Subprime Crisis Building In Auto Sector | Real Vision™

Subprime Crisis Building In Auto Sector | Real Vision™


Hi, I’m Grant Williams.
About a month ago, in Things That Make You
Go
Hmmm, I wrote a report called “Car Trouble”
about the US auto industry.
And I wanted to
flesh that story out for you today because
it’s something that is happening right now,
and it’s
a lot bigger story than people think.
To do this, I’m going to enlist the help of
a couple of people– Daniel Ruiz, a fantastic
auto
analyst from a company called Blinders Off,
who presents an incredible amount of information
and digs really deep into the sector; and
my good friend Michael Lewitt, who’s a person
I
spend a lot of time talking to about this
particular industry because he follows it
very, very
closely.
We’re going to give you a sense of what’s
going on, give you a sense of where the
problems lie, how big they are, and at the
end hopefully a few ideas how you might profit
from it.
The US auto industry is a big deal.
It represents 3% of US GDP and employs roughly
5% of
the total workforce in the United States.
In the last six years, $775 billion of exports
of cars
and auto parts have left the United States,
making it by far the biggest export sector.
The
number two is aerospace, which is a distant
$125 billion dollars behind it.
On a global basis,
research and development in the auto industry
is the second biggest sector of 40 sectors
measured worldwide– it really is a big deal,
not just in the United States but beyond.
Car sales have been rising now for some six
straight years, ever since Cash for Clunkers
was
instituted in 2010, and that’s been a huge
benefit for the industry as a whole.
It gave the auto
industry a $3 billion jump start when it needed
it most, back in the depths of the post Great
Recession period.
But what it’s actually done is pulled forward
a hell of a lot of demand.
And we’re at the point now where we’re seeing
the back side of that demand, and the missing
purchases that have all been made in the last
six years are starting to be felt.
Throw in the fact
that in the era of cheap money you’ve had
this surge of people looking to borrow money
to
buy cars at really low interest rates, and
you see auto loans ballooned to over a trillion
dollars
now– that’s way higher than they were before
the credit crisis.
In amongst those trillion dollars, the fastest
growing sector– I hate to say it– is once
again
subprime.
And while the subprime sector is not as big
a problem on a wider basis as
mortgages were back in 2007, 2008, the 2015
series of subprime auto originations are
forecast to see the biggest delinquencies
of any tranche before that, with default rates
projected
to hit 15%– that’s a major problem.
To help me pick this apart and give you a
sense of where the problems lie, how big they
potentially are, and what you can do about
them, I’ve enlisted the help of two really
smart
guys.
First of all Daniel Ruiz of Blinders Off,
who’s a hardcore auto industry analyst who
has
as good a grasp on this sector as anyone I’ve
seen, and he’s got some fascinating information
and charts for us that gives us his perspective
of where he thinks the problems lie.
And my old friend Michael Lewitt, who runs
The Credit Strategist.
Michael’s a brilliant thinker,
a great communicator.
He’s one of the guys I rely on when I’m thinking
through the auto sector,
trying to get a handle on where the problems
lie, Michael’s someone I go to frequently.
So those two guys are going to help me and,
hopefully, help you make sense of this whole
thing.
Kicking things off is Daniel Ruiz.
And Daniel starts by looking at a sector of
market that
perhaps is not intuitive to most of us.
He goes straight for the used car sector.
And there’s a
really good set of reasons for that, and Daniel’s
going to lay them out for you right now.
I’m going to start with the used car values,
which really, in my opinion, is
the foundation of the entire automotive industry.
And one chart that’s gotten a lot of
popularity lately is the NADA Used Vehicle
Price Index.
It’s been falling, significantly, and
because of that decline, we’ve had a lot of
attention on used car values.
It’s probably best that I start at the beginning,
which is what happened during the last
recession?
Because used car values fell significantly
during the last recession, but something
else happened.
And I want to talk more about the recovery
and why we’ve had the results
that we’ve had in the automotive industry,
with last year being a record-setting year–
and
so was the previous year.
Used car values have rebounded really, really
sharply since the recession.
That was largely
in part because new car sales volume was very,
very low during the recession.
Used car is
nothing more than a new car once it rolls
over the curb.
So we had a really, really short supply of
pre-owned cars coming out of the recession.
The
government stimulated the automotive industry
with what we all know as Cash for Clunkers-
– great program, stimulated sales, we had
a huge spike in volume of new cars sold.
But
used car supply was actually starved, because
those sales did not produce trades.
So we
actually took trade ins out of the equation
with Cash for Clunkers and further starved
used
car supply.
Since then, we’ve enjoyed what I would consider
are extremely short trade cycles.
So I’m
going to start with the why– why are we seeing
the things that we’re seeing?
Why are we
reading about the negative effects that falling
used car values are having?
We’ve all become very familiar with the NADA
Used Car Value Index.
I’m going to explain
why it relates to higher delinquency rates
and subprime, why auto loan originations are
falling, and why there has been a divergence
between auto incentives and sales volume.
Typically the more manufacturers support cars
with incentives, the more cars they sell,
but
that’s not been the case.
We’ve now missed new car comparisons four
months in a row
despite a higher incentive spend.
So again, why is this happening?
It all relates to used car values.
The simple answer is as used car values fall,
it has a lot of
impact on all the things that we’ve just talked
about.
And there’s a lot of negative equity
out there.
So that’s at the core of things, and I truly
believe that used car values are the
foundation for the entire automotive industry.
I’m going to start with talking about trade
cycles, because I think that’s something that’s
at
the core of this.
We’ve enjoyed really, really great sales numbers
for a long time.
And the
reason why is because we’ve had extremely
short trade cycles.
When used car values are really outperforming,
as they did shortly after the recession, it
allows dealerships to trade folks out of cars
a lot quicker.
An optimal trade cycle happens
when the principal balance owed on a car meets
the current market value of that vehicle,
at the point where there is no inequity or
when you’re in an equitable position.
That allows
an easy transition from the car that you currently
own to that new car that you may consider
purchasing.
So for years we had a very, very strong and
very short trade cycle.
Customers would come
into a car dealership for an oil change, and
it was a very, very easy thing for a salesperson
to walk up and say, hey, would you like a
new one?
Would you like a different color?
Would you like something with the newest upgrades?
And by the way, your payment’s not
going to go up, because you have equity in
your car and we really need it.
So it was a very, very easy transaction for
quite a long time.
But things have changed.
The
effect of falling used car values takes that
out of the equation.
Trade cycles are extremely important.
The vast majority of new car sales involve
a trade-in.
If we’re bringing our cars back quicker, that
has a direct effect on sales velocity of new
cars.
The shorter the trade cycle, the higher the
sales velocity of new cars.
The longer the
trade cycle, the slower the velocity of new
cars.
What caused used car values to fall?
What was the correction?
What happens?
It’s important to understand the effect that
leases have on used car values.
As a used car
manager working at a car dealership, you have
to consider quite a few things when you’re
trading in a vehicle.
How am I going to market the vehicle?
How am I going to sell the car?
Where am I going to price the vehicle?
Who’s my competition in my local market?
Something that needs to be of big consideration
is that used cars always have to have a
value proposition to a new car.
And what most consumers measure as value is
their monthly
payment.
There has to be a good reason for buying something
that may not be the perfect
color, that might have some miles and some
wear and tear, that that’s had some usage.
And the reason why folks buy pre-owned cars
is because they present a better value in
terms of monthly payments than new cars.
Well, when leasing gets to a certain level–
and really to extremes, which we’ve seen where
$50,000 cars are leasing in the mid $400 range.
That puts a really, really significant
downward pressure on used car values.
Used car managers really have to figure, how
am I going to market this car to a potential
customer?
How am I going to justify the payment compared
to a potential lease on a new
car?
It leaves you in a situation where if you
have a $45,000 car and somebody wants to trade
it one year later, is a $10,000 depreciation
enough?
Is a $15,000 depreciation enough?
$400 is a $20,000 loan.
And when you have $50,000 cars that are leasing
for $400 or
$500 per month, there’s no market for that
one-year-old car.
There’s no market for the twoyear-
old car.
And it puts significant pressure on all vehicles
that are pre-owned.
I think when most of us think about the auto
sector, we instinctively think
about new cars.
You drive down the street and see dealer lot
after dealer lot filled to the brim
with shiny new cars.
But as Daniel points out, it’s the used car
market that really has a massive
effect on the overall industry, and the undercurrents
that Daniel lays out are really quite
surprising.
I was taken aback with just how serious they
are when you look into it, and
illustrates perfectly the knock-on effect,
which is something we try and talk about at
Real Vision
all the time.
To get another perspective on the auto industry,
I wanted to call my friend Michael Lewitt.
Michael is someone that I rely on when I’m
thinking about this and trying to get my head
around it, because he looks at this stuff
all the time.
He’s one of the best credit writers out
there.
He writes The Credit Strategist.
So I sat down with Michael for a chat to get
his
perspective on the auto industry.
OK, well, when we were putting this story
together about the auto sector, one of the
first people
I thought of, Michael, was you, because over
the years you have been one of the people
that
I’ve relied on to keep me current on the state
of play in the auto sector.
So I wanted to bring
you in and get your thoughts on where we are
on the time line for this whole thing playing
out.
Right now you have retail suffering from a
real structural shift that’s clearly
having an impact not only on industry but
on the economy, unemployment– everything
else.
And I think autos are the next industry.
Just like retail, a lot of it is technology-driven
through
Amazon.
I think autos are the next.
I think autos have one advantage– they were
not sunk by private equity firms coming in
and
loading them down with debt.
They don’t have that problem, although they
still have significant
health care and legacy obligations left over
from the bankruptcies and so on.
Michael makes a great point tying in the auto
industry to the retail sector and the US consumer.
It’s a very important linkage to make.
Now, the US consumer is 70% of the economy.
So it’s vital to understand what’s happening
to the US consumer.
Michael takes a typical credit guys look at
the auto companies.
And his point that they’re not
weighed down by the debt strapped on to them
by private equity is important because with
that they’ve been even more trouble.
But it’s clear that as the US consumer comes
under
pressure, the auto industry is going to be
one of the sectors that suffers the most.
The overall industry, I think, is probably
going to see– at least in the US– lower
volumes.
I
mean, China and other places is a whole other
issue.
But there’s clearly secular change
coming, and it’s going to have major impact
on the US economy.
While we’re talking about
what’s already happened to the manufacturing
economy in the US, and there’s been some
positive signs because of the recovery of
GM and Ford and so on, I think we’re now going
to
see another potential leg down.
If the volumes, which are now like– what–
$17, $18 million a year, fueled by a lot of
subprime
auto loans and so on are going to fade.
I mean, right now we’re at peak inventories.
We’re
at peak subprime loans.
We’re at levels that are not sustainable.
So you’re also going have
to deal with that.
But it’s unlikely that these levels are going
to continue in a 2% growth
economy, so you have—
Well, that’s something I wanted to dig into
with you, because if you look at this, these
companies they have pulled forward a lot of
demand, going all the way back to Cash for
Clunkers.
They’ve managed to have rising sales for seven
straight years now after that.
But the last four months, we’ve seen that
turn.
We’ve started to see auto sales decline, and
most worryingly– perhaps– truck sales, which
as the price of gas came down.
So if you add that, you add the massive amount
of inventories on dealer forecourts, which
is
at levels– I don’t think the data goes back
to the ’80s.
We have never even had close to this.
And the subprime trade– you’re are three
to five year time line.
I’m interested to see how you
see that playing out, because when you look
at how important the US auto industry is to
the
US GDP– it’s 3% GDP and employs 5% of the
workforce, I think– it’s something that they
can’t
allow to be in trouble, you know what I mean?
So–
Well, Three to five year– I didn’t mean to
interrupt.
Three to five years is– what I’m talking
about is the beginning of real secular structural
change.
I’m not talking about the cyclical change,
the turn in the market.
Inventories are at record
highs.
There are record numbers of cars coming off
leases.
Used car prices are dropping
sharply.
The average age– I still think the average
age of the fleet is over 11 years, if I’m
not mistaken.
People keep their cars longer.
I keep hearing about the strength of the consumer,
the strength of the consumer.
I think that’s
one of the great fairy tales.
The consumer is still dealing with epically
high and rising health
care costs.
The health care system is failing, and until
they– and even if they come up with a
solution to Obamacare, it’s going to take
at least a three-year sort of turnover to
fix it.
So people don’t have– they’re borrowing money
to buy these cars.
And so you have over $1
trillion of subprime loans, all this other
stuff.
And the Fed is raising rates– they’re still
very low,
but you have a situation where it may not
be three to five years until you start seeing
the
numbers of cars manufactured and so on get
reduced.
And that would be coincident with other things
we’re seeing that suggest that a recession
is a
real possibility.
You know, the yield curve is inverting.
It gets flatter every day.
The Fed’s going
to raise rates later today unless a meteor
hits the world.
And so the shorter end’s going to
likely to move up further.
I don’t see that.
The long end this morning, I thought I was
misreading
the tenure of the 213, which really shocked
me, which was at 220 just last Friday– Monday.
So the curve is flattening.
So when you have all these indicia that show
you that the economy is not growing and that
we’re likely heading towards slower conditions,
and autos are right in the heart of that.
So I
think that when you have what I call cyclical
conditions combining with secular conditions
or
structural conditions that are all negative,
that’s not good.
And I think– in fairness, I think the auto
industry needs to be commended, because it
is
definitely trying to get ahead of the curve
on the technology side and everything.
But on the
sales side, it’s doing the same old stuff,
which is incentives and all this stuff.
And then the
lenders are just making money available, but
money’s getting cheaper.
I mean, remember– auto loans are on the shorter
end of the curve, and that’s the side that’s
going up.
Now, it’s still very low, but it’ll end up
being a problem and you’ll see defaults rise
and everything.
Now, I don’t view auto loans as a threat to
the economy the way housing was.
It’s just not–
you can walk away from your car.
You can’t walk away from your house as easily.
But it’s going to be a problem.
And I think that time frame is shorter than
three years, because
you’re just seeing it coincide with other
signs that the economy is slowing down.
We’ll come back to Michael later.
But what I want to do now is switch the focus,
go back to
Daniel, and get his thoughts on the leasing
and securitization of the auto industry, which
plays
a big part in trying to understand, again,
these cross-currents that are forced upon
the industry
by securitization of finance.
So let’s get Daniel back in and hear his thoughts
on the lease
market.
Another thing to consider is the level of
negative equity that we have in leases today–
active
leases that have not matured yet.
Credit risk on a lease is very different than
credit risk on
a regular automobile loan.
Losses happen on regular automobile loans
when they default.
How much was owed?
What was the balance on the vehicle, and how
much should we
recover when we sent the vehicle to auction?
But they require that default in order to
realize
those losses.
With leasing, you introduced residual risk.
A lease does not have to default in order
for a
captive bank to lose money on the transaction–
it just has to mature.
And what’s concerning
is the level to which these loans have been
securitized.
An auto lease, asset-backed security is a
thing, and it adds a layer of complexity that
really
needs to be looked into.
The level to which loans have been securitized
is back to the peaks
before the recession.
And it’s very understandable, because for
years used car values
outperformed residual values.
So as these leases matured, the clients–
it was never a risk
to the captive bank or the bondholder.
When leases mature and they have equity, it’s
a huge boost to new car sales, because the
equity can be used towards a down payment.
The customer rarely ever returns the car.
They’ll choose to buy it before returning
it, because they want that built-in equity,
and they
look at it as a value.
It’s only when used car values start underperforming
residual values that we need to become
concerned.
And this is what concerns me about these securitized
loans and leases– it’s
needless to say that the amount of residual
losses that are currently on the books unrealized
is significant.
There are over 10 million leases outstanding,
and for every $1,000 that these
captive banks miss that residual calculation
by, every $1,000 represents $10 billion.
So now I’m going to focus on GM, because they
have the largest day supply out there right
now as far as manufacturers, and their response
has been the most extreme, in my opinion.
I was concerned that if we miss sales figures
in April, manufacturers were going to respond
by raising incentives pretty aggressively,
because we’re so close to the time of the
year
where we have to get rid of leftover product.
Higher incentives is exactly what we got.
They responded to their day supply problem
very
aggressively with a very, very low lease payment
on a Silverado and a 20% reduction from
MSRP on a Chevrolet Malibu.
One has to consider what the direct effect
of that level of discounting is going to be
on
used car values.
What’s a one-year-old Silverado worth today?
A two-year-old Silverado?
If you’re taking 20% off on a new Malibu,
how much do you have to discount that one
or
two-year-old Malibu so that, if you try to
retail it, there’s some sort of a value proposition
to
the new car?
As buyers of cars, we look out for incentives,
and we like them to be as big as they possibly
can be in order to get a discount on their
shiny, new car.
But when Daniel talks about the
incentives and what the dealers are having
to do to try to shift some of this massive
inventory
overhang, you start to think of it in a different
way.
And this notion of incentives and the
degree to with which they’re becoming increasingly
more important to the manufacturers, is
something that Michael and I spoke about on
our call.
The incentives now are at all-time highs–
I think $4,000.
I heard an advert on the radio this
past week advertising $14,000 off a Dodge
Ram truck.
And I was trying to figure out what a
Dodge Ram truck must cost.
And that’s got to be a 30% discount on that
thing, or 20%.
It’s a good–yeah, the incentives are crazy,
because the lots are full.
Driving around South
Florida the lots are full, and there are only
so many people for so many cars.
There are a lot
of immigrants down here, there are a lot of
immigrants in the US, but now there are fewer
immigrants in the US.
So if the population stops growing from that
segment, they’re not going
to be getting cars.
So I think that the industry is running up
against it, and they’re trying to deal with
it in the
traditional way on the sales side, on the
nontraditional way with the technology and
everything, but it’s not going to be a smooth
transition.
That commercial I heard on the radio for the
big discount for the Dodge truck– when I
heard
it, I was astounded at the sheer size of the
discount.
But Daniel makes a great point– that this
is something that, once it starts, this is
a set of dominoes that just keeps toppling.
And as GM
cuts prices, so Ford will have to cut prices,
so Chevy cut prices, and the dominoes just
keep
cascading.
And this is really just starting to get going
now.
So it’s a great time to be a buyer of a car
because the incentives you’re going to get
offered, but it might not be such a great
time to be
a buyer of the stocks of the automakers.
Another thing to consider is that when one
manufacturer has a day supply problem– like
GM, for example– the other manufacturers
don’t rest while they get their house in order.
The auto industry is very, very competitive.
Anyone that competes directly with GM is going
to adjust in order to not lose market share.
So the heavy discounting becomes contagious
and the unintended collateral damage is used
car values.
This is all happening at a very bad time,
and it’s why I consider this to be the perfect
storm
for used car value declines.
There’s such heavy emphasis on new car incentives
to deal
with this day supply problem and it’s putting
such enormous pressure on used cars, and the
timing couldn’t be worse.
Something that I’m keeping an eye on that
is extremely concerning to me is the amount
of
2016 leftovers that we have in May of 2017.
Pick your favorite search engine for vehicles.
Plug in 2016 new cars at any distance, and
you will be amazed at how many vehicles we
have available.
And we’re halfway into 2017.
This is extremely alarming, and the reason
why is because 2016’s represent the most
heavily discounted portion of new car inventory,
and these cars aren’t selling.
It’s a very
strong indication that demand has fallen for
new vehicles.
Dealers put a lot of emphasis on making sure
that new vehicles never roll into the next
model year.
And the reason why is because, at a certain
point in time, a manufacturer will
stop supporting leftover models.
They’ll simply make a lump sum payment to
the dealership,
and at that point, it becomes their problem.
This makes the 2016’s that are leftover today
extremely difficult to sell because they’re
competing against the heavy incentives on
the 2017’s.
In a lot of cases, it’s less expensive,
from a payment standpoint, to purchase a new
2017 versus a heavily discounted 2016.
I look at the 2016 leftovers like plaque that
builds in an artery– they’re just slowing
things
down.
And you have to wonder how many 2017’s are
going to be leftover.
Once enough
these cars pile up, the patient has a heart
attack.
You have to stop production.
So perhaps you’ve seen the chart for Morgan
Stanley Research projecting as much as a
50% decline in used car values in the next
two years.
When I first saw the chart, I just
simply could not believe that something like
that would be possible, knowing full well
that
we have a perfect storm that would make that
scenario very, very likely.
We have a day
supply problem from new car manufacturers
that’s putting a massive amount of pressure
on
used car values, ahead of a huge, huge supply
problem from lease maturities.
And the
leases are going to go to auction, because
they have negative equity.
We also have the potential for more supply
from subprime loan defaults.
There’s a recent
report that Santander, one of the largest
subprime lenders out there, only verified
income
on 8% of their customers.
This is extremely concerning to me.
It’s because the subprime lending industry
is also extremely competitive.
When somebody
walks into a dealership, they want to purchase
a car and they have bad credit, their
application gets sent to multiple banks.
The responses are then reviewed and the most
appealing terms are selected.
The most appealing terms are not always interest
rate.
Oftentimes the approval that has the
least amount of stipulations, the one that
has the least amount of checks, is the one
that’s
chosen to quicken the sale.
If a customer can’t provide proof of income,
if they can’t provide
proof of residence, it could delay the sale.
There’s also a risk that the customer might
go to
another dealership and purchase from them.
The lenders know this, and no income verification
is a competitive advantage.
Does any of
that sound familiar?
Taking shortcuts, not verifying things, all
in the pursuit of more loan
originations?
We’ve been here before.
Apparently we haven’t learned anything.
Daniel asked exactly the right question–
haven’t we learned anything?
But unfortunately these
days that question always seems to just be
rhetorical, because of course we haven’t learned
anything.
We’re right back where we are, and all the
conditions are in place for another storm
along the same lines as we saw in 2008.
And although, as I said earlier in the program,
the subprime auto sector is a much smaller
part of the US economy, the ripples that this
can have through a sector that employs 5%
of the
entire US workforce are seriously, seriously
dangerous.
So having established all this, having understood
where the problems lie, and hopefully giving
you some sort of sense of the severity of
them, what happens next?
Where do we go from
here?
Well, Daniel has a roadmap of his own, which
I want to share with you.
What happens next will be a series of events
that will have a domino effect.
In my opinion,
what we’ll see next is– we’ve already seen
elongated trade cycles in passenger cars.
We
will now see elongated trade cycles in light
pickup trucks and SUVs.
The next thing that we’re going to experiences
is an affordability issue, when residuals–
which adjust quarterly– continue to fall
until they reach equilibrium with used car
values.
New car sales volume will continue to decline.
The day supply at dealers will continue to
rise.
At some point, dealers will refuse inventory
from manufacturers.
When that happens,
manufacturing will slow or stop while we work
through the supply issues.
This has a potential to last for a very long
time, because we not only have a new car supply
problem, we also have an inbound used car
supply problem.
And that used car supply
problem is unrelenting until the end of 2019.
So that’s how Daniel sees things playing out
in the not too distant future.
But I wanted to get
another perspective and I wanted to see what
Michael thought.
And Michael brought up
something very, very interesting, and that’s
the effect that technology is going to have
on the
car industry.
And unfortunately, like all technological
change, it’s massively deflationary.
And for an
industry like the auto industry, that relies
on selling more and more cars every year,
that’s
another headwind it’s going to have to deal
with.
Their balance sheets are OK.
The issue is they are wrestling with truly
historic technological
shifts.
A double whammy of electric cars– or what
I call non-fossil fueled cars– and this
driverless car thing.
My mom’s a perfect example.
My mom is 86.
God bless her.
She can still drive, but she doesn’t
like to.
So we just gave back her car last week.
And she doesn’t need it anymore, between
Uber and if she wanted to get a car, we could
get her a car that she doesn’t have to drive.
I
mean, that’s historic.
Otherwise I got to go schlep and take her
everywhere, which I am happy
to do.
But that’s just a whole segment of the population.
And I live down here in Florida, so we see
all these elderly people driving, which is
not a good thing.
And it just ripples through.
It’s
number of cars manufactured.
It affects the insurance.
It affects everything.
But I still think it’s three to five years
away, but it’s three to five years of, I think,
a continual
transition away from the traditional auto
manufacturers.
And unless they are able to shift,
which I think they’re doing–
But what does all this mean for us as investors?
Michael and Daniel have painted a pretty
troubling picture of the US auto industry,
and I wanted to ask Michael how he thought
this
would play out and where we as investors should
be looking to try and, A, represent the view
that’s been put forward in this video and,
B, the companies and the stocks through which
we
want to make some money out of it.
When you think about this and you lay this
progression out in your head, where do you
think
people should be looking for the first sign?
Should they be looking at the credit company?
Should they be looking at the Big Three?
Should they be looking at like the Ally Financials
or
the Santander– the subprime auto loans?
Where do you think the signs are going to
come
and where do you think people should be focusing
their attention?
Well, the first thing is I think the Big Three
are sort of dead money.
I think that GM is the
cheapest stock in the S&P 500.
And I think its going to stay near the bottom.
I just think that these are deep cyclicals,
and they’re just not going to go anywhere,
in my
opinion.
I mean it is a cheap stock by every measure,
but it’s going to stay cheap because of
what we’ve discussed.
I think that the problems are going to come.
I think that you’re going to see rising defaults
with
the lenders, and they’re going to be problematic.
And they’re going to have other problems
with consumer loans and everything else, so
I think they’re depending on– you have to
sort of
go granularly– but I think they’re an area
that’s going to be a problem.
What’s interesting is everybody looks at the
financials and go, oh, well, rates are going
up,
that’s good for the financials.
But it doesn’t always work out that way, because
there are other
things going on.
And then I think the rental car business is
going to continue to suffer.
And then you have the
auto parts industry and anything ancillary,
because if in fact– the first wave is going
to be just
cyclical.
The second wave is going to be structural.
And when the structural wave comes, it’s
going to look more like what’s happening in
retail, where we actually have much lower
demand for your product.
And then you’re going to see the auto parts
makers and so on– the Auto Zones, Pep Boys,
and all that stuff.
And it’s funny– those seem to be real favorites
of a lot of the hedge funds,
and I wouldn’t be surprised to see that money
sort of start to exit, because the macro picture
for them is not there yet, but it’s going
to start to become problematic.
And that’s a business– one of the reasons
the FANG stocks are so popular is because
future
growth is considered very high.
I don’t see how you make that case for anything
auto related,
other than possibly Tesla– but that story’s
so far ahead of itself it’s just ridiculous.
I think that you’re looking at a slowing growth
sector that you need to sort of start exiting,
because it’s moving away from the old model
to something that we don’t know what it’s
going
to look like, but it’s not going to look the
same.
OK, so we’ve covered a lot of ground today,
and I want to try and wrap that up for you
and
give you an overall sense and recap some of
the charts we’ve seen.
And the first component
of this that I really want to pay attention
to is the physical side of the cars themselves.
You look at auto sales which, as you can see
here, have rallied strongly since the trough
in
2009, we’ve had six straight years of rising
sales.
But that trend has clearly changed.
And
you can see it’s not just a domestic problem.
Domestic cars, imported cars, are all seeing
declines in sales on a year-on-year basis,
and that is a big problem for companies like
GM
and Ford, for example.
And Michael Lewitt calls GM and Ford dead
money, which means he doesn’t expect the stocks
to really go anywhere.
And that’s never a good thing if you’re looking
to invest in a company,
but if you’re looking to short something or
you see a story with problems, then having
stocks
that really aren’t going to go anywhere is
actually a great head start.
If you add into the mix
the finance arms that GM and Ford have, which
could be a source of some trouble for them,
as we’ve seen with the loan numbers, that
could give you a good tailwind if you want
to have
a short in either of those companies.
So that’s the physical side of the equation.
The other component of this is the finance
side, and this is where, perhaps, the problems
are
going to start manifested themselves very
soon.
Auto loans in total now are over a trillion
dollars– and of that, subprime loans have
increased rapidly.
And we started to see a–
delinquency rates rise very, very quickly.
That shows the stress that these guys are
under
because, as Michael pointed out, most of these
loans are at the short end of the curve, and
that’s where the Fed tightening is going to
have its biggest effect.
So you can expect to see that contagion spread
through the 2015 series of subprime loans
are forecast to hit possibly 15% default rates,
which is a significant increase.
And this is
going to put some material pressure on companies
like Capital One, as you can see here.
And another company that you might look at
is Ally Financial.
And the third one may be
Credit Acceptance Corporation.
But to me the poster child for all this is
Santander.
Daniel talked about them only doing due
diligence on about 8% of their subprime loans.
And when you understand that those
subprime loans form 80% of their loan book,
you realize what a precarious position they’re
in and how easily that stress could come to
bear on them and cause severe problems for
the
stock.
So there you have it.
The US auto sector is a big part of the economy–
3% of the economy,
employs 5% of the workforce– and it’s a major
driver of US economic performance.
And to
me, to Daniel, to Michael, and to many other
smart thinkers around the world who are
looking at this stuff, the problems are starting
to build in that sector and it looks like
a place
that’s going to come under significant pressure.
Hopefully we’ve give you a sense of the currents
and the dynamics that are going to create
that pressure and we’ve given you a few ideas
as to how you might profit from it.


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