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Auto and Consumer Products: High Stock Prices, Poor Fundamentals

Michael Alkin, the Portfolio Manager of the Tullamore Fund at Hilton Capital Management, argued at the January 2018 Vancouver Resource Investment Conference , that the auto and consumer products sectors are facing extremely poor fundamentals at a time when their stock prices are high and sales are faltering. He said stocks in both sectors are going to be sold off hard.

Auto Industry

Alkin said, When things are at peaks, things look good until theyre not. Wall Street, he said, tends to extrapolate out from the current situation, but often that is a mistake. Although the auto industry has been on a long uptrend, he believes it is about to implode.

The US auto industry employs about 5% of the US workforce and represents about 3% of US GDP. The industry exported $148 billion worth of vehicles and parts in 2016 and half the companies on the Dow Jones rely on automobiles and the industry for revenue.

The Soaring Auto Market

Since the 2008 recession there has been a big recovery in auto sales, from 9 million units in 2009 to 18 million units per year today. The average price of cars has increased from $28,243 in 2008 to $36,113 today, which is a huge 27% increase. The industry has added more jobs, wages are rising, and with gas cheap and interest rates low, the environment has allowed far more people to buy more expensive cars. The recovery in the housing market since 2008 also boosted sales of pickup trucks. Auto companies, parts makers, and every business in the auto industry have all seen soaring margins.

Clouds on the Horizon

However, incentives for sales are at record highs. The average incentive is $4302/unit compared with $4,001 in December of 2016. Incentives as a percentage of MSRP are at about 11.2% and in 17 of the past 18 months incentives have average more than 10% and yet auto companies are still having a hard time selling new cars. In 2017 vehicle sales were down 1.8%; the first decline since the 2008 recession. For 2018, analysts are also estimating a low single-digit decline in sales. For the big 3 automakers, it will be the second year in a row of a decline in sales. GM is down about 2.7%, Ford about 1.1% and Fiat Chrysler about 8.6%.

Something is wrong, Alkin said, if incentives are up and sales are down.

Used Cars Drive the Auto Market

What drives the US auto market? Alkin asked. Used cars. The pricing of used cars drives the sale of new cars. In the last recession, new car volumes were very low at 9 million units compared to 17.8 million today. Post-recession, the supply of used cars was very low because there were so few trade-ins. The limited supply led to a surge in the price of used cars.

The key for most people buying a car is the monthly payment, he said. High used car prices lead to higher equity in a car, which leads to more residual value when you go to trade it in. Furthermore, with low interest rates and a highly valued trade in, people can get very low monthly payments. If a $45,000 car can be leased for $400/month, it then puts great pressure on the price of used cars. Why buy a used car when you can get a new one for a low monthly payment? Therefore, youve seen a huge surge in leasing since 2012. Alkin said, leasing is now crack for automakers. In 2009, GM lease penetration was 2%. Now it is 27%. For Ford, leasing penetration jumped from 5% to 23%.

Debt to Subprime Borrowers

Low interest rates drove leasing and now all those used cars are hitting the used car market, which will drive down prices. There is also $1.2 trillion in debt in the system; with 20% of the debt is subprime auto loans. Lenders are lending money to those with credit scores below 620, with 20% of the new car origination loans falling into the subprime sector. Most (70%) of the loans are by auto finance companies, and they have lent $200 billion. Some $435 billion has been loaned to customers for auto loans with credit scores below 660, which is 1/3rd of the market. Some 23 million consumers hold subprime auto loans.

The loans are now starting to lead to defaults. Subprime defaults on auto loans were at about 10% in 2008. They are at 9% today. Auto lenders and banks are already cutting back on loans, which is similar to what happened when the housing market collapsed.

Record lease expirations are pressuring used car prices down. Therefore, residual prices that people have as value in their cars are falling. New cars then become less affordable to more and more people. Therefore, fewer new cars are sold. Subprime auto delinquencies are climbing, even as automakers are heavily dependent on leases and subprime customers. Auto parts makers, retailers, financiers will all suffer. All while car company stocks are trading at peak margins.

The fundamentals are signaling that trouble is ahead, Alkin said, and the stock market hasnt factored it in yet. Short car company stocks or, if you are in stocks in the auto industry, get out!

Consumer staples: A long move up

For the past 15 years, there has been a huge cash flow into big name consumer brands, which have enjoyed strong earnings, providing investors with dividends of more than 2.5% annually. To this was added a boost from investors seeking high yields, since some of these safe investments returned more than 16% annually. Consumer product stocks enjoyed what Alkin called, A monster move up.

Tough Times Ahead: Baby Boomers and Millennials

Valuations of consumer goods companies are at record highs. However, growth doesnt support these valuations, nor do the fundamentals. Demographics are against such brands, Alkin argued. They are selling less to a growing group of people: Baby Boomers, who are aging fast. We spend 40% less on consumer spending between ages 45 and 74, from an average of $70,000/household when we are 45 to 54 to only $40,000/household when we are 65 to 74. Spending on food declines 35% between 45 to 74 years of age ($8,406 to $5,500 per household). Retirees spend 30% less on soap, shampoo and hair care products. With 50 million retired people, such a decline means $1.5 trillion less in consumer spending overall. Retirees are also more health conscious, so they buy less of what big companies sell. Oreos give way to fresh fruit as a snack.

Millennials, born between 1980 and 2000, are the biggest age cohort in US history. There are 93 million millennials versus 77 million baby boomers. Unfortunately for consumer name brands, more than half of millennials have no use for brands, and they demand more choice for less money. Technology is changing how people buy; people can comparison shop and try new brands easily. Millennials also want local, small and organic, and when big companies buy local brands to tap into that desire, the local brand loses its appeal.

Why Consumer Stocks have Remained High

Even so, consumer product stocks keep moving higher, even though average sales growth was just 2.5% the past three years; half the growth rate of the S&P 500. EBITDA growth (cash flow) grew just 6%, much slower than the overall market. How have consumer product companies responded? To grow earnings, consumer companies have cut costs and, with clean balance sheets, the borrowed cheap money (adding debt) to buy back stocks to increase earnings per share. With fewer shares, profits per share increase even if you arent actually selling more products.

A Looming Sell Off

Consumer product company balance sheets, however, are getting near where they cant borrow more, Alkin argued. The companies have no answer to declining baby boomer sales or to millennial disinterest. Wall Street estimates are starting to decline, but the stocks havent responded yet. Alkin believes that consumer product stocks are going to get sold off hard.

S&P 500

One index that will most likely be adversely affected by the negative fundamentals in the auto and consumer products sectors is the S&P 500 index. Therefore, lets look at the S&P 500 e-mini contract supply and demand levels in the special Variable Changing Price Momentum Indicator (VC PMI) weekly report that we published on May 18, 2018.

The e-mini S&P contract closed on Friday at $2713. Closing above the 18-day moving average, which is the VC PMIs first filter, of $2708 confirms that the trend momentum is bullish coming into this week. The VC PMI gives us the inverse relationship as well, where we could potentially see a reversion in the price occur. When it does, it would activate a signal to neutral. In this case, the market closing below $2708 would negate this bullish short-term trend to neutral.

The second filter that we use in the VC PMI is the weekly price momentum. The weekly price momentum is the average price, mean or equilibrium price that the VC PMI identifies for us as we come into next week. By extrapolating this average price, we can calculate the extreme above the mean. In this case, the sell one (S1) level is $2736 and the sell two (S2) level is $2759.

The VC PMI is able to create the structure of the extreme levels of the mean and give you a high probability that if the price crosses these levels, it activates a trigger point for you to execute the signal on a self-directed basis. In this case, the price closing below $2718 is bearish, so coming into next week we have a bearish price momentum.

However, if the market closes below $2708, based on the first filter, it would activate this first filter as a reversion point. By closing below the weekly VC PMI price momentum indicator, it activates the extreme below the mean or the extreme below the relative implied volatility using the weekly data. In this case, it activates the buy 1 (B1) level of $2695 and the buy two (B2) level of $2678.

When the price reaches any of these extremes above the mean of S1 or S2 or below the mean of B1 or B2, it gives you a high probability that the reversion to the mean might occur back from these levels to the mean. The B1 and S1 levels indicate a 90% probability that the price will revert back to the mean. The B2 and S2 levels indicate a 95% probability that the price will revert back to the mean. As you can see, the VC PMI clearly identifies for you that if we come down into these levels of $2695 to $2678, it recommends for you to cover any short positions and look at the long side. If you activate any longs, it tells you where to place stops. If you buy into $2695 or $2678, you should use $2678 as your stop level.

The strategy for the e-mini S&P 500 for next week is to sell the rallies into these S1 and S2 levels, which are the highest probability to go short. If the price climbs into the B1 or B2 levels, if you are short, it is good to cover at these levels and allow for the market price to dictate the next trigger point.

S&P 500 Futures versus SPDR S&P 500 ETF Trust (SPY)

Lets take a look at an instrument that self-directed traders can use to take advantage of the condition of the market in general on a longer-term basis than trading the futures contract day to day or swing trading. Trading the S&P 500 futures contracts offers a tremendous amount of risk and it is not suitable for everyone. The contract is highly volatile and unless you are well financed, it is a very large contract to trade for the average investor. The futures markets are used primarily by large financial institutions to apply protection or hedging strategies against their stock portfolios.

For the average investor, I recommend an instrument that follows the e-mini S&P index called the SPDR S&P 500 ETF, which you can use to follow the S&P 500 market without having to worry about margin. The difference between the futures contract and the SPDR S&P 500 ETF is that for a futures contract you have a margin requirement to initiate the contract and you are subject to additional margin calls if the market moves against you. The margin is a percentage of the total value of the entire S& P500 index. For most individual investors, this amount is an impossible financial challenge to meet. Trading in margin can be very, very risky and you can lose a lot more money than you put up or than you would like to.

What we suggest for those investors who would like to have some limited exposure without eliminating the profit potential of trading in the S&P 500 index market, is to use the SPDR S&P 500 ETF. You can buy it for dollars per share as a security or stock, and hold onto it for as long as you wish.

The VC PMI and the SPY

Lets take a look at the supply and demand levels for the SPY we have identified using the VC PMI. The SPDR contract closed Friday at 271.30. With the market closing above the 18-day moving average that we use as the VC PMIs first filter to identify the trend momentum, it indicates that the market is bullish. The algorithm also identifies for us the reverse, if it occurs; if the price closes below 270, it would negate the weekly bullish short-term trend to neutral.

The second filter the VC PMI uses is the average or mean, which is at 272 and provides a bearish indication because the price closed below 272 on Friday at 271.30. The VC PMI tells us that it has activated a bearish signal, but if it closes above 272, it would negate this bearish signal to neutral.

By closing below the average, mean or the equilibrium point, the VC PMI is able to extrapolate the extreme below the mean. If the market comes down to B1 and you are short, the VC PMI indicates that you should cover at 270 or at B2 (268) during the coming week. If the price reverts back up to the mean of 272, it would negate this bearishness and activate the extreme above the mean of the S1 level of 274 and S2 of 276, and the supply levels that would be activated. The VC PMI is able to give you a structure with clear data points, in this case for the SPDR S&P 500 ETF. You can use this structure in the same manner as trading S&P 500 futures, but with no margin requirement.


When we take a look at the fundamental picture mentioned above in the auto and consumer products sectors, especially if interest rates continue to rise, as I have argued previously, it is clear that rising interest rates are not the best answer to generate economic growth. Rising interest rates will significantly harm the sale of cars and ripple negatively throughout the auto industry. In the economy as a whole, the level of debt is at historic levels and the danger of rising interest rates jeopardizes the integrity of interest payments. Rising interest rates will affect every individual and institution who hold a vast amount of debt based on the free money we have been using for the past 9 years. As I have argued before, I dont believe the economic numbers justify a rise in interest rates which seems to be the policy of this US administration. I think the auto industry and the consumer products industry are beginning to show cracks in the system and a continuous rise in interest rates is a danger to the global economy.

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About the author

After more than 30 years in the financial market business, Patrick MontesDeOca has developed a unique and automated trading tool based on a combination of Elliott Wave, Fibonacci, WD Gann and Vedic Mathematics. This proprietary trading tool, the VC Price Momentum Indicator, is a revolutionary trading tool that identifies major cyclical changes and trading opportunities in the commodities and financial markets with unprecedented accuracy.

Learn how the fully automated VC PMI works, see its trading record, and begin to delve into the way professional traders trade. MontesDeOca, has spent more than three decades trading all types of markets, beginning in 1974 as a legal, banking and trading advisor for several major Latin American coffee exporters. During the 1980s he became a member of the New York Coffee and Sugar Exchange, and the New York Mercantile. He also served as a consultant and technical analyst for the Mexican government. He created the MCTS Markets Commentary, an advanced automated and technically oriented market letter for the financial and commodity markets published daily in Consensus Magazine since 2003. He is a widely published author, technical analyst and commentator in,  INVESTING.COM, and complex multifaceted system is now completely automated and is available from TradeStation Technologies app store.

contributing author since 12/18/2017 

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