, never camera shy, just stayed on his roll.
 

They were all great but one stood out as I was talking with Ben Hunt and Steve Blumenthal the next morning. Art’s father died just as he graduated from high school, and he had to go to work. He was applying here and there and his uncle, who was a bartender, was looking rather pensive and one of his clients asked, “What’s the matter?” He explained about Art’s situation. The bartender wrote a name on a card, handed it to Art and said, “Go see this man at the stock exchange.”
 

So Art took that card and went to the exchange (and I’m skipping a bunch of the story about how he negotiated to get on the floor where the action is rather than in the back room) and agreed to work for $75 a week.
 

Art had one other interview lined up that kept raising the amount of money that they would pay until he got $115 a week, his own office and a secretary. It was for a brand-new mutual fund. Art called the original company back and told them of the competing offer and the partner at the firm said, “Son, this is Wall Street. Your word is your bond. If you want to work here you better remember that. Are you coming to work at the price we offered?” Art hung up, thought about it and called back to say he would be there Monday to work at $75 a week. Art decided that his word was his bond.
 

Five years later, at 23 years old, Art had his own seat on the exchange, one of the youngest members. Twenty-five years later he was the sheriff of the exchange, a story I’ve told before. The next day we talked and I encouraged him to write his memoirs, as he has seen 50 years at the exchange and the era is ending. Today, it is not much more than a TV set for CNBC. It’s sad in a way, but 90% of NYSE stocks are traded off-exchange already. They could close the exchange and nothing would happen.
 

If you know or ever meet Art, bug him about writing his memoirs. I guarantee you it will be a bestseller. And one you want to get.
 

It’s time to hit the send button. You have a great week! And get together with some friends and swap a few stories. We all have them. I look forward to meeting you someday and hearing your stories.
 

Your nostalgic-but-still-looking-to-the-future analyst,


John Mauldin
Chairman, Mauldin Economics


The Fed Won’t Save Emerging Markets

Past emerging-markets troubles have ended with the Federal Reserve cutting rates, but the central bank is unlikely to end its tightening campaign now

By Justin Lahart

Stocks in Argentina and other emerging-market countries last week tumbled into bear-market territory.
Stocks in Argentina and other emerging-market countries last week tumbled into bear-market territory. Photo: Roberto Almeida Aveledo/Zuma Press



When emerging markets run into trouble, the trouble can keep getting worse until the Federal Reserve rides to the rescue. But what if the Fed never shows up?

The decision by Turkey’s central bank on Thursday to sharply raise interest rates was just the latest sign of how unsettled emerging markets have become. Facing a deep slide in the lira and a steep run higher in inflation, the central bank felt compelled to lift rates to restore investor confidence—a risky gambit that boosted the lira but could further damage the economy while inviting President Recep Tayyip Erdogan’s ire.



It isn’t just Turkey: Argentina and South Africa also are in serious trouble. An inflation problem is just one of the issues Mexico’s incoming populist president will face. Indonesia has an inflation problem and lots of foreign debt. And while it is possible to view each country’s woes as idiosyncratic, investors aren’t seeing it that way. Last week, emerging-market stocks tumbled into bear-market territory.

Part of the challenge for emerging markets comes down to what the Fed is doing, and here the problem takes on a familiar hue.




The Fed has been raising rates and, with the economy growing strongly and unemployment low, it seems likely to keep on raising them. That in itself wouldn’t be a problem for emerging-market countries if their economies were powering ahead. But in many cases growth is slowing, which, combined with higher funding costs, makes for a dangerous mix.

The emerging-market troubles in early 2016 shared a similar dynamic. The Fed had raised rates for the first time since the crisis in December 2015, and signaled an intention to keep raising them. But the convulsions in emerging markets made the Fed worried about the U.S. economy and it delayed further rate increases. That is similar to what happened in the late 1990s when the Fed raised rates, helping to set off a series of emerging-markets crises culminating with the 1998 Russian debt default. The Fed ended up cutting rates in response.

But the Fed might not be deterred this time. The central bank isn’t nearly as worried about the U.S. economy as it was in early 2016. U.S. financial markets are less vulnerable to an emerging-markets crisis today than they were in the 1990s.

There are factors that could mute the impact of the Fed’s rate increases on emerging markets. The U.S. and other developed economies are doing well, so expanded exports might provide some emerging-market countries with a boost. China is adding fiscal stimulus, which also should help. But the risk is that those positives won’t do enough to offset the Fed, and bad as things for many emerging markets are now, they only get worse.


The Bolivarian wave

A rude reception awaits many Venezuelans fleeing their country

Turmoil in Latin America is causing mass migration



PACARAIMA is a speck of a town in the Brazilian Amazon on the border with Venezuela. Recently, it has been the entry point for tens of thousands of Venezuelans fleeing hunger, violence and hyperinflation at home. Most continue by foot 220km (135 miles) on the motorway to Boa Vista, the capital of the state of Roraima, where they struggle to survive by unloading lorries, hawking crafts and selling sex. About 2,000 of the poorest have stayed in Pacaraima, pitching tents in the streets. That has strained the town’s resources and the tolerance of its 12,000 inhabitants.

On August 17th several men, apparently Venezuelans, robbed and beat a shop-owner. At an anti-immigration march the next day, hundreds of locals threw stones at migrants’ tents and set fire to their belongings. More than a thousand Venezuelans fled into the jungle or back over the border. Their makeshift homes burned to the ground. Brazil’s president, Michel Temer, sent 60 troops to restore order.

Though the Venezuelan exodus sometimes seems as invisible as tiny Pacaraima, it is the biggest movement of people in Latin America’s recent history. Since Venezuela’s economy began to slump in 2014 under Nicolás Maduro, a socialist strongman, perhaps 2.3m Venezuelans have sought refuge in neighbouring countries. The size of the exodus rivals those of war-ravaged Afghanistan and South Sudan.

Unlike many rich countries, which have been closing their doors to migrants from northern Africa and the Middle East, Latin American governments have mostly let people in. Left-wing governments in the early 2000s relaxed immigration laws, says Luisa Feline Freier of the Universidad del Pacífico in Lima, Peru. The right-of-centre governments that succeeded them in several countries maintained these policies as a rebuke to Mr Maduro’s regime.




As Venezuela’s crisis has worsened, the number of people fleeing has surged. Unlike those in earlier waves, the newer migrants tend to be poor rather than middle class. The exodus has prompted some countries to impose restrictions on their borders. Ms Freier fears that Latin American countries will soon become as wary of immigrants as many European ones.

On August 16th the government of Ecuador announced that it would turn away from its border Venezuelans not carrying passports, saying they posed a security risk. Most of these were heading towards Peru, which is receiving a record 5,000 Venezuelans a day. It imposed its own passport requirement with effect from August 25th and said it would not issue work permits to Venezuelans who arrive after October. Many do not carry passports. Because of a paper shortage and software problems, getting one can take two years. A bribe to jump the queue can cost up to $1,000.

Venezuelans are not the only migrants provoking unease. In Costa Rica, the backlash is directed at Nicaraguans, who are escaping the repression by Daniel Ortega, Nicaragua’s president, of opposition protests. From April to July 23,000 migrants sought asylum in Costa Rica, which has a tradition of generosity to refugees. On August 18th hundreds of protesters in San José, the capital, chased Nicaraguans in a park and set fire to their flag. The United Nations reprimanded the instigators.

Chile’s strong economy makes it a magnet for migrants. The number of foreigners registered there has risen almost five-fold in a decade, to 750,000 last year (about 4.5% of the population). Perhaps 300,000 more were living in Chile illegally. Last year the number of Venezuelans in Chile grew by about 100,000. Many had sold all their belongings to pay for the 12-day bus trip. More than 100,000 also came from Haiti, the Americas’ poorest country. A poll last year found that two-thirds of Chileans wanted to restrict immigration.

Sebastián Piñera, who became Chile’s president in March this year, responded by tightening its relaxed immigration policies. He abolished a visa that immigrants could apply for after entering as tourists and placed restrictions on tourist visas for Haitians. Venezuelans are being treated more generously; they can get a “democratic responsibility” visa allowing them to work.

The main holdout against the trend towards harsher treatment of migrants is Colombia, by far the largest destination for Venezuelans. Around 900,000 have moved there, a third of those this year alone. Juan Manuel Santos signed a decree that “regularised” 442,000 undocumented Venezuelans before he left office as president on August 7th. For the next two years they will be able to work, get health insurance and study—benefits that 1.5m other Venezuelans living illegally in Colombia and elsewhere have a hard time claiming. The new conservative president, Iván Duque, has not changed Mr Santos’s policy. Colombia’s “migration director” criticised the restrictions in Peru and Ecuador, and restated Colombia’s commitment to helping Venezuelans.

In part, Colombia’s generosity is a form of gratitude to Venezuela, which took in more than 700,000 Colombians during the country’s half-century war with the FARC guerrilla group. The war ended in 2016. Some 250,000 Colombians have now come back from Venezuela, adding to the strain of coping with migrants.

Activists and some politicians are trying to keep doors ajar. After Ecuador’s ombudswoman called its passport requirement “cruel” and filed a complaint with the supreme court, the government said it would not apply to children accompanied by parents who have passports. The UN High Commissioner for Refugees (UNHCR) said in March that many Venezuelans qualify as refugees under international law. It is urging governments to issue humanitarian visas and work permits. Aid from richer countries like the United States “could make the difference between Venezuelans being supported and Venezuelans being blocked at borders”, says Chiara Cardoletti-Carroll of the UNHCR. Ecuador has called a meeting of leaders from the region in September to discuss a co-ordinated response to the crisis.

But diplomacy may not ease tensions in the host countries. In Roraima, the army has taken over responsibility for providing shelter, food and health care to the Venezuelans. So far, though, the government’s policy of “interiorisation”—sending them to richer states with more jobs—has failed. Just 800 migrants have been moved.

One reason is “institutionalised xenophobia”, says a Roraima official. This is sharpened by a general election due to take place on October 7th. On August 19th Roraima’s governor renewed a plea to Brazil’s supreme court to shut the border. That did not stop hundreds of Venezuelans from coming on August 20th. They had little choice, says Jesús López Fernández de Bobadilla, a Spanish priest who serves breakfast to 1,600 migrants. “Over here it’s purgatory, but over there it’s hell.”

America Has Fallen Out of Love With the Sedan

The relationship between people and their cars is changing, and sport-utility vehicles are winning

Justin Metz



From gangster getaway cars and the Batmobile to the humble family sedan, the basic three-box configuration of a passenger car—low engine compartment, higher cabin, low trunk in the rear—has endured for decades as the standard shape of the automobile. 
Until now. Sedans, long a symbol of the American open road, are fading in the rearview mirror. In an industry-altering shift, millions of drivers have made what seems to be a complete embrace of sport-utility vehicles.


The speed of consumers’ change in taste has caught auto makers off guard, and they are racing to rework their lineups. Less than five years ago, U.S. new-vehicle sales were split equally between passenger cars and light trucks, a category that includes SUVs, pickups and vans. Today the share of cars has slipped below a third, according to Wards Intelligence, and analysts expect it to shrink to a quarter of the market in coming years.

One factor: Over the past decade, car makers have figured out how to offer the best attributes of an SUV—more cargo room, higher seating with better visibility and improved bad-weather handling—in smaller, carlike packages that use far less fuel than their predecessors. Many of the small models add just $20 or $30 more a month to a traditional car payment. That also helps auto makers, which earn higher profits on these vehicles. 


Jeep Cherokee and Grand Cherokee vehicles for sale at a dealership in Moline, Ill. Photo: Daniel Acker/Bloomberg News 



At heart, however, the travails of the car stem from the shifting relationship between people and their automobiles. Owners are less concerned with the shape of the sheet metal or what’s under the hood than they are with how many people their vehicles can transport, or how much sports gear or home-remodeling supplies they can put into the rear hatch.

“It’s all about activity today, rather than elegance or performance,” said John Wolkonowicz, an automotive historian in Boston. SUVs “are made for dogs and kids and activities and taking care of the house. It’s the tool that does the job.”

Before a recent camping trip, Eric Moe, a 31-year-old manager at a manufacturing plant near Madison, Wis., stuffed his small Honda SUV with four coolers, three tents, four chairs, 17 gallons of water and loads of camping gear. On the road, his SUV got better gas mileage than any of the three cars he had previously owned.

“I’ll probably never go back to a sedan,” said Mr. Moe, who traded in his Ford Fusion for the Honda HR-V two years ago.

Buyers are getting hooked young, too, partly because parents are putting new drivers in SUVs for safety reasons. The Insurance Institute for Highway Safety has said that “bigger, heavier vehicles are safer” because they “protect better in a crash.” In recent years, the nonprofit group has advised parents against putting their teens in small cars, long the predominant first set of wheels for young drivers.

Gordie Stewart, a Toyota dealer near Birmingham, Ala., said customers often cite the safety factor when choosing SUVs. Mr. Stewart is a believer himself.

In the fall of 2015, his teenage son texted a picture of himself standing roadside next to his crumpled Toyota 4Runner SUV, which had just been totaled in a crash. His son walked away unhurt. Mr. Stewart has since replaced the SUV with another 4Runner and now three of his son’s friends drive the same model.

“If everyone else out there is driving black SUVs like the CIA and you get in an accident in your small car, you’re gonna lose,” Mr. Stewart said.

Passenger cars aren’t dead. Americans purchased more than 6 million of them last year. Most auto makers say they are committed to keeping their staple car models in showrooms, even though they are quickly ripping up manufacturing schedules for cars that were once mainstays of their lineups.



Ford Motor Co.and Fiat Chrysler AutomobilesNV have gone further in betting that the shift is permanent, purging most or all sedans from showrooms to make room for more trucks and SUVs.

General Motors Co.executives have said they would keep selling their most popular passenger-car models, though people familiar with the plans say the company will eventually chop several models, including the Chevy Impala, a name that dates back to the 1950s. A GM spokesman declined to comment.

Auto makers are adding a vehicle type called a crossover SUV, which combines the sport-utility body style with the frame of a passenger car. Crossover SUVs also generally provide a smoother, quieter ride with better fuel efficiency than truck-based SUVs, an innovation partly forced by stricter emissions regulations set by President Obama’s administration.

For the 2017 model year, crossover SUVs averaged 26 miles per gallon versus 30 mpg for cars, according to an estimate from the Environmental Protection Agency. Fifteen years ago, the truck-based SUVs that dominated the sport-utility market returned 16 mpg, versus 23 mpg for cars.

In 2012, executives for GM’s Buick brand introduced the Encore. It was tiny, built on the same basic frame as GM’s smallest cars, and 3 feet shorter than a Buick Park Avenue sedan from the mid-1990s. Its rounded, blunt shape took some getting used to; one critic called it a “chrome potato.”

One critic called the Buick Encore, seen at the 2014 Los Angeles Auto Show, a ‘chrome potato.’ Photo: Frederic J. BROWN/AFP/Getty Images 



The Encore soon became Buick’s top seller in the U.S. There are now a dozen petite SUVs on sale in the U.S., including the Honda HR-V, the Mazda CX-3 and the Jeep Renegade. The so-called subcompact SUV category was the fastest-growing major vehicle segment in the U.S. for the first six months of 2018, according to trade publication Automotive News. Most of them start around $20,000, a price point that for years only got buyers a small car.

Americans also are buying more pickup trucks in recent years amid an improving economy, but SUVs remain the fastest-growing truck category. Pickup trucks accounted for about 16% of overall U.S. vehicle sales in 2017, versus 14% in 2010. The share of SUVs rose to 42%, from 30%.

Car TroubleSUVs have led a surge in light-truck sales,leaving passenger cars behind.Share of total U.S. car salesSource: Wards Intelligence* includes SUVs, pickup trucks & vansNote: 2018 sales through June



Auto makers expect the popularity of SUVs to more than offset declines in sedan sales. While it costs an extra $1,000 or so to produce a compact SUV instead of a car built on the same basic frame, buyers are willing to pay $3,000 to $4,000 more for the SUV, saidBob Lutz,a retired executive who ran product development for GM, Chrysler and BMW .


“The more the industry shifts” to SUVs, he said, “the more money everybody makes.”

Mercedes-Benz, BMW and Audi forged their identities on sporty sedans but now are stuffing their showrooms with SUVs. Toyota Motor Corp.and Honda Motor Co., which built their reputations on reliable family sedans with ironclad resale values, at times have seen Camrys and Accords pile up on dealer lots. 
Both are scrambling to make more crossover SUVs. In 2017, passenger-car sales for Toyota, Honda, Nissan Motor Co., Hyundai Motor Co., Kia Motors Corp.and other Asian auto makers collectively slid nearly 9%, while their truck and SUV sales rose 8%, according to researcher Autodata Corp.




When Stephen Ho went to replace a 1995 Toyota Camry sedan in December, a priority was a vehicle with a more commanding view of the road. He bought a new Toyota C-HR small SUV, which is several inches higher off the ground than his hand-me-down Camry.


“I was tired of being blinded by everyone,” said Mr. Ho, a 28-year-old engineer in Merced, Calif. “Now I’m only blinded by half of everyone.” 
 
    Ford’s Model T had a high roofline, similar to today's SUVs.








 


In the early days of the automobile, cars more closely resembled SUVs than sedans. Cars like Ford’s Model T had a large, boxy passenger compartment raised off the ground, with a high roofline. Sedans came to the fore in the 1920s and ’30s, as car makers rolled out lower-profile styles and introduced more steel in the design of door panels, pillars and roof to protect occupants, saidJohn Heitmann,a historian at the University of Dayton in Ohio.

Sedans cemented their popularity in the 1940s and ’50s, partly due to the influence of Harley Earl, GM’s head designer when the Detroit auto maker dominated the U.S. market. With creations like the Cadillac Series 61 in the 1940s and the Chevy Bel Air in the ’50s, Mr. Earl’s preference for lower, longer designs permeated the U.S. market.

“My sense of proportion tells me that oblongs are more attractive than squares, just as…a greyhound is more graceful than an English bulldog,” Mr. Earl wrote in a 1954 essay in the Saturday Evening Post. 

GM’s longtime design chief Harley Earl favored long, low silhouettes, influencing the styling of passenger cars on American roads for decades. Photo: General Motors 



In later decades, station wagons, followed by minivans, sought to challenge the sedan’s status as the family hauler. SUVs surged in popularity in the 1990s with rugged models like the Ford Explorer and Nissan Pathfinder, bouncy trucks that delivered poor gas mileage. A gas-price spike in 2008 hurt sales and SUVs were vilified as symbols of excess, leading to the demise of GM’s gas-guzzling Hummer brand in 2010.

Auto industry executives don’t expect sedans to roar back even if gas prices rise, largely because the newest breeds of sport utilities don’t require buyers to sacrifice as much on gas mileage. 
For GM and Ford, the sedan fade comes not long after both redoubled their efforts to take on Toyota and Honda in the market for midsize sedans, long the industry’s biggest category and one dominated by the Japanese companies.





When Ford rolled out a redesigned Fusion at the Detroit auto show in 2012, the family sedan generated the sort of buzz typically reserved for exotic sports cars. Some auto critics compared its styling to an Aston Martin. Sales surged for a few years before beginning a steep decline in 2016.

A Ford Expedition on an assembly line in Louisville, Ky., in 2017. Photo: Luke Sharrett/Bloomberg News 



Last summer, Ford executives under new CEOJim Hacketttook a hard look at the traditional sedan market and where buyers were going, Ford Global Markets ChiefJim Farleysaid in an interview. The data pointed toward a continued rush to SUVs by both baby boomers and younger buyers, he said.

“It became very clear to us, we’re going to have to offer more choice and reinvent our lineup,” Mr. Farley said. “We are redefining what our vehicles look like. You’re going to see a different type of silhouette.”

The pivot to SUVs crimped GM’s plans to revitalize the Chevy Malibu, introduced in the late 1970s but long a laggard in the family sedan market. When GM showed a redone Malibu at the New York Auto Show in 2015, GM product chiefMark Reusssaid it would serve as the “heart of what people think” about Chevy.

By early 2017, GM executives were busy slashing the budget of the next generation of the Malibu and the smaller Chevy Cruze sedan, people familiar with the matter said. Chevy executives pleaded with GM’s product planners to accelerate the timetable for new SUV models instead, the people said.

Mr. Reuss declined to discuss the fate of specific models but said GM is “not giving up on a bunch of sedans on a strategy basis” in the U.S., partly because they’re still needed in overseas markets.

Some 200 miles from GM’s Detroit headquarters, about 4,000 employees had been working around the clock for several years assembling the Cruze in Lordstown, Ohio. The factory had become a symbol of GM’s comeback after its 2009 federal bailout, when Detroit auto makers were out to prove they could make quality small cars. In the past 18 months, GM has laid off more than 2,000 workers in Lordstown.

Glenn Johnson,a former United Auto Workers official who has worked at Lordstown nearly 40 years, has seen mass layoffs only once before, around the time of GM’s 2009 bankruptcy. Then, the cause was the financial downturn and GM’s own mismanagement.

“There is nobody to blame in this situation,” Mr. Johnson said of the latest layoffs. “The problem is with sedans across the industry, small, medium and large. This consumer shift has happened so fast.” 


     Chevy Cruze sedans for sale in Englewood, Colo. Photo: David Zalubowski/Associated Press