Research & Commentary

Deflation in Auto Industry Looms

The tires of the U.S. auto industry have been pumped up with credit. They may be about to deflate.

Inflation is an increase in the amount of money and credit in an economy. Deflation is a decrease in the amount of money and credit in an economy. The cycle of inflation and deflation, especially with regard to credit, repeats time and again because it is driven by irrational, herding crowds of humans. A build-up of excessive credit in an industry or economy (inflation) inevitably leads to deflation. This has been proven throughout history, yet we humans continue to sustain the cycle because, collectively, we are irrational economic agents. In the mid-noughties, it was subprime lending in the real estate sector that fueled a boom which led to the inevitable bust. Now it could be the auto industry’s turn.

“I was basically putty in their hands, totally swept off my rational sensible self, drawn into this vortex,” the Financial Times quotes a subprime borrower as saying when asked about how she was sold a new Chevrolet SUV back in 2012. According to the May 2017 article, she was still struggling to pay the $10,000 balance of the original $16,000 loan. The Chevy was by then worth around $750 second-hand. Her experience, and many like it, have seen some fines levied against providers of auto credit. Yet the credit boom has just kept going. Issuance of auto-related, subprime Asset-Backed-Securities (ABS) this year is (so far) on course to beat last year’s record of $25.4 billion.

The chart below shows the share price of Credit Acceptance Corporation (ticker, CACC), one of the biggest subprime lenders in the auto industry. The price has just reversed from the upper bound of a long-term trend channel – it’s difficult to tell from this logarithmic scale chart, but the share price dropped by 20% just days after the channel was touched. And just look at the volume. Volume tends to expand dramatically as trends mature. Back in 1995, it was after the share price had advanced over 1,000% since 1992. Then, volume exploded again in 1997 after CACC had started a decline that would eventually see it lose 91% in value. Now, a Fibonacci 21 years later from that nadir, and with the share price of Credit Acceptance Corp. up some 15,000%, we can see that volume has once again expanded dramatically. For us, this is as clear a sign as any of a bubble in subprime lending for the auto industry. When it bursts, and this chart is alluding to it being sooner rather than later, the deflation that ensues may be quite historic.

After the real estate crash, subprime lenders were accused of dangling the dream of property ownership to those who could not afford it. The dream of owning that big shiny truck could be going the same way.

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