Posts filed under “Cycles”
Household Debt and Post-Recession Auto Lending
O. Emre Ergungor, Caitlin Treanor
St Louis Fed, 03.06.2015
The question now is whether the decline in borrowing has hit an end, signaling a return of consumer confidence. Data from the New York Fed’s Credit Panel suggest that the answer may be yes. Home mortgage debt and credit card debt have stopped contracting. Student loans never really shrank. And auto loan balances (which include leases) have been rising for more than three years. Newly originated auto loans hit $105 billion in the third quarter of 2014, the highest they have been since the third quarter of 2005.
Why are auto loans in particular increasing so rapidly? The increase could be the result of borrowers suddenly wanting to purchase more cars, or it could be that lenders are more willing to provide credit, or it could be some combination of both. Parsing out the precise story—how much of the increase is due to an increase in the demand for cars or an increase in the supply of credit finally meeting more of the existing auto demand—is difficult.
One way to examine the issue is to look at which individuals are receiving auto loans. Breaking down auto loan data by Equifax Risk Score, we can see that new loans are not just going to low-risk borrowers. Individuals with both good and bad Equifax Risk Scores are being extended more credit. Banks are extending more credit largely to those with a higher credit rating, while finance companies are extending more credit to individuals of all risk-levels, including those with subprime credit ratings (650 and below). Finance companies supply more than twice as much credit to this group as banks.
Given that a chunk of the increase in auto loans is being dealt out to the highest-risk borrowers, this could be an indication of declining risk-aversion among lenders and an increased supply of credit. On the other hand, that people with the best credit ratings, who likely had uninterrupted access to credit even after the downturn, are also seeking out (and receiving) more auto loans suggests that the increase in lending could be an indication of increased demand for cars.
To further understand recent household borrowing trends, we can look at data from surveys of lenders and consumers. The Senior Loan Officer Opinion Survey on Bank Lending Practices, published by the Federal Reserve Board, is a survey of up to 80 large domestic banks and 24 US branches or agencies of foreign banks, which asks questions about changes in the standards and terms of, as well as demand for, the banks’ loans. Since April of 2011, results from this survey indicate a consistent easing of standards on auto loans. This is further evidence that the willingness to take on more risk has increased.
In the Survey of Consumer Expectations, released every month by the Federal Reserve Bank of New York, individuals are asked if they think it is generally easier or harder to obtain credit today, compared to 12 months ago. Since mid-2013, more consumers have found it easier to obtain credit (not auto credit specifically). The percentage of respondents reporting that it has gotten harder has gone down (from 49 percent in January 2014 to 39 percent in January 2015), while the percentage of respondents finding it easier has increased (from 14 percent in January 2014 to 24 percent in January 2015).
However, attractive financing options are likely not the only driver of the trend in auto loans, and an increase in demand for new vehicles could also be moving the market. The stock of cars on US roads is aging. According to the automotive market research firm Polk, the average age of US-registered vehicles was 9.6 years in 2002. This shot up to 11.2 years by 2012. If the difficult labor market environment and the tight credit standards of the past have discouraged the purchase of new vehicles, those effects are finally abating. Pent-up demand among auto consumers for new cars may now be showing up in the auto-loan data.
Increased demand is possibly the result of aging cars on the road. According to the automotive market research firm Polk, the average age of US-registered vehicles was 9.6 years in 2002. This shot up to 11.2 years by 2012. Pent-up demand among auto consumers for new cars may now be showing up in the auto-loan data.
There are two noteworthy trends in auto loans that have been laid out here. One, the state of the auto loan market has quickly rebounded post crisis. And two, there has been continued growth in auto loans across the board, including high-risk loans. There are some indications of increasing demand for auto loans as well as greater willingness to lend to riskier borrowers. One can only hope that lenders learned a valuable lesson from their past subprime lending experience.
NASDAQ 5000 – Crash? Bubble? Fair Value?
March 4, 2015
Almost fifteen years ago, on April 1, 2000, we wrote and published a piece entitled “Will the NASDAQ sell-off become a crash?” We have now retrieved that piece from our archives and posted it on our website.
In preparing that piece we evaluated the stock market and made a theoretical calculation in which we merged two companies, Cisco and Microsoft. We assumed that their reported earnings were accurate. We found that the two companies merged together had earnings of $10 billion and their merged theoretical market valuation amounted to $1 trillion. Our conclusion at the time was fairly straightforward. There was nothing wrong with either company. Both Cisco and Microsoft were fine, large, developing, worldwide leaders in the Technology sector. The stock price, however, was wrong. At 100 times earnings, the price of the theoretically merged company’s shares was not justified by any valuation technique. The combined GDP of all countries in the world was estimated at $30 trillion.
We concluded in our piece that the NASDAQ at 5000 was setting up for a crash. The fourth page measures the value of Cisco against a list of companies (that list included Apple). 15 years ago, we forecast that NASDAQ 5000 would lose over two-thirds of its value before the crash and sell-off ran their full course. Never did we think that the result would be a loss of 80% of its value.
This week, Convergex published a piece including their discussions of NASDAQ 5000. Author Nicholas Cola titled the piece “NASDAQ 5000 – Don’t Call it a Comeback” (March 3, 2015).
(See below for full report)
Here is the summary, which tells most of the story:
With the NASDAQ Composite back to the magic 5,000 level, today we look at the “heavy hitters” in the index. The companies with the top 10 weightings comprise some 32% of the entire index, led by Apple (9.9%), Microsoft (4.8%) the two flavors of Google (4.6%). So where do NASDAQ Comp valuation levels sit at 5,000, and what do you get for your money? Forward P/E multiples based on analyst expectations are 19x earnings, a noticeable premium to the S&P 500 at 17x. In return for that markup, those top 10 names in the NASDAQ offer the promise of real revenue and earnings growth. Analyst estimates for top line growth in 2015 for the top 10 names average out at 13.7% and the 3-year CAGR through 2017 is 11.2%. That translates into 9.4% earnings growth for this year and 11.7% compounded growth through 2017. The real question behind NASDAQ 5,000 Version 2.0 is simple: what price do you pay for growth stocks versus the broader index.
Let’s take a look at the issue now compared with conditions when our NASDAQ 5000 piece was written 15 years ago. Microsoft is now 4.8% of the index, Cisco is 2%, and Apple is approximately 10% of the index and the largest weight. The Convergex research piece provides the remaining information in detail. For information about Convergex, visit www.convergex.com. If you want to send them a reply on their commentary or obtain a copy of Nicholas Colas’s March 3, 2015, piece, we suggest sending an email to Convergex at email@example.com. Note: Cumberland is a user of Convergex’s services and receives their research missive daily.
So what does it mean that the price/earnings ratio is no longer 100:1? It is now in the mid-teens. The stocks currently represented in the NASDAQ are still heavily focused within the Technology sector. Some of the companies, whose market prices may be high relative to past references, are supported by profits and robust estimates of future growth. What is the condition of those companies? Do they have large reserves of cash, or are they involved in heavily leveraged debt structures? Cash seems to be the answer in most cases.
What is the basic condition of the Technology industry? In the dot.com era 15 years ago, as the NASDAQ steamed toward 5000, there were many companies that had no product or earnings. They had only future prospects. Companies formed in garages and found themselves with overnight capitalizations in the billions. Technology sector fever gripped the stock market as a whole, with the Tech sector priced at nearly one-third of total market value at its peak. The price of stocks relative to America’s gross domestic product (GDP) reached all-time highs, based upon trillions of dollars in market value for companies that were little more than concepts. By some estimates, the US market cap was $7 trillion in excess at the top of the tech bubble.
Is the picture the same today with the NASDAQ at 5000? We think not. Could the NASDAQ go through a correction? Yes. We have had an extended bull market of six years’ duration. Corrections have been elusive but are inevitable. That includes the NASDAQ.
We wrote about the NASDAQ 5000 15 years ago as a bubble, the forerunner of a crash, and a valuation supported without earnings or momentum other than prices set by speculative fever. Now, 15 years later, the NASDAQ represents companies that have worldwide growth potential and are revealing once again the remarkable robustness of technology advancement as a business model. These companies are very American. Look at the NASDAQ list and note the nature and structure of these success stories that are rooted in the United States.
Is the NASDAQ 5000 a crash in the making? Fifteen years ago the answer was, without equivocation, yes. Today, the answer is no. It is 15 years later.
We are overweight the Technology sector in our US exchange-traded fund (ETF) managed accounts. Those ETFs contain the stocks mentioned in the Convergex report along with many others. We think the outlook for this sector’s evolution is strong and strategically long-term, with higher earnings, profits, dividends, and stock prices ahead.
We put together a short video on this NASDAQ 5000 phenomenon and how it figured into the creation of our ETF separate account management structure back in 1999. You can view the video here.
David R. Kotok, Chairman and Chief Investment Officer
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