General Motors Company (NYSE:GM) is not my favorite stock. I’ve never owned GM — or any car manufacturer — because of how any change in economic conditions affects them. Right now, however, my biggest long-term concern for GM stock (and other car manufacturers) is that the U.S. consumer is over-leveraged again.
And that debt is going to wreak havoc at some point.
The State of the Consumer Is Shaky
The NY Federal Reserve’s Q3 of 2017 data trends on U.S. consumer debt is pretty awful.
Particularly concerning: the credit quality of auto purchasers is getting worse.
Looking at page 8 of the data trends, you’ll see that while those with credit scores of 720 or above have borrowed in roughly stable amounts going back to the financial crisis, those below 720 have been increasing. The 660-719 tranche has increased loan quarterly lending from $10 billion in Q1 2010 to more than $30 billion in Q3 2017. The 620-659 group has grown from about $9 billion to $20 billlion in the same. And the big subprime borrowers — with 620 or below — have grown from about $14 billion to $30 billion.
On page 12, all this debt is starting to default, with auto loan delinquencies moving from about 3% to 4.5%.
Meanwhile, the transition into delinquency has risen from 7% to 7.7% over the past five years. The transition into serious delinquencies (90 days plus overdue) went from about 1.7% to 2.3%.
Why do we care?
Here’s the problem. People are not using free cash to buy cars, or much of anything else. So they buy cars using debt, and now the rate of default is rising.
GM stock is heavily dependent on its finance business. Even a tiny uptick in defaults can wipe out huge profits in good accounts. If the default rates continue in this direction, and they will, that will impact profits at General Motors.
When there is a default on a loan, the principal still has to be collected on. If it isn’t, the loss for GM negates the profits from several other loans.
Let’s say the average interest rate on all cars is 8% of the car’s value. (It isn’t that high but bear with me.) That 8% is GM’s profit from each car loan. But, if just one car loan blows up, the 8% interest rate 12 other loans is negated. This is because the loss of an entire principal is equal to the profit from 12 other loans.
As defaults increase, demand for used cars — the ones most likely purchased by subprime lenders — decreases. Therefore, prices decrease.
Bottom Line on GM Stock
As used car pricing declines, it cascades to new car buyers. They figure they can get a used car way more cheaply than a new one, and then new car demand falls.
It’s the same with trucks. Thus, GM stock is beholden to this undercurrent of credit use that is bad for everyone.
There is also the ongoing problem regarding transportation network companies (TNC). Services like Zipcar and Uber are making it easier for people to forgo car ownership. For many Americans, getting rid of their cars completely is becoming a more economical choice. That means people will buy fewer cars, both used and new.
That’s why I don’t like car stocks, not even GM stock.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance and is the Manager of The Liberty Portfolio at www.thelibertyportfolio.com. He does not own any stock mentioned. He has 23 years’ experience in the stock market, and has written more than 2,000 articles on investing. Lawrence Meyers can be reached at [email protected].