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Sunday, 3 February 2008

Automobile Wreckage. It Isn’t Just Ford and GM - An Occasional Letter From The Collection Agency

Automobile Wreckage. It Isn’t Just Ford and GM

Contained, they said. No spillover from the financial collapse, they said. The consumer is resilient and will continue spending, they said. Who are “they” you ask? The politicians, bankers, Fed speakers, analysts, brokers, economists and talking heads on the financial and - of late - mainstream media. All out there telling you its going to be okay, that the sweet life will roll on for just about everyone.

Why do they do this, why do they want you to believe that life will always be sweet? Simple. You have to continue to spend rather than save to keep the circle of money and credit viable. If confidence evaporates then spending stops as consumers begin to act in a discretionary manner, hoarding cash to buffer against the possible “unexpected” hard times. You can see the political advantages that accrue if you can say the hard times are due to an unexpected event. You don’t get the blame and the public accept the medicine required to alleviate the situation.

Everyone is focused on housing. All well and good but, without sounding dismissive, it’s built into the scenario now. We know foreclosures are rising and will more than likely will continue to rise. We know what effect that had on the pricing and rating of CDOs and MBS and the effect that had on CDS. The losses may well continue to rise, by huge amounts but…..we know. The focus has been upon the contained area, the Colosseum in which the blood would be spilt. We have been diverted from watching events elsewhere, beyond the blood sodden sand of the Circus Maxed-outus.

Not anymore. No we have definitive proof that it isn’t just housing that is suffering the blows of the Gladius. After the promises come the facts. That second largest purchase, the automobile, is entering the arena and it’s already wounded from previous contests.

Enough of my similes. Lets look at the automobile industry in the US.

Friday saw the release of the sales figures for the US domestic automobile market. Ugly would be a kind description. I want to use the January y-o-y figures to show just how hideous the economy is becoming. It’s not just domestic manufacturing that’s suffering. Importers (i.e. Japan and the Far East) are selling less in the US marketplace.

Firstly let’s look at the raw January y-o-y figures:

Ford Motor Co. reported Friday its U.S. light vehicle sales fell 3.9% in January.

In January, GM North America produced sales fell 5% in January.

American Honda Motor Co. Friday said its sales in January fell 2.3%.

Toyota Motor Sales U.S.A. Inc. said Friday its U.S. sales fell 2.3% in January.

Nissan Motor Co.'s Nissan North America Inc. division reported total sales in January fell 7.3%.

Porsche Cars North America Inc. said Friday its January U.S. sales fell 13%.

Kia Motors America on Friday reported January U.S. sales of 21,355 units, down 5.2%.

American Suzuki Motor Corp. said Friday its U.S. auto sales fell 13% in January.

Hyundai Motor America said January sales fell 23%.

Mercedes-Benz USA said Friday its U.S. sales rose 7.1% in January.

Mazda North American Operations said Friday sales in January rose 10.2%.

The last 2, Mercedes and Mazda, look healthy but both rises are on relatively small volumes as we shall see. Similarly Porsche and Suzuki figures are on small volume too. All the large volume producers lost sales volume. I am not overly interested in truck v car v SUV sales. I am looking at volume not choice.

Total sales for January vs January ‘07 were:

Ford - 159,355 down from 165,877

GM - 297,000 down from 313,000

Honda - 98,511 down from 100,790

Toyota - 171,849 down from 175,850

Nissan - 76,605 down from 82,644

Hyundai - 21,452 down from 27,721

Kia - 21,355 down from 22,465*


According to AutoData Corp, overall car sales fell last month to a seasonally-adjusted annual rate of 15.2 million vehicles. That’s the weakest pace since the ending of heavy discounts at dealerships in late 2005.

Without doubt sales of the second biggest purchase made by the US consumer have plummeted y-o-y. If the US consumer is now withdrawing from big ticket purchases (including Porsches) then not only will manufacturing head into a deeper recession but the service industry will also see a reduction in income. Discretionary spending, reliant for so long on the continued use of credit, is grinding to a halt.

Let’s have a look at some possible opportunities. I remind readers, I am not recommending any positions in any instruments. All I wish to do is point out the possible areas that may be affected.

Here is the DJ US Auto Index from Bigcharts:

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You can see the components here , with the DJ Automobiles& Parts Titans 30 Index here

Let’s look at some individual stocks:

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Simply put, they are all at or near resistance. The reaction to this resistance will be most revealing.

Did consumers suddenly decide that in mid 2007 they were not going to buy a new vehicle? Indeed they did as we can see from the falling car sales but was this new choice forced upon them?

Most consumers use credit to buy vehicles, many rolling forward outstanding vehicle loans into the new loan taken out. As can be seen in the charts above, that rolling of credit appears to have
stopped and it's reflected in the share prices of the Auto makers. Indeed the charts are highly responsive to the tightening of credit in August, the attempted talk down of the threat into October and then the second bout of credit being squeezed.

With the tightening credit conditions generally the Auto sector is vulnerable to a further deterioration in sales volume and will experience the latest development in the Housing sector - consumers walking away from debt.

Watch the Dealerships, will we see people driving onto the forecourt, parking up, returning the keys to the office and then walking to the bus stop? I think we will and sooner than most think. That Fed/Treasury/Congress/Presidential handout might just be enough to buy a second (third?) hand car, for cash.

This has ramifications beyond consumer spending. Just as with housing, loans made on vehicle purchases (and credit cards) were repackaged and sold on as derivatives, namely CLOs.

Here is the derivative published by showing the price and spread on the front contract:

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We see the same deterioration in price and the widening of spread that has become so familiar in the CDO/MBS indexes. As with housing, the inability to create further derivative structures due to rising spreads (risk premium) will curtail the lenders ability to clear the balance sheets and facilitate further lending.

It isn't just the index which is dropping. TRR (Total Rate of Return) CLOs are struggling too as Fitch Rating Agency have noted, downgrading 28 tranches and also placed an additional 37 tranches on Rating Watch Negative. Unsurprisingly TRR CLOs are a mixture of derivatives of loan portfolios that according to Fitch are now at risk for intensified spread/credit risks. Market values on the SMi U.S. 100 have fallen 6% since mid '07. Considering the type of asset and its potential lack of worth in a flooded market (unlike housing) I expect spreads to widen considerably.

It seems to me that a combination of tightening credit for the consumer, caused by the inability of lenders to clear balance sheets due to derivative markets pricing in higher risks which is stifling new issuance, will cause a real fall in spending on Autos. It should not be forgotten that other unsecured debt will have the same problems.

The possibility of widespread damage in the US domestic Auto industry beyond GM and Ford seems much greater today than at any other time.

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