Inside The December Retail Report: “Disappointing” Isn’t The Half Of It

by David Stockman, Contra Corner

Today’s 0.9% decline in December retail sales apparently came as a shock to bubblevision’s talking heads. After all, we have had this giant “oil tax cut”, and, besides, the US economy has “decoupled” from the stormy waters abroad and is finally on its way to “escape velocity”.

The Wall Street touts and Keynesian economic doctors have been saying that for months now—-while averring that all the Fed’s massive money printing is finally beginning to bear fruit. So today’s retail report is a real stumper—–even if you embrace Wall Street’s sudden skepticism about government economic reports and ignore the purported “noise” in the seasonally maladjusted numbers for December.

All right then. Forget the December monthly numbers. Why not look at the unadjusted numbers in the full year retail spending report for 2014 compared to the prior year.  Recall that the swoon from last winter’s polar vortex overlapped both years, and was supposed to be a temporary effect anyway—–a mere shift of consumer spending to a few months down the road when spring arrived on schedule.

On an all-in basis, total retail sales in 2014 rose by $210 billion or a respectable 4.0%. But 58% of that gain was attributable to two categories—auto sales and bars&restaurants—which accounted for only 28% of retail sales in 2013. And therein lies a telling tale.

New and used motor vehicle sale alone jumped by $86 billion in CY2014 or nearly 9%. Then again, during the most recent 12 months auto loans outstanding soared by $89 billion. Roughly speaking, therefore, consumers borrowed every dime they spent on auto purchases and took home a few billion extra in spare change.

The point here is that no economy can thrive for long—especially one already at “peak  debt”—-based on consumer “spending” that is 100% dependent upon borrowed funds. Yet that has been the essence of the retail sales rebound since the Great Recession officially ended in June 2009. Auto sales, which have been heavily financed by borrowing, are up by about 70%; the balance of non-auto retail sales, where consumer credit outstanding is still below the pre-crisis peak, has gained only 22%.

Stated differently, the only credit channel of monetary policy transmission which is still working is auto credit. Yet as indicated earlier this week (see, “The US Hasn’t “Decoupled” And There Ain’t No Giant “Oil Tax Cut”) that actually amounts to a proverbial “accident” waiting to happen.

On the margin, the boom in auto loans, which are now nearing $1 trillion in outstandings, is on its last leg. The latest surge of growth has been in “subprime” credit based on the foolish assumption that vehicle prices never come down; and that the junk car loan boom led by fly-by-night lenders is nothing to worry about since loans are “collateralized”. That is, they could be made to derelicts and deadbeats as long as their location is known to the repo man.

The problem with that glib assumption is that it ignores the lesson of the housing crisis, where it was also said—by Bernanke himself—-that nationwide housing prices never fall. Yet what happened in 2006-2007 is that the residential housing stock got massively over-priced, and was then collaterized at these lofty, unsustainable levels. So when the last deadbeat mortgage borrower got funded, the price level broke and the house of cards came tumbling down, pulling prime borrowers as well as subprimes underwater as valuations plunged.

And so it goes with autos. Including the backdoor debt on rental fleets and leased vehicles, there is now more than $2 trillion of debt on the auto fleet, and there are millions of vehicles coming off-lease owing to the financing surge of recent years. When the subprime car loans begin to fail at double digit rates—-and frisky lenders like Santander are already there—-the repo man will get busy like never before. And that will mean, in turn, a tsunami of discount vehicles at the used car auctions, and a subsequent bout of price destruction up-and-down the entire auto food chain.

The reason is straight forward. Loan-to-value ratios are already upwards of 120% in many instances; and lenders are financing not only the vehicle purchase price, but taxes, title, insurance, amounts owed on “underwater” trade-ins and cash-back awards, too.

So when the new/used vehicle price chain breaks, there will be a spillover effect on the prime lending and new car segment, as well. Namely, credit terms will tighten dramatically owing to rising defaults; an increasing share of households will be too underwater on existing loans to finance a new car; and the sub-prime sector will go into shutdown mode, as it did after 2008, when the plug is abruptly pulled on its junk bond financing and private equity sponsorship.
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