Reply #40: Ten problems for 2005 [View All]

http://www.prudentbear.com/archive_comm_article.asp?category=Guest+Commentary&content_idx=39491

1. The rubber will finally hit the road for the automobile manufacturers as well as automobile retailers and auto part suppliers. During a historically difficult economic growth environment, automobile manufacturers have "magically" induced the American public to "buy" their new vehicles at a pace which just a few years ago was thought to be impossible. The problem with the sales activity is that many, if not most, of the sales were encouraged and facilitated through financing that left much of the risk on the seller's balance sheet. The manufacturers basically allowed consumers to get their cars for "little or no money down," in some cases with no payments for 3-6 months, while accepting favorable financing terms (for the buyers) and extracting no collateral to do so. In addition, the manufacturers continued to produce vehicles at a pace that created a glut of new cars that last longer and have better warranties than previous production ramps ups. This has created a situation where we now have the "youngest" and potentially longest "life span" vehicles on the road than ever before. Used car values have dropped substantially, and in the next few years many consumers will own their vehicles "free and clear" and will have little or no incentive to buy a new car.

The real "bogey man" for the automobile manufacturers may come in the form of credit defaults. During this period of peak sales, those sales have become harder and harder to come by, and the sellers have become more and more lenient with credit approvals. Those two factors were a terrible combination for Sears a few years ago, and I foresee a similar problem for the lending arms of the major automobile manufacturers. Finally, as sales slow, the earnings from the financing divisions will drop. While the sales trends have been artificially propped up by incentives and creative financing deals, the bulk of the auto manufacturers' earnings over the past three years have come from the financing of the vehicles. Some 50-75% of profits came from the financing divisions of Ford and General Motors. Slower sales will necessitate difficult production cuts that could last for 12-24 months. The combination of production cuts, lower earnings from the financing arms, and higher credit defaults could produce a very difficult economic reality for the automobile industry.

2) Higher Interest rates will matter and will have a negative impact on many consumer areas, but most significantly on the over-heated HOUSING market. The marginal buyer who was given the gift of low interest rates, an easy lending environment, and lax appraisal process for the last three years will now encounter the reality that a home purchase is "the biggest and most important purchase of your life." Carry costs will become unmanageable, ARM's will adjust higher and raise mortgage payments, and any economic difficulty or career disruption will result in a problem. For new buyers, the mortgage application/approval process, along with the valuation/appraisal process, will become more stringent and less forgiving. The refinance activity that helped to support homeowners with carry costs, upkeep, and home improvements will slow with higher rates and more stable or falling home values. Homeowners will struggle to deal with higher rates on adjustable rate mortgages (ARMs) and will find it difficult to extract any new cash from their homes. Low interest rates that fueled strong sales of new and existing homes will be a distant memory, and further increases in home sales and prices will become harder and harder to achieve.

Homebuilders that have continued to forecast unabated sales growth, and have built inventory of spec homes and acquired land for future building, will find a more difficult pricing environment and a less than able consumer. And remember the one about "three hikes and a stumble" and "don't fight the FED"? Well, how about "five hikes and a wipeout" and "don't forget that stocks usually go down when rates go up"!

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I continue to believe that we are in a long-term period of economic decline. I see the last few years, since 2000, and the next few years, till say 2008-2010, as the 2nd Great Depression for the majority of the US population, especially the rapidly growing middle and lower class. As with most things, financial well-being and economic prosperity are "relative" and relative to past economic periods, the current state of our economy and the future economic outlook is at best "relatively" dismal. Unfortunately the baby boomers are unprepared for this economic reality, and the government is totally unprepared to take care of them . As the "greatest generation" lives longer than any of its ancestors, the economic reality of huge healthcare costs, lack of employment opportunity, lack of savings, and high costs of living will create a very difficult period of time for this huge swath of the population during their "golden years."