The strength that prevailed in the used-car market for the first part of the year subsided in May, with values increasing a modest 0.9 percent from the previous month, according to Juan Flores, Kelley Blue Book's director of vehicle valuation.

The modest uptick in May relative to the 1.7 percent increase reported in April is evidence that values are continuing to stabilize, Flores wrote KBB's Blue Book Market Report for June 2010.

"It's important to note that strength between January and May each year is generally inconsistent with seasonal factors; however, this year a limited supply of good condition vehicles and increased demand from budget conscious consumers is keeping the market lukewarm," he wrote. "While this type of strength is not typical for this time of year, nothing in the automotive industry has gone as usual for some time. The unstable economy played a major role in valuations and continues to do so as we move into recovery."

He says leading up to Memorial Day weekend, values were relatively steady for the month. Increased incentives have helped most major automakers earn double-digit sales gains with the exception of Toyota.

Bargain hunters are still showing interest, but not as many from previous months. For these shoppers, the state of the economy plays a major role in their purchase decisions, driving more cost-effective buys. Less expensive vehicles offering the best value proposition are driving market interest. Consumer demand for used vehicles remains strong compared to last year, as seen in a 3.5 percent year-over-year increase in values, according to Flores.

New Subcompact, Compact Entrants Could Satisfy Demand and Stabilize Prices

Car values jumped 1.1 percent for the month, with most segments performing in line with the overall average, Flores wrote.

Adversely, hybrids are softer than all other car segments, down 0.9 percent month-over-month, as fuel prices are not yet high enough to justify the upfront premium hybrid vehicles command. While this segment is underperforming the market, relatively inexpensive compact and subcompact cars are each up 1.2 percent.

High unemployment and overall uneasiness in the current economy have kept these values from underperforming the market. If the economy strengthens and consumer confidence improves, we would expect demand for these vehicles to taper off and possibly drop, especially if gas prices remain affordable. If gas prices rise (which they typically do in summer), demand will increase for these vehicles first, not hybrids, due to their low cost of entry and excellent fuel economy.

New entrants into these segments, such as the Ford Fiesta, Mazda2, Nissan Cube and Kia Soul, could help keep the supply of these vehicles high enough to satisfy demand and keep prices steady in the future, even if gas prices increase. In today's marketplace, since car shoppers are looking to more practical, cost-effective options, we would expect to see demand for inexpensive vehicles remain strong, Flores wrote.

Affordable Gas Prices Keep Truck and SUV Demand High

Full-size SUVs and pickup trucks were among the best performers year-over-year. While gas prices are slightly down over the past month, they have still increased about $0.40 per gallon on average compared to this time last year. Since the price of gas remains affordable, it is not pulling demand from the truck and SUV segments, according to Flores.