Juggling Dynamite

When money is ultra-cheap, many people do dumb things with it. During the pandemic, interest rates dropped to record lows and demand for vehicles (and auto loan securities) lept while repossession actions halted. Some 86% of new purchases and 56% of used vehicles are financed. Canadian auto loans presently range in interest rates from 3.99% to 31.99%, depending on the borrower.

With many having bought vehicles at elevated prices over the past two years, now interest rates are sharply higher, and fuel costs are crushing. People need to spend less on transportation. Naturally, defaults are rising, and repo activities are back in full force. On the leading edge of the credit cycle, auto defaults are an economic indicator that leads mortgage defaults by about six months.

Massive used car supply is coming to market as two million-plus US repossessions in the first six months of 2022 eclipse full-year norms pre-pandemic.   This video offers a good update. Here is a direct video link.

Worthwhile macro listen.

Stocks have fallen for a number of reasons this year. But there’s another shoe that’s about to drop that should send equity prices even lower: margin compression. Despite companies’ profits getting squeezed by higher input costs due to hot inflation AND rising costs of capital, Wall Street analysts are still projecting robust earnings growth for 2023. Those estimates are going to have to come down soon in order to better match the unfolding reality. Next month’s earnings calls are likely to be the catalyst for that, as companies reveal the havoc this current margin compression is having on the current and future earnings. So even if markets experience a short-term bounce over the next few weeks, it’s likely to be short-lived once the Street is forced to take margin compression seriously. Here is a direct video link.

While the price of equities has been falling, earnings estimates (the “E” in PE ratios) have remained elevated.  As shown below, the decline in global purchasing manager indices (in dark blue since 2000) suggests a significant earnings decline (light blue) is likely over the next year.  If this unfolds, equity valuations will be revealed as much higher than presently estimated, and equity prices should follow lower.

Danielle was a guest with Jim Goddard on Talk Digital Network talking about recent developments in the world economy and markets. You can listen to an audio clip of the segment here.

Retail investors have not yet dumped their stocks, but as shown below since 2016, the outflows from bonds have been capitulation-like year to date. Stocks have catching down yet to do.