By Michael Lombardi, MBA for Profit Confidential
Automakers in the U.S. economy are getting a significant amount of attention these days because they are selling more cars. In August, total light vehicle sales by the automakers in the U.S. economy increased 17% from a year ago. They sold more than 1.5 million cars in August compared to 1.28 million cars last August. (Source: Motor Intelligence, last accessed September 10, 2013.)
On the surface, sales reported by the automakers are exuberant. They show consumers are spending. And if this continues, maybe we will see some economic growth in the U.S. economy.
Sadly, this is a one-sided conclusion. When I look into the details, it turns out Americans are indeed buying cars from automakers—but on borrowed money.
Here’s what you really need to know other than just focusing on the sales by automakers:
Since the Federal Reserve introduced its easy monetary policies, there has been a significant increase in auto loans to the subprime borrowers—those with a low credit score of less than 620—compared to the prime borrowers—those with a credit score of 760 and above. (Reminds me of the housing crisis we saw in the U.S. economy not too long ago.)
In the second quarter of 2009, there was $10.8 billion of outstanding auto loans to the subprime borrowers in the U.S. economy. Fast-forwarding to the second quarter of 2013, this number stood at $21.2 billion—an increase of more than 96% in just a matter of a few years. In the same period, the amount of auto loans to prime borrowers only increased 38%! (Source: Federal Reserve Bank of New York web site, last accessed September 10, 2013.)
Unfortunately, the problem doesn’t end there. Auto loans continue to increase in the U.S. economy. In the second quarter of this year, auto loans as a whole increased to $92.0 billion—the highest level since the third quarter of 2007. (Source: “Household Debt and Credit Developments in 2013 Q2,” Federal Reserve Bank of New York, August 2013.)
Now this will really alarm you…
Auto loans delinquent for 90 days or more in the U.S. economy now sit at 3.6% of all loans. With interest rates already rising, I can only see this number growing.
Are auto loans going to be the next big bubble to burst in the U.S. economy?
I remain cynical of the optimism we are seeing regarding the automakers. If all of the pieces of the puzzle fall into place as I expect, this won’t end well. Those automakers enjoying higher stock prices now may quickly see their fortunes turn.
Michael’s Personal Notes:
I keep a keen eye on the second-biggest economy in the world simply because China is experiencing an economic slowdown that can and will affect the U.S. economy, and hurt the profitability of our U.S. multinational companies.
Since the beginning of this year, the economic slowdown in the Chinese economy has been gaining strength. In the second quarter, we saw the economic growth rate in the Chinese economy fall: the second-biggest hub in the global economy grew at 7.5% in the second quarter, compared to 7.7% growth in the first quarter.
When it comes to economic analysis, one thing I focus on is the long-term trend in statistics. When I do just that, the Chinese economy is going the wrong way—and I believe there’s trouble ahead for China.
We’ve seen this in the past with our own economy; when there’s too much credit and rapid expansion, an economic slowdown usually follows. Just look at what happened during the housing boom in the U.S. economy—credit grew, and we saw ruthless lending practices to attract subprime borrowers.
Right now, we are witnessing a significant amount of credit expansion in the Chinese economy. The total credit to the private sector has increased more than 166% between the first quarter of 2008 and the last quarter of 2012. (Source: International Bank of Settlement web site, last accessed September 10, 2013.) In the chart below you can clearly see how much credit has risen in the Chinese economy. This should be taken as a warning sign of just how deep the economic slowdown in the country must be.
My concern? What happens to the profitability of U.S.-based companies operating in the Chinese economy?
Let’s use General Motors Company (NYSE/GM) as one example. In 2012, the company sold 2.8 million vehicles in the Chinese economy. This brought in $33.36 billion for the company, a staggering 22% of its total sales. (Source: “2012 Annual Report,” General Motors Company web site, last accessed September 10, 2013.)
If we see the economic slowdown in the Chinese economy continue on its path, would companies like General Motors (GM) be able to keep the same levels of sales? And what would happen to GM’s stock price?
GM is just one example of a company embedded in the Chinese economy; there are many more, including Wal-Mart Stores, Inc. (NYSE/WMT), NIKE, Inc. (NYSE/NKE), Caterpillar Inc. (NYSE/CAT), and YUM! Brands, Inc. (NYSE/YUM), and other big American names.
I can’t stress this enough: the U.S. economy is highly connected to the Chinese economy. If the economic slowdown in China continues, then you can expect many large-cap companies in key stock indices to see their stock prices fall.
What He Said:
“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in Profit Confidential, May 2, 2007. From May 2007 to November 2008 the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.