Auto Manufacturing: An Industry Whose Time is Up

(Original article appeared on my seekingalpha blog)

It looks like GM has tentatively agreed to sell its Saturn brand, only days after agreeing to sell its Hummer brand to a Chinese company. Finally it seems GM is taking steps in the right direction, shedding non-core assets and brands and closing dealerships. I’m sure that the current economic crisis and the heavy hand of government played no small part in helping encourage these transactions. The question of the day is, “Why didn’t they do this sooner?”. I’m by no means an expert on the subject but it seems obvious that the auto industry has been in trouble for years. Anecdotal stories of unsold cars piling up in parking lots, 0% financing, cash back incentives, free OnStar/satellite radio, years of free warranty coverage, etc, have been used for some time now to move cars from the factory floor into the hands of consumers. These do not seem to be signs of a healthy industry, poised to relive the glory days at any moment.

Of course it’s easy to judge managers with the benefit of hindsight, but it does beg the question of what was the fallback plan? Did management really think that sunny days for the industry were just ahead? Why didn’t management pay down debt during the “good times” to put this company in a better position? We don’t know what GM is getting for the sale of the Hummer and Saturn brands, but odds are it is near fire-sale prices. Why GM didn’t take action sooner to reduce debt (by selling assets at far higher prices), restructure the business and re-steer this Titanic in a new direction is worthy of question. Maybe the unions are to blame? Or maybe a version of the Greenspan/Bernanke put was just too tempting to resist for highly paid managers that didn’t want to “rock the boat”? Sadly I think Tom Velk of McGill University said it best:

“The auto industry today is like the textile industry in the UK in the 19^th century. It’s bound to go to the emerging nations: India, China. India has a $4,000 car. […] It’s an industry whose time is up.”

(See video here)

The government has made it clear that it wants to see auto manufacturing stay in North America, and in the end, a solution likely will be found. But bailouts and rescue packages are merely prolonging the inevitable in my opinion (as much as it saddens me to say it).

Disclosure: no positions.

Musings from a Market Meltdown

They say keeping a diary during times of extreme market crisis can be useful for reflection purposes. Let me just say that the crash in the fall of 2008 was enormously stressful. I can’t begin to describe the stress of watching this market from the front row seats, gory day in and gory day out. It started out bad and then got worse. No one called how bad it would get (well, almost no one). It began when the markets dropped by 20% and everyone said it was the technical definition of a bear market. Then every day it seemed the market would go down by 200, 300, 400, 500 points or more. One day the TSX index was down over 1,000 points in one day! I emailed a friend and said “Black Monday, in our lifetime”. This crash was every bit as severe as the 1929 stock market crash, only the timing was different. Instead of one big crash it was a series of cascading crashes, or “death by a thousand cuts” as some say. The problem is, everyone also knew that the rebound would be swift and violent. 80% of the gains in a new bull market are made off the bottom, everyone says. But trying to pick a bottom was an exercise in futility. The VIX index was over 80, daily volatility was 400 points or more. I can’t count the number of times I placed a long trade, trying to pick a bottom, only to get stopped out and then have to try again. I liquidated much of my holdings but not enough. I still lost a lot money, as did many people. It seemed like nothing worked anymore. The Bollinger bands, at 2 standard deviations from the moving average no longer worked anymore. The market would break on the downside, then break some more. As they say, the market can stay wrong longer than most people can stay solvent. Everything got hammered. I started to think that nothing worked anymore. Technical analysis, fundamental analysis, everything seemed broken. The market could go to zero, the experts would say. The VIX could go over 100 or more. But part of me wanted to buy. A very smart portfolio manager I know said, “If you just landed here from Mars with money in your pocket, you would feel like a kid in a candy store when looking at valuations of solid blue-chip companies.” Valuations had come way down in a short amount of time (but many said they would go down further). Dividend yields were high (on a relative basis). Forecasts were so dire, everything looked so bleak. Hedge funds were liquidating. Debt was abhorred. It was thought that all companies with large debt levels (relative to cash flow) would simply go out of business. I knew it was irrational. I made some good purchases in corporate debt at the time. The problem too is that all correlations go to one in a crisis as everything goes down, and large caps rebound far more quickly than the small caps. Tax loss selling was rampant. People were scared, they didn’t know whether to buy or sell (but mostly they sold). Margin calls were rampant. Forced liquidation. Warren Buffet’s, “Be fearful when others are greedy and be greedy when others are fearful” rang in my head. But to act on it was nearly impossible. Working in the finance industry and trying to invest in it seemed counter-intuitive. We all feared we would lose our jobs at any day. Cash was king to fund the seemingly inevitable unemployment and mortgage payments (that have a surprising regularity about them). It seemed the entire capital markets system was thrown on its head. Forecasts of the Dow sub 600 were published and believed by many (similar to Dow 100,000 on the upside). Then, without warning the market snapped back. Thanksgiving Day (in Canada) the market was up over 1,000 points in a single day. In January 2009 the weekly technical indicators flashed a buy signal, but I didn’t believe it, and the market went down some more. Then in March 2009, when it seemed like the market would go down forever, it turned sharply upwards. No one believed it at first. As usual, the markets “climbed the wall of worry”. More forecasts came out, saying the entire finance and insurance industry was going bankrupt. Just like that, a few points at a time, the market climbed higher. Up 30%, then 40%!! Still people didn’t believe it. “The next leg down is coming” people would say. But the smart money made money. Those who were willing to put up risk capital during the most dire of times made money. Big money. 200%, 300% or 500% in some cases! I too underestimated the impact of tax loss selling, particularly in the junior sector. Canada was an especially interesting case, as the markets rallied here stronger and longer than in the US. While the markets topped in July 2008, the US topped out earlier. With the devastation that took place in the fall of 2008 it created a unique situation. Gains from earlier in the year had been replaced by paper losses, hence triggering a larger tax loss selling season. Thus the predictable response, with the small caps rallying immediately and violently in the beginning of 2009 as investors bought back everything that had been dumped more than 31 days earlier (the minimum amount of time prescribed by the tax code to declare a capital loss). It was a time of opportunity but I didn’t capitalize nearly enough. Governments continued to throw money at the problem, and were quick to proclaim that things were on the mend at the first sign of positive indicators on the horizon. It was an experience that I'm not eager to repeat any time soon. Post Script (Sep 2010): I remember Jim O'Shaughnessy on BNN saying, "This is a once in a lifetime opportunity to buy stocks" and looking at the charts it seems easy. I can imagine my kids looking at an old stock index chart and asking "Dad why didn't you just buy at the lows - everyone knows the stock market will go back up one day." And yet to buy then was exceedingly hard. No one knew how long it would last. Like Buffett who started buying in the early 80's, it took over five years for his position to be validated. A lot can happen in 5 years. It's really really hard to ignore the dire media reports and buy. Hence I did not capitalize on the situation as much as could or should have in hindsight!