Picture Paul McCartney sitting at a bus shelter near his home on Liverpool’s Penny Lane waiting for John Lennon to meet him. There, he took note of a barber’s shop with a picture of its clients and a nurse selling poppies for Remembrance Day, November 11th, the day World War I officially ended. McCartney later turned these images into a number one hit in the U.S. But because the February 1967 release was a double-A side single with “Strawberry Fields Forever,” it failed to reach number one in the U.K. Double A-sides didn’t feature a B-side and both sides are prospective hits with one side promoted more than the other. As an aside, did you know that “Penny Lane” had no guitar part? It was only John Lennon on piano and George Harrison playing the conga drum. Despite not topping the U.K. charts, the song was so popular that street signs on Penny Lane began disappearing after its release. The town wisely painted “Penny Lane” on buildings to avoid further theft.
You never want to find yourself at the intersection of Penny Lane and Wall Street. Penny stocks can yield massive short-term returns from hugely discounted prices. But a penny stock is nearly worthless with good reason.
Generalities aside, the U.S. used vehicle market has two companies – Carvana (purple line) and Vroom (light blue line). Both have been trading towards penny lack of status. CarMax (orange line), the nation’s largest used-car retailer, has been trading in kind with its online rivals. AutoNation (pink line), the largest auto retailer in the U.S. which generates 35% of its sales from the used vehicle market, has outperformed. Year-to-date, Carvana is down -97%, Vroom is off -91%, CarMax has declined -51% and AutoNation has fallen a lesser -4%.
Disclaimer: We’re not providing advice on single name stocks; instead, the examples of Carvana and Vroom feed the macro story as it pertains to the highly relevant used car market.
The business model for these companies is predicated on rising used vehicle inflation. Any adult in the year 2019 would have known that’s an oxymoron. Carvana and Vroom, which did buy high, are now faced with selling low. In other words, their inventory and business models are upside down, which manifested as such: Carvana’s stock price peaked on August 10, 2021, at a price of $370.10. Yesterday, it was trading in the vicinity of $7 per share.
As for the broad used vehicle market amidst a pandemic that caused new car inventory to vanish:
- In the 808 months from December 1953 to March 2021, there were only 22 months that registered a used vehicle CPI inflation rate of 20% or more — a 3% hit rate.
- In the 13 months from April 2021 to April 2022, every month posted an inflation rate of 20% or greater for a 100% hit rate.
Bubbles tend to pop, not gently deflate. In September, used vehicle CPI was running nearly one-third April’s pace, or a 7.2% year-over-year (YoY) rate (green line). Despite its small weight in the CPI of roughly 4%, over the 12 months ended September, used vehicles alone added 0.3 percentage point to the 8.2% CPI inflation rate. Scaling this to underlying inflation, the contribution was 0.4 percentage point of the 6.6% core CPI rate.
This week’s report on the Manheim Used Vehicle Value Index revealed a 2.2% seasonally adjusted month-over-month decline in October, which generated a -10.6% YoY decline (yellow line). Manheim noted that all major market segments saw seasonally adjusted prices that were lower. Even though Manheim tracks wholesale prices, prior to the pandemic, it led the CPI by five months with a correlation of .70. Post-COVID, that lag time has shortened to two months with a correlation of .96. Even if it doesn’t show up in the data tomorrow, used vehicle deflation is a done deal in 2022 and set to accelerate.
Yesterday, Transunion, which tracks more than 81 million auto loans, said 60-day-plus delinquencies hit 1.65% in the third quarter, the highest in at least a decade. As reported by CNBC, “The biggest impact is being felt among subprime borrowers.” We put in a message to the consumer credit reporting to ascertain the extent to which subprime is underperforming. Would you believe it? Crickets.
As we’ve written extensively in Quills, lenders are holding repossessed inventory from auction to delay recognizing losses on soured loans. The source of stress is that unqualified borrowers didn’t have to make payments for a very long time. Per Transunion, approximately 200,000 auto loans that previously took advantage of the pandemic-era accommodation are now listed as 60 days delinquent. “About 100,000 accounts that are more than 60 days delinquent remain in accommodation programs.” It’s been 31 months since the CARES Act was passed which created all manner of forbearance and some debts still aren’t being collected.
Are markets sniffing out the fire sales to come? Carvana’s credit default swap (CDS) curve has inverted (third chart) – a default within six months or one year has a higher probability than two to five years. Investors are insuring against an immediate default. We don’t know if Carvana will land on penny (stock) lane, but S&P has slashed its credit rating to CCC+. Regardless of the fate of one firm, collapsing used vehicle prices will provide relief on the inflation front for months to come, if not longer.