I assume you saw the article about sub prime sales and the auto companies using incentives to pull forward demand into Aug. The Chrysler IPO is set for 10/13 so look for one more month of hot sales from them.
Labor Day sales were also pulled forward to Aug. so Sept sales should be interesting.
I know what your thinking, what is Duke getting at with all this stuff? A number of things. C aside, auto sales were flat vs last year. YOY comparisons will be difficult in Q4 and with credit being restricted you should begin seeing negative YOY sales figures. GM & F are worldwide companies and the increase in the value of the dollar is going to hurt these companies overseas profits. That will translate into lower incentives at US dealers as GM & F try and protect profits. It is a connected world and when you get hurt in one place you try and make it somewhere else.
What about SIRI. This week US companies raised 68B in the bond market. SIRI wasn't one of them. You may be surprised that I have no problem with SIRI's price in the current market. The problem is that everything in the current market is overpriced due to the Fed's plan to inflate asset prices. When and if the market falls, it will take everything, including SIRI with it. Can the market euphoria explain away flat retail sales, falling profit margins due to currency conversions and tightening credit? Maybe because we are in an Alice and Wonderland market but I doubt it.
The S&P didn't hit 2020 last week so we couldn't get a start on the correction. Three more days to hit it so let's hope the futures are up on Mon. and TU. Anyone notice the resistance on morning gap ups in the S&P? People like to associate events with sell offs. It is more interesting than taking about credit or currency conversions.
How about the Alibaba IPO at 165-200B valuation to look back on and have people say, What were those investors thinking when they ponied up those kinds of bucks for the equivalent of the Chinese Amazon?
The problem for loan officers is that they panic. They lump everyone in the subprime world together and start restricting credit to everyone. The A paper is still going to pay but everything gets shut down at the same time. It is getting tougher for credit worthy A paper to get loans for big ticket items. They are being shunted over to the previously owned lot. It is just a matter of time before it shows up in new car sales.
There is another canary in the coal mine for the market as a whole that no one has been discussing. What do you know about currency trading? Probably nothing because the average investor doesn't trade Euros. The decline in the Euro price is about to impact on multinationals earnings. You will start hearing about it in Oct but it became a big deal for us this week. Let's say you are McDonalds and you have 600 stores in France. You get paid in Euros and for the past year you converted your Euro profits into dollars at $1.37. Rates were stable so you weren't worried about currency conversion. Now you make the same money but you get less than $1.30 for that Euro. Your profits just declined 6% in the last month and there is little you can do other than hedge by selling forward contracts. Some companies like IBM get paid in dollars overseas so they avoid currency conversion but companies that take dollars are about to see their earnings take a big hit. The analysts will conveniently see this at the next CC but not before. As far as 3rd Q earnings estimates for multinationals, forget about them. The question is did Draghi do enough to overcome the surprise that is coming or will this be the unknown catalyst that drives the market down.
The story is always the same. You come up with a great idea to serve the subprime market. You start out serving the people between 600-650 FICO score. Most of these people are honest hard working people who had their credit dinged because they lost a job, got sick or got laid off. Sometimes they picked up the payment after 90 days but FICO is unforgiving so they are stuck in subprime. They are A paper but want to reestablish their credit so they manage their life accordingly and about 94-96% make their payment on time. Conn's makes money in three ways. They buy discontinued or seconds in bulk. The stuff is good but might be last year's model or have a scratch on it. It is sold as new so Conn's not only makes the normal profit but also makes the extra profit because it is a second. Then Conn's finances the purchase charging an average rate of 12% interest while paying the subprime bond market 5%. That 7% is icing on the cake and let's you chalk up $3.25/share profits. Your shares soar and everyone is fat dumb and happy. But it is all about growing so someone has a bright idea. Let's expand down to B paper. So now you give credit to people between 550 and 600. You raise the interest rate to 18%, there is more default but the extra 6 points covers it. But you are not growing expodentially so you know what happens. Let's go deep subprime down to 450, C & D paper. Business explodes. You are charging 1.8% downpayment, that is $18 for every thousand in merchandise. Then you and your stockholders are surprised when 3 months later they stopped paying. Wake up they never intended to pay. They understood you needed them to goose sales and they took the stuff for free. You deal with the loss.
So what is the point of the story? The same thing is happening in the auto business. The big leader in the business these days is C, breaking all those records every month. Any idea why? Nothing to do with redesigned Jeeps. They launching an IPO this month. It is Conn's all over again.
Whenever there is a major correction in the market the Street likes to tell you that there was no way to see it coming. Jim Illurio gave up trying to predict the correction as I told you last week but said it will happen. We just have to face the fact that we will be blindsided by it because no one has been able to predict the top. Maybe he is right or maybe he doesn't understand what causes a major correction in the market. What if there really was a canary in the coal mine but people just didn't recognize it because they didn't know where to look.
I operate in the world of credit. No one actually understands this world or how it works including me. There are patterns but no rules. The pattern I'm seeing is shrinking credit availability and that has always presaged a falling market. It is just a matter of time.
Ever hear of a company called Conn, Inc. Probably not, but it is one of those canary in a coal mine stories I follow. The stock went from $3.00 to almost $80.00 and then dropped 30% in one day this week. There was a lot of money to be made on the way up and on the way down. The story of Conn Inc is the story of what is happening in the credit markets.
Conn's stores, about 90 of them, are located in the South and Southwest. They are a Texas based company so maybe LR has heard of them. They sell appliances, mattresses, furniture and electronics to a growing but underserved part of the population. Let me translate that for you. They sell consumer goods to that have little value once they leave the store to subprime borrowers that no one else in their right mind would give credit to and the store self finances 79% of all the stuff it sells by borrowing through junk bonds. It is a great business, same store sales are up 12% YOY, revenue up 30% and the company opened 14 new stores. The only problem is that all of a sudden the people who bought the stuff have stopped paying. That is a problem for a company that self finances.
As the rugrat would tell you, only a fool would try and predict the market which means The Duke is eminently qualified to take a stab at it. Four weeks ago I told you that the small sell off would end between 1899 and 1907. It ended at 1904.8. I said we were headed back to test 1991 and we could get into the low 2000 range.
So far the high is 2005. All luck, of course, since no one can predict the market.
For some of my new readers or the all ones who forgot, let me take you back to 10/2/11. The market was in a 22% free fall after S&P downgraded the US credit rating and the S&P had closed at 1131.42 on 9/30. On 10/2 The Duke said the market would bottom that week at 1080 and would begin a new leg up. On TU the market bottomed at 1074.77 and began this leg up. It has lasted much longer than I anticipated but then who thought the market would buy QE to this extent?
But all good things come to an end and so do the harmful ones. I'm on record as saying we would have a 20/25% decline in the market beginning in the late Q3 or early Q4. Tomorrow is 9/1 and the market has held off to get us to this point. I'm sticking with the overall thesis but I actually see the market topping out in the next seven trading sessions with 2020 being the top. QE in Europe or disappointment. Time will tell.
There are many disconnects between the fundamentals and the story being told by the pundits on CNBC. I suggest you read an article published by Doug Noland called Pondering The Summer of 2012 and 2014 if you are interested in exploring some of them. Detailed but worth the read.
This week Jim Illurio a CNBC contributor gave up trying to predict when the next correction would take place. He joined a long line of other people who have thrown up their hands trying to predict a correction. The bull market seems unstopable. At one point the NAZ was up 15 days in a row and the AAII Sentiment index hit 51.92 bulls and 19.2% bears on Thur. Here are the bull readings for the last 4 weeks. 8/7 30.89, 8/14 39.81
8/21 46.11 and 8/28 51.92.
So why would anyone try and predict an end to upward trend?
Here is the untold story. SIRI set up a 600M ASR, a forward contract by another name, to purchase the CBH's shares that were not short at the time. They bought 112.5M shares for 353M, all disclosed in the 10Q. So let's say The Duke meets with a CEO to put together this plan. You think we just pull 600M out of the air because we like to tie up money for four months? The $600M represented SIRI's best guess as to the total number of unshorted CBH shares times a given price. In English, SIRI was hoping to buy 175-180M shares which means there are 60-65M unaccounted for shares. Maybe these shares will be shorted before 12/1, sold shortly after or held long term but that is the story everyone missed. The ASR closed 8/1 and without an increase in the SI there were no further large buys by SIRI from the CHB.
The estimates for Aug. auto sales from JD Powers and LMC Automotive are out and they are interesting. The estimates for Aug 14 is total retail sales of 1,331,000 and total sales (includes fleet sales) of 1,493,000. This compares with Aug 13 sales of 1,335,085 and 1,500,624. At first glance you might surmise that sales are dropping YOY. That would be logical but as I said, if you don't like the numbers you merely reinterpret them. Actually, the headline says that auto sales will be up 3% YOY. Now how do you accomplish this little trick? You see in the footnote it tells you there were 28 selling days in 2013 vs 27 this year the average number of cars sold on a per day basis between 2013 and 2014, the AVERAGE is up 3% YOY. Back in May there was an extra selling day in 2014 v 2013. Sales were up 5.2% but no one mentioned they were only up 1.8% if you factored in the extra day. We have a story to sell. Don't let the facts get in the way.
BTW, the article doesn't say why sales are starting to fall. Do you know why? I told you the reason. You are a subprime borrower with a score between 450-550. You are C/D paper. In June you could buy a car. In Aug there is no loan for you.
Tomorrow summer officially ends, at least in The Land Of The Duke. I can hear the ocean in the background but it is too early for the sun to be up and most people are just getting ready to go to bed. In reading The Duke you might get the impression that I'm a micro manager. Whenever I go on vacation, I tell my AA that she has my cell number and can reach me in case of an emergency. It is our little joke. When I get to Dulles, I turn it off and won't turn it back on until I arrive back at Dulles tomorrow night. That way she can tell people she can't reach me. She never learned to lie which I told her was a requirement to be employed at any law firm.
Anyway, I always do call in on the Friday before I return. She filled me in on the latest crisis and told me the new work was arranged on my desk as it always is...in four piles with the most urgent in the left hand pile and the least urgent in the right hand pile. You already know that I start with the right hand pile first.
The real reason I'm calling in is to find out if maybe the younger partners have staged a coup, taken over the firm and forced me into retirement. I want to know this before I get on three planes tomorrow and spend 18 hours to get home. Isn't the bloodless coup supposed to happen when the dictator goes on vacation? No such luck, I have obviously hired the wrong people over the years.
Computers allow you to keep up with the comics which means I read Wrongway's latest try at analysis. On 8/26 he wrote SXM; Expect a SIgnificant Short Increase At The Next Release. That night the SI FELL 6.3M shares. In the comment section I congratulated him on the brilliant analysis and asked if we could expect another article the next day? I even gave him a hint. Just because SIRI wanted to buy the shares from the CHB, it didn't mean they wanted to sell.
Nine guys write about SIRI on SA, the three stooges squared. No one saw the story even though it has been there for a month. Have you figured it out?
Last week Wrongway published an article on TU telling or hoping everyone would sell their stock to SIRI so they could buy more shares in the BB. He owned Aug 16 $3.50 calls. A normal person would want the stock to go up but not Wrongway. So what happened? SIRI started to rally on Wed and hit the $3.58 target I gave you on Sunday. In the comment section to his article I asked him to explain why analysts were cutting their EPS estimates for SIRI in 2014 & 2015 so he produced an article that showed EPS is unimportant to SIRI. A few weeks ago Certifiably Nuts wrote an article that said sub growth was unimportant to SIRI's price appreciation. Some things make no sense.
Last week a guy named nyrugrat (where do you get these screen names) said only a fool would try an predict the market. So let's see, I predicted that SIRI would hit 3.58-3.60 and it hit it on FRI and that the S&P would bottom between 1899 and 1907 and go to 1991 to the low 2000 level. It bottomed at 1904.78 and went straight up to 1965 so far before correcting down to 1956. So am I an educated fool, a lucky fool or a damn fool?
Easyazzz asked whether SIRI is going to $2.74? He is asking the guy who said SIRI had to hit $3.58 BEFORE it could go to 2.74. It is called a countercyclical rally within a long term downtrend. Anyone remember that The Duke went long at $3.09. Countercyclical.
There is a lot of things I don't understand right now. I will be on vacation next week and maybe when I return in two weeks I will have figured it all out. Maybe the market will have figured it out by then.
At this point Goldman notifies the Seller of the oil in SA that it has a $Billion and the oil gets shipped. When it arrives in New Orleans Goldman wires the money to the Seller. I get my crude, refine it and sell it at a profit. I give the $B plus interest to the MM and they give me back my collateral, the bonds, which I return to Goldman. Everyone has made a profit and everyone is happy.
What you should understand from this is that Treasuries are the grease that keeps the world economy going since they are the collateral that underpins most of the trade in the world. On a daily basis there are about 1.6 TRILLION dollars in repo out there. So what is the problem you ask? Here is the problem. The Fed bought 20% of the Treasuries in its QE program taking them off the market. The US government deficit shrunk this year so there is less supply then anticipated. People are getting nervous and are buying more bonds so there are less in circulation. All in all the world's credit markets are beginning to freeze up because the demand for collateral is outstripping supply. The Fed never saw it coming so they recently allowed banks to borrow the Treasuries they hold to keep wheels of commerce going. Unintended consequences. Everywhere I look, credit is drying up or becoming more expensive when you can get it. The Fed can't do another QE program because there is nothing to buy out there without messing up world commerce. It is a mess and when the stock guys figure it out there should be some waterfall drops in the market as everyone heads for the exits at the same time. The World According To Duke. We will see how it plays out.
There are many things that drive the market and the world's economy but few people really understand what it is. I have conned myself into believing I understand how it works. I may be totally wrong but I can tell you that Bernutty and the Fed agree with The Duke so if I have it wrong, I'm in good company. It is all about cheap credit and money flow into the market. That is what QE is all about. The Fed surpressed interest rates (ZIRP) and flooded the market with money by buying bonds (QE) and the money found a home by being invested in the stock market and made everyone rich. Its Hollywood so everyone lives happily ever after, except there are unintended consequences to dumb policies and the Fed didn't understand the consequences.
I told you that the bond boys see a recession while the stock guys see a booming economy. So why are interest rates on the 10Y dropping into the danger zone at 2.35% now as I predicted a few weeks ago. It has to do with a bleak picture that is unfolding in world commerce that is barely being discussed.
World commerce depends on the treasury market and something called the overnight repo market. So how does the repo market work and why is it necessary. Let's say I am a refiner in Louisiana and I want to buy a tanker with a billion in oil for my refinery. The oil is in Saudi Arabia but it won't be shipped until I pay so where do I get a $billion. I borrow it. I go to Goldman and say I want to borrow a billion. They say they know a money market fund that will loan me a billion because I will pay a higher rate of interest than is currently available. But they want collateral. They want Treasury bonds so if I default they can sell them and get their money back. I don't have treasury bonds but Goldman does so they lend them to me so I can pledge them to get the billion. I agree to buy them back from the money market (repo) and give them back to Goldman when I sell my refined product. I give the bonds to the money market and Goldman gets the 1B.
There was a time, back in the Dark Ages, when I thought I understood the stock market. The period was known as BQE, Before QE when things actually made some sense. Today things make no sense, at least on the surface and the explanations we get are less than illuminating. If you are a somewhat literate investor you know the stats. Consumers account for 70% of the economy and housing is one of the biggest drivers of the recovery since it creates jobs and consumer purchases...furniture for that house you bought.
So this week we got the important reports on the nation's economy. Here is how Yahoo summarized the reports, "Earlier retail sales for July were reported flat, missing estimates and the weakest readings since July 2011....A weekly U.S. report showed a decline in mortgage applications volume to a 14 year low despite lower mortgage rates...
The market rallied on the news since the prevailing investment theory is that bad news is good news and this will delay the Fed from ending QE or cause it to delay raising interest rates, or both or none of the above but anyway it is all good so buy stocks.
The Yahoo article carried an explanation of why the retail sale numbers weren't as bad as they looked from Nick Reich CEO of Earning Scout. Here is what he said, "When you talk retail, one does not necessary mean the other." If you understand that gibberish let me know what he meant because The Duke doesn't have a clue. The next morning I watched the Chief Economist from Wells Fargo explain away the numbers in English that I could actually understand. You see consumer spending is no longer important to the economy and housing is even less important. Betty Lu was confused to hear this so she asked well what is going to drive the economy? The economist said, business investment. Alexis Steele said, but there is no indication businesses are investing in plant or equipment. The Economist said they aren't but soon they will, so just buy stocks and everyone nodded in agreement.
I am not sure why you are asking the questions. Japan's economy is a basket case. Soaring inflation and a contraction in the economy that is greater than the government predicted due to the sales tax increase. Everything is playing out exactly as I predicted which is why the IMF just cut worldwide GDP for the second time this year.
Since we are on the issue of topics you won't read over at SA, Ford Equity Research cut its rating on SIRI to SELL on 8/1. They echoed the frustration that S&P has with SIRI's earnings. "Recent changes to analysts' forecasts and variances between reported and estimated earnings provide important information about a company's future performance. Earnings forecasts for SIRI have been decreasing which portends a deterioration of future earnings growth."
What is this earnings forecasts have been decreasing bit? Go to Earnings estimates on this site. Consensus for SIRI was in 2014 and 2015 was cut after the latest CC by a penny. Shouldn't Wrongway be addressing why consensus is being cut even with all the BBs and glowing analysis he writes. Or maybe a topic of conversation should be how higher interest rates or a recession would impact auto sales in 2015. Sorry, I forgot SIRI is insulated from all this.
Last week I told LR that the market would rally from a 1899-1906 base. It started FRI. This will be the last rally before the late third Q early 4th Q sell off I predicted in Jan. We will get close to the old 1991 high and could go over 2000 like the NAZ hit 5000. For SIRI it means we get to 3.58-3.60..a 50% retrace of the fall from 4.18 to 2.98. At that point it becomes a short.
I'm looking forward to the day when I am not the bearer of bad news on a weekly basis.
Of course, that is only part of the story. Why would credit dry up for C&D borrowers you ask? It is those junk bonds I have been talking about. You see all those subprime loans get bundled up into junk bonds by Wall Street to yield seekers. That is what the term "securitization of subprime loans" loans. Junk bonds are a mixture of A, B, C, and D paper. The more A paper, the safer the loan but the smaller the interest rate. A paper pays less than C/D paper. So you want yield with safety. You buy a bond with 80% A paper, 10% B paper and 10% C&D paper. You read the prospectus which disclosed the auto co. underwriting practices and loan origination criteria. That is all fine except if GM isn't following its own criteria that A paper isn't any safer than the D paper and you swear never to buy another bond issued by GM. That is the risk to GM and ultimately to SIRI as an auto parts supplier to GM and the whole auto industry.
Since we are on the topic of junk bonds, lets look at a story the WSJ carried on 8/7 entitled Junk Bond Exodus Accelerates. Here are some quotes. "Investors pulled a RECORD 7.1B from junk bond funds in the week ended Wednesday...The outflow is the fourth consecutive weekly decline. The average junk bond yield hit 5.78% up from 5% last month...(An analyst) said high yield borrowers would likely wait to issue debt. It doesn't benefit anyone to bring deals right now..Everyone is a bit nervous.
The problem for SIRi is two fold. The auto co. will have trouble recycling the suprime loans they are generating and SIRI will have a problem selling it bonds to finance BB #3. Do you ever wonder why The Duke is the only person who discusses subprime loans and junk bonds? I do. Next time you read one of those glowing analysis over at SA ask them how the junk bond exodus or subprime lending problem could impact SIRI. I would love to read their IN DEPTH ANALYSIS.
But the subprime buyer starts to worry about the payment. The dealer says don't worry. The Fed has lowered interest rates and we now have 84 month loans which didn't exist when you bought you last car. What it all means is you can get this baby today at the same payment as your making on your current 4 year old car. The deal is done. The problem for the borrower is that he has taken out a loan for 130% of the value of the car and when he drives it off the lot the auto will depreciate another 30%. But subprime borrowers are savy. They don't care because the junk bond buyer is going to get stuck with the tab. The borrower has no money and you can't get blood from a stone. Why do you think I have bad credit and #$%$ were you thinking when you gave me this new car for my 4 year old car and my signature on a piece of paper?
The problem with the little story is that GM's underwriting criteria doesn't allow for the creation of the downpayment or for all this other stuff to be rolled in to the balance. Dealers have been known to fudge salary numbers but it is all part of the game in moving the metal. It has happened before and it will happen again. Auto companies will be found not to have followed their underwriting guidelines and dealers will have failed to follow federal guidelines in the origination of the loans. Standards will be tightened. There will be no loans given to people with C&D credit. New car sales will fall and SIRI subs will suffer. It is a pattern that repeats itself over and over. The investigation will take 6 to 8 months. Put it on your calendar.