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Trading  | July 1, 2017

We’ve spent a lot of time of late writing about the pending collapse of the U.S. auto bubble.  When it comes, that collapse will, at least in part, be due to the fact that over the past 6 years, new leases, as a percent of overall car sales, have soared courtesy of, among other things, low interest rates, stable/rising used car prices and a nation of rental-crazed citizens for whom monthly payment is the only metric used to evaluate a “good deal”…even though leasing a new vehicle is pretty much the worst ‘deal’ you can possibly find for a rapidly depreciating brand new asset like a car…but we digress.

Of course, what goes up must eventually come down.  And all those leases signed on millions of brand new cars over the past several years are about to come off lease and flood the market with cheap, low-mileage used inventory. 


By the end of 2019, an estimated 12 million low-mileage vehicles are coming off leases inked during a 2014-2016 spurt in new auto sales, according to estimates by Atlanta-based auto auction firm Manheim and Reuters.

Auto Leases


And, of course, that kind of supply increase will take it’s toll on used car prices…with Morgan Stanley recently noting that used car prices could drop by up to 50% over the next 5 years.


But apparently America’s “rental society” is rubbing off on Europeans and it has some auto ABS investors across the pond a bit worried about what it might mean for used car prices.  Here’s more from Bloomberg:

“If there’s a steeper decline in car values, then borrowers will be incentivized to return their vehicles and it will be bondholders who bear any losses,” said Aaron Baker, a London-based credit analyst at Banco Bilbao Vizcaya Argentaria SA. “This exposure to used-car prices could be catastrophic.”


While residual values have been securitized in the U.S. since at least the 1990s, Europe is now catching up. The number of transactions backed by residual values in the region rose to 14 in 2016 from just one in 2009, according to UniCredit SpA.


Almost 80 percent of the 6.2 billion euros ($7.1 billion) of auto-debt securitizations sold in Europe this year included cash flows from residual car values, up from 47 percent in 2012, according to data compiled by JPMorgan Chase & Co. In the U.K., deal exposure last year rose to as much as 55 percent from less than 20 percent in 2015, UniCredit data show.


But it’s not just leasing that’s taking hold…it seems that Europeans have generally embraced the creation of their own consumer credit bubble with 85% of cars now being financed versus only 50% back in 2009.

The trend toward securitizing residual car values is also being fueled by a rapid expansion of consumer credit. More than 85 percent of new cars in the U.K. are now financed, up from just over half in 2009, according to data from the FLA trade group. Most of that debt consists of so-called personal contract purchase agreements, which are similar to short-term leases and encourage buyers to return cars at the end of the contract.


That’s putting downward pressure on second-hand car prices, according to Moody’s Investors Service. It’s also increasing household borrowing, making automakers and consumers more vulnerable to any increase in interest rates.


“There’s no guarantee that actual residual value cash flows will match the expectation,” Moody’s warned in its rating of a Volkswagen AG deal in March.

Of course, we all know how this movie ends.  So, to our European friends, enjoy the centrally planned credit bubble while it lasts because when it all comes crashing down it is slightly less than pleasant.

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