Auto Finance Summit 2008

Posted February 17, 2010 By admin

What economic recovery plan? What economic downturn?

In early November Talking Heads were breathlessly reporting the economy "grew" with 3.5% in third quarter … Now that the economy was recovering. End of the economic downturn also signaled the end of the recession that began in the fourth quarter of 2007. And because much of this growth to pickup in auto sales. To read the full government report, go to www.bea.gov.

The index of leading economic indicators has been positive for seven months now, also suggests that the economy is improving.

So is it true? Are we on a sustainable growth now? Is this the government's recent release on the economy means the worst is behind us? Is the Index of leading economic indicators tells us the same?

Well, let's look at the reports and see where the growth came from. Maybe it will give us some answers.

To start, 3rd quarter growth rate has since been revised downwards to 2.8%. And following table shows the contribution to growth from the various sources of our economy.

Contributions to growth were as follows:

I appreciate this data table is a little busy, but it is important to understand the real nature of what some call a recovery. You will notice the largest contributor to third quarter economic growth was inventory restocking. In my mind, to put things back on the empty shelves are no growth. It is simply the opposite of the massive and aggressive destocking we saw in the fourth quarter of 2008.

So if we take out the release, the growth rate slips to 1.9%. Let's also eliminate defense spending and health care that are not growth lines. After all, who support our troops in Iraq, Afghanistan and around the world, should not be regarded as economic growth. And several health benefits to an aging population should not be considered new growth.

If we abolish the defense and health care, growth is now reduced to only 1.1%. But a major contributor to this residual growth is car sales. Let us now look a little deeper into this post.

Month months for auto sales is highly volatile and seasonal. So while we had the idiotic "Cash for clunk" government giveaway program that began kicking some sales in the third quarter, there are two other factors that are larger. Pent-up demand has been rising and Cash for the clunk was just a catalyst.

Pent-up demand is from the rising average age of cars on the road, now 9 years old. Moreover, interest rates on car loans in the near half of what they were in early 2007. The average car now has over 100,000 miles on it and interest on new car loans is low. Emission Standards, 10% of the payout has not changed over the last many years, and average prices have not changed much and is just below $ 30,000.

Most of us are accustomed to seeing the total number of purchased cars illustrated by the following diagram. But remember, many of the cars we buy are imported, and not add to U.S. economic growth. This chart gives us a full picture of consumer's vehicle sales in the last decade.

As you can see, auto sales plateaued long ago to around 16 million a year. As car buyers went on strike last fall, auto sales plunged to less than 10 million a year, a sales level not seen since the early eighties.

But the pent-up demand from an aging fleet and low borrowing rates will increase demand for cars from its current level.

There is another factor that will give us insight into future auto sale. There are now 1.2 vehicles per licensed driver. This means that only 83% of the cars we buy are transportation needs. The remaining 17% is discretionary and purchased to support our lifestyle. So whenever we are in a squeeze and should be cut back, like recessions, we can easily cut back on purchases of cars.

Clearly, this is what we experienced last fall and during the first half of 2009. We can delay our car buyers, and has. Eliminate this estimate demand car sales will stabilize at 13 million about a year.

Let us now look at car sales, which affect our economic growth. The following chart shows the cars sold each month, which was manufactured in the USA.

Source: U.S. Department of Commerce

The pink shaded areas of the chart are periods of recession. You will notice that car sales have been falling steadily in the last decade, recession or not. We saw a dramatic falloff in previous years, and sales have partially recovered in the third quarter. But this recovery is really much a part of the longer-term pattern and not unique to this recession.

Outcome of pent-up demand and low borrowing costs means that auto sales will be higher than the low monthly sales earlier this year. I expect auto sales to resume their long established pattern of seasonality and volatility.

Now, let's go back to our "growth" story. As we have seen, the only major contributor to the 3rd quarter growth was auto sales. And many commentators attribute this to the government's stimulus program. This is nonsense.

Aging, high mileage vehicles and low interest rates are more durable and strong influences on car sales to any government giveaway can be. Offsetting these positive factors are a negative; discretionary car buying decisions, corresponding to 17% of the total demand. Car buyers can easily be delayed or even canceled … at least for a time.

Trade Imbalance = Oil

And before we all celebrate this runaway growth, we need to remind ourselves of the negative influence on the growth of trade with a minus 0.8%. This is primarily our oil imports. More growth will make this trade imbalance worse, as we import more oil to accommodate greater economic activity.

Congressional Research Service, research arm of Congress recently published a report on U.S. oil reserves show the U.S. has the world's largest reserves of fossil fuels, more than even Russia. The report is titled "U.S. Fossil Fuel Resources: Terminology, reporting, and Summary "and was released on October 28, 2009. Go to www.opencrs.com to download this report.

We have the largest endowment of fossil fuels in any country, and we import large quantities of oil. This is the result of bad policy and political and environmental pressures. Sorry not exploit our own resources reduces our economic growth with the continued downward pressure on the dollar.

Leading economic Indicators

The Conference Board's Index of leading economic indicators are telling us since April that the economy is improving. The index has been positive every month since then. But let's take a closer look at the parts of this index. The major contributors to the positive results have been supplier performance (release the shelves) and stock and bond market. As I said before putting things back on the empty shelves should not be considered as a sustainable growth.

The equity and bond markets have zoomed higher. The stock market is up 62% since its low in March. Corporate bond prices have risen as well, especially the high yield market up 56% since the low in March. These increases have come without the benefit of increased earnings, stretching valuations to nosebleed levels.

Other components such as consumer expectations (low and lower), jobless claims (bad, but stabilizing), average workweek (stable, on a 45 year low) and building permits (rising from a very low base and still unsustainably low) tell a different story. So it seems to me the index of leading economic indicators leads us astray, with the only indicator of growth is an unjustified increase in capital market prices.

Some "growth" story, huh? Conservative investors should be extremely cautious in this environment.

What About next quarter?

I think it is important to see this much touted "growth", the story of the third quarter's economic performance as an isolated event.

After all, how this quarter and next quarter, growth will come from … More war? More bandages and cymbals? More cars, we do not really need? I do not think so.

Long-term sustainable economic growth comes from new business formations that provide goods and services demanded by consumers. These companies hire more workers and expand because their products are sold at a profit. Driven by self-interest, each of us, assures it will happen …. Unless our government obstructs and destroys this natural growth phenomenon with high taxes and burdensome and costly regulations.

And that is where we are. No entrepreneur is sane, To start a business today. Barriers to success and growth is just too great, making entrepreneurial activities too risky. Prospects for a strong and sustainable economic growth is not good until the government removes these obstacles.

What are the chances of our radical Muslim socialist president and a like-minded Congress understand the true sources of growth? The actions by this administration and Congress to date to ensure a limited and short-term economic recovery. The economy will substantially degree underperform its potential.

What Recession?

Now that we certainly are very small growth in 3rd quarter growth numbers and the prospect of growth in the coming quarters is not good, let's have a look at the economic downturn and see how bad it is.

Was there a Recession? Of course there were. But we have to investigate it a little closer to seek insight about its severity, spread, and duration. Simply accepting government's revelation that real GDP declined for two consecutive quarters is not very useful to investors.

We have to understand parts of the economy, there is solid and secure, and the parts are extended and vulnerable. Actually, I find it useful to think of the recent economic events in the form of 2 economies.

Two economies

Is there a recession or two economies? I believe recent economic events are better explained by considering not a monolithic economy goes up or down together and unity, but rather by considering 2 economies operate somewhat independently.

An economy is stable and healthy, and another is false, ill and had no business there in the first place. But they are interrelated … so good or poor performance can arise when performance of the other.

The first relates to supply goods and services that we all need, such as shelter, food, clothing, and other normal needs of U.S. families. This includes education, entertainment and lifestyle. As you will see that this economy is vital, healthy and well.

The second economy is one that should never have existed in the first place. It is an economy based on the liars and losers buy houses that were not home. This economy are sick and dying, and at some point will no longer exist.

Study of never ending stream of economic data in the two economies will give us insight into investing opportunities and dangers.

The Real Economy

Headline numbers are often on unemployment. And it is true that unemployment now exceeds 10%, and shows little sign of slowing. During the Employment is 18%. There seems to be plenty of political pressure to do something at the high and rising unemployment, and the government will certainly try. But as always, they will be too late, and follow the wrong actions. The latest jobs summit is a huge joke.

The following chart compares the total payroll employment (not unemployment), with total income and personal consumption expenditures. Payroll employment includes most of us. It does not include self-employed and agricultural workers.

Normally, unemployment is the most commonly reported figure, but it is a confusing row. It includes the unemployed who report every week, but not those who do not report or whose benefits have expired or those who have given up seeking employment. There are millions of these people, and unemployment numbers ignore them completely. I find it more appropriate to consider how many of us are employed and how it has changed themselves. That is why I use employment instead of unemployment.

Payroll employment (blue line) has decreased dramatically since late 2007. Nearly 8 million people have lost their jobs in the last two years. Both economies have been hit. For example, 1.6 million construction workers have been dismissed because of something construction work. But the real economy have also shed jobs. Manufacturing employment declined by 2.1 million people. This reflects both the long-term trend to lower production in the U.S. and the sharp reductions in panic stop in the supply chain last fall.

Payroll employment behaves as it has in past recessions. In the period 2001-2002 recession, employment fell and remained in decline after the recession was over. We should expect the same from this recession … a continued decline in employment.

The diagram also shows personal income (green line) and personal consumption expenditures (red line). Although employment have fallen down a cliff, both income and personal consumption has been stagnant. During the previous recession income and consumption continued to rise as employment fell.

Income dropped a bit, and personal consumption has not declined at all during this recession. Average compensation has actually increased. The same happened in the last recession. Income leveled off, and personal consumption continued to increase.

There are several parts of his personal income. It includes employee compensation, but the biggest part, proceeds from investments and income from the government in the form of transfer income. Examples of government payments, social security, welfare and Medicare payments.

There is no recession in personal consumption. 70% of personal consumption, and this sector has increased each quarter. Indeed, service costs never fell a quarter, a recession or not.

The next chart compares the total income which has not lost in this recession for paid compensation has. In fact, you observe an extension t of the two lines, especially since 2005. Wage income is important because it is the primary driver of the total income. And that is the source of the public tax revenue.

Given the massive number of unemployed we would expect salaried income to fall and it has, but not significantly. Indeed, income per employee increased during this recession.

Services employment is virtually unchanged. Decline in retail employment has been offset by increases in health care employment and federal employees' jobs.

Healthcare and federal government workers ask, "What recession?"

Source: St. Louis Federal Reserve Bank

Although income levels have remained essentially flat during this recession, the problematic point in this graph is paid income is decreasing. If salaried income continues to decline, our economic "recovery" will be short-lived.

Let us look at some anecdotal indicators to examine the recession from a different perspective than just the government's indicators. We will look at entertainment, charitable giving, lifestyle expenses and others have a better understanding of this "recession".

America 's Pets

Consider America's love affair with our pets. According to the National Pet Owners Survey, 62% of American households own a pet. Ownership has increased over time, up from 56% of households, when the first survey was taken in 1988.

The following table shows the total cost of pet ownership than a decade.

Annual Pet Expenses

($ Billions)

As you can see, our pampering of pets increased in both the last two recessions. Both ownership and the amount has been expanded. New products, such as hospice care and a carrier other than transporting pets are just two examples of how we grow on our pets, not in a recession.

Our pets are asking, "What Recession?"

Garbage

Next let us consider our production of waste. In particular, scraps quantity of food produced by U.S. households and restaurants.

America's scraps

Source: Environmental Protection Agency

Tonnage produced decreased bit in the last recession in 2001, but rebounded the following year. Even with those 2% so that the percentage of leftovers total solid waste rose to 11.4%. In 2008, a recession years, both the amount and percentage increase. America produced a record 32 million tonnes of food scraps in the deepest recession since the early seventies.

Trash hauliers asking, "What Recession?"

College Football

Let us ask the U.S. College football fans. We will examine their response to this crisis by looking at the National College Athletic Association Division I Football attendance records for the last six years. This does not cover all college football game attendance, but Division I is the top level of competition in college football and has the widest following. The following table shows the Annual attendance records at the 119 schools included in Section I.

Source: National College Athletic Assoc.

As you can see, the participation increasing every year, recession or not. In the deepest recession since at least mid-70s, college football participation includes climbing.

College Football fans ask, "What recession?"

New companies

As we all know that small businesses are an important and significant contributor to our economy and overall employment. There are about 6 million U.S. businesses that employee people. The difference between small and large firms, the number of employees. Large companies are defined as those with 500 or more employees. There are only 18,000 large businesses in the U.S.. Small businesses, those with less than 500 employees accounted for 64% or 14.5 million of the 22.5 million new jobs added to the economy from 1993 to 2008. A third of these new jobs came from new businesses.

The following chart shows the total new firms started in proportion to the number of businesses closed, and the relationship begins to closures. Approximately one percent of new businesses are added Each year for the 6 million existing businesses. The failure rate of new businesses within the first five years of existence has always been high, around 80%. The diagram below does not track, it just shows the number of businesses opened and closed each year, not their life.

As you can see, closures amounted to about 85% of new business formation from 2004 to 2007. But the ratio shot up to 95% in 2008, clearly reflecting the difficult business climate.

Business Formations and Failures

Source: Small Business Administration

New businesses is a key element in employment and economic growth. While new starts have remained essentially flat, the errors increased dramatically. The recession is just one reason. Federal regulation is another. Here is the cost of federal regulation on businesses each year.

Annual Cost of Federal Regulations

(Cost per Employee)

Source: Small Business Administration

As you can see, the economy best growth engine, small businesses bear the greatest burden. Federal Administrative costs for small businesses is 45% higher than costs for large companies. This will tend to hold strong economic growth and make small companies lack is more likely. High taxes and penalties regulations ensure economic growth in coming quarters will be tepid and fragile.

Charitable Giving

You would expect Charitable Giving to fall when times are tough. And it did fall in 2008, but not significantly. Interestingly, contributions to churches and domestic and international charities actually went up. The large decline was that human service organizations and education.

The following schedule outlines Charitable Giving During this recession, shows the source as primary individuals, and recipients are primarily churches.

Charitable Giving

Source: Giving USA 2008 Report

Most employers say, "We do not care if there is a recession." And many churches and charities say, "Thank God for the generosity of the American people, even in hard times.

Cuts

Everything goes up? Of course not. Discretionary spending has fallen. We buy fewer cars, which we already discussed, and our vacations are cheaper and extravagant. We've cut down on eating out, especially in upscale restaurants. The days, $ 50,000 ice sculpture business lunches are over … at least for now. And no one will miss them, except the ice sculptor.

For most families go about their lives as they always have. But fifteen million unemployed must have some impact on us all. You and I may have a job but a family member, friend or someone we know is probably out of work.

Recession and unemployment lead to economic problems. But we must remember recessions are a natural and necessary part of the economic cycle. Which is why we call it a cycle … it is both up and down phases. Economic cycles are healthy. Top cycle goes too far. At its peak, it encourages marginal investments fail. These errors lead to economic shifts, including unemployment, but also pave the way for the next up cycle to begin.

Solomon, the wisest man who ever lived, assures us there will always bicycles, and they will exist as long as the earth exists. So instead of trying to oust them, which governments are desperately trying to do, so we should include them in our investment planning, as a normal and recurring event.

The false Economy

This is an economy that never should have existed in the first place. It could not exist without the liars and losers. I am talking about millions of homes we build, there was not home. Liars and losers bought them to still higher prices, all promoted by the government's requirement for banks to lend to unworthy and unqualified borrowers. This was the triumph of hope over experience, and was inevitably will end badly. Liars are not worthy of credit and losers can not afford them.

Housing bubble that resulted took time to form as the following chart illustrates.

Source: U.S. Census Bureau

The blue line shows the steady rise in total U.S. housing units. The sharp decrease in 2002 is only a change in the way the Census Bureau tracks this information and not an actual decline.

From 2002 until 2008 America added to its inventory of houses. In 2002 our housing inventory was 117 million homes in 2008, our housing stock was 130 million houses. By the end of 3rd quarter of 2009 we had 130,302,000 units. This includes both single family and multiple family dwellings. The number of households has been stagnant over the past 6 years at 110 million approx. The current number is 111612000.

About one million new households formed each year. And they need homes. A good rule of thumb is the United States needs to build new houses just to the new household formations annually.

The number of houses and the number of households should track closely. In the past, (these two lines of blue and red lines) were very close together. In 2002 the blue line and red line started to deviate. From 2002 to 2008 we built 13 million homes, we do not need, and it was not occupied. It's a bubble!

The graph also shows the median house price in green (right scale), which started rising, which comes out of the 2001-2002 recession.

As house prices rose, we built yet more houses. The difference between the houses and households are empty houses, which keeps growing as we build more houses.

This increasing pattern of higher prices and more empty houses just kept worse, creating a massive housing bubble. This was, of course, all activated by the idiots in Washington who wanted all voters to be homeowners, although it was temporary and foolhardy.

The music stopped, when house prices may rise further, and began to decline in mid-2007. After a delay, started new housing starts to decline from the unsustainable rate of 2.2 million per year.

As you can see by the chart below, starts climbed rapidly after 2001-202 recession, despite no increase in households. And now, new housing starts have plunged significantly below the levels of new household formations. As the excess inventory is absorbed, new housing starts will resume a more normal and sustainable level of around 1 million one year.

Source: U.S. Census Bureau

Let us add another dimension to this sorry picture, financing. If all of these houses had been Built with 100% of the equity they would not have been built. The reason they were built was because 100% or nearly 100% financing was available to unworthy borrowers. Congress passed laws requiring banks to lend to the liars and losers. This created a recipe for pain that built the bubble larger than market forces would have allowed.

The following chart illustrates the total debt of all U.S. households (blue line). This is primarily mortgage debt but also includes $ 2.5 trillion in consumer debt such as car loans and credit cards. I have also included two of the sources of financing for mortgages, which allowed the housing bubble much worse than it should.

The first source is the mortgage pools (red line), arranged by hundreds of small mortgage originators and sold to investors from Wall Street firms. The second was the government agency backing pools as Freddie Mac and Fannie Mae (green line).

Source: Federal Reserve

After being increased rapidly from 2002 to 2008, total household debt has leveled off and begun to decline. Mortgage pools have fallen dramatically. Essentially, no new pools have been formed, and the existing ponds will be paid or charged off. The sad part of this is that the government sponsored loans are still rising. Everyone, it seems, understands a housing bubble apart from the government.

Build houses, we need not be financed with loans, we could not pay staff millions of people. Many are now unemployed.

The following chart shows the employment levels of both construction and financial services industries. As you might expect, construction is a more volatile industry than banking. Just as both industries have shed millions of employees over the past two years.

Source: St. Louis Federal Reserve Bank

One million six hundred thousand construction workers and almost 500,000 financial services workers have been dismissed since the recession began.

According to the American Bankers Association, 14.1% of single-family houses were either criminals or foreclosure status. This is an all time high since the American Bankers Assoc. has been collecting data in 1972. This corresponds to just over 4 million households.

As the largest mortgage lenders, banks have suffered massive write-offs and losses. So far this year, 129 banks failed and were closed by FDIC. This compares with 26 bank failures in 2008 and just three in 2007.

Unfortunately, the real economy, and many normal and prudent banks and borrowers were trapped in this housing bubble. Rising house prices affect any family who moved to professional or career reasons. They would pay more and borrow more to their new house. And bursts bubble has left them with less equity than when they bought the home. In reality, the solid, at least for the next few years, in homes with loans larger than the value of the house.

Limited Loans

Banks are becoming much more cautious in their lending as the housing meltdown and the freeze of credit markets. The following chart shows how they invest now. It is certainly not in loans to businesses and consumers.

As you can see, business loans (called C & I loans) has decreased by 250 billion dollars over the past year. And consumer loans decreased slightly. The real eye opener is the excess deposits banks must keep with the Federal Reserve Bank.

All banks are required to maintain a minimum level of reserves are held on deposit with the Fed. The smallest is shown in green line from 2000 to October 2008. Much of the 700 billion dollar government rescue plan, money that went to the stiffening of the large banks last autumn, was immediately redeposited with the Federal Reserve. As you can see, excess reserves zoomed from near zero to $ 1 trillion in the past year.

Conclusion

The declining availability of credit from banks, falling employment, falling house prices, bank failures, housing foreclosures, and extremely low new housing starts are all clear evidence that false economy are disappearing.

The false economy is not very large in proportion to our national economic engine, but nevertheless, it creates lots of pain. Unfortunately, this is how bubbles end … in pain and loss.

Ok, so let's add this up:

-Most of our economy is solid, smooth and healthy.

-The outlook is for slow growth until the risk / return is in better balance

Housing-bubble is deflating and the false economy are disappearing

Portfolio Strategy

My analysis is that there was no decline in large parts of our economy, and there certainly was no improvement.

The outlook is for us to sputter along, dragged down by too many rules confiscation taxes, and the slow abandonment of the economic principles that made us the most powerful economy on earth.

In this environment it becomes important to adhere strictly to our investment disciplines of high and sustainable income. We will continue to avoid investments in False economy, such as housing and finance.

Can you live a long life and prosperity,

Mike Williams, CFA

About the Author

Mike Williams is a professional money manager and Chief Investment Officer for Panhandle Portfolios, Inc. He has a BBA from the University of Massachusetts, an MBA from Southern Illinois University, and has held the Chartered Financial Analyst (CFA) certification since 1990, Certificate #13376.

He has been a credit analyst, a foreign exchange exposure analyst, an international pension expert, an international equity portfolio manager, a Japanese stock analyst, and the founder and chief executive officer of several companies engaged in a variety of business ranging from commercial real estate in New England to recycling electronics in China.