The following commentary and short idea is from the latest issue of my Short Seller’s Journal. This is a weekly newsletter with economic and general market analysis as well as my favorite short ideas based on in-depth fundamental analysis. You can learn about the newsletter here: Short Seller’s Journal information.
I truly believe that what we’re seeing in the stock market is the anticipation of the Fed abandoning rate hikes after this month’s and possibly cutting rates starting in early 2024. In addition, I think the market actually believes in Santa Claus in the form of a soft landing or even no recession. Ironically, the economy is already recessing – just look at the latest retail sales report. The expression of the market’s view is in the format of hedge fund algo gamma squeezing, rabid short-squeezing and drooling retail idiots throwing everything they have at tech stocks and risky call options.
Investors are heaving cash at tech stocks. According to data from EPFR (EFPR is a provider of fund flows and asset allocations data), another $1.9 billion flowed into tech funds for the week ended July 19. This is cash from individuals – high net worth/retail – who in my opinion are being led to a slaughter. This was the pattern after the tech bubble popped. After the first part of the bloodbath, retail doubled down on their tech bets and lost even more money in the next big leg down in the stock market. In addition, per the NAAIM (National Association of Active Investment Managers), active managers’ exposure to the stock market has soared to 99%, up from less than 20% in October 2022 and the highest since November 2020.
Consumer spending is also slowing. A Fed survey released on July 16th showed that credit applications for any type of credit declined to its lowest level since October 2020. The overall rejection rate of credit applications increased to 21.8%, the highest level since June 2018. The rejection rate for mortgage purchase applications rose to 13.2% – i.e. 13.2 applications per 100 are denied. Auto loan rejections are at an all-time high. Based on real retail sales and credit applications, the consumer is in a recession.
But there’s more. It would appear that a lot of consumers are squeezed for cash. A report on July 7th showed that Google searches on the term “pawn shop near me” started rising in January and hit an all-time high at the beginning of July. This is further evidence that households are getting squeezed by the depletion of savings and persistently high inflation for necessities.
The Philly Fed index remained at -13.5 in July, which was its level in June. Wall Street was forecasting -10. This is the 10th straight month of contraction. The index continues to reflect the contraction of manufacturing activity in the Philly Fed region. The new orders index further declined to -15 from -11 in June. This is probably the most telling indicator of manufacturing activity and wholesale/retail demand for manufactured goods.
Retail sales rose 0.2% in June from May, missing the Street forecast of 0.5%, and were up just 1.49% YoY vs Wall Street’s consensus of 1.6%. There’s not a lot to dissect in the report but I’ll note that using just the CPI measured inflation real retail sales (“unit” sales) declined in June on a monthly basis and declined even more on a YoY basis. If the Shadowstats number for inflation is used, the decline in real retail sales is deepe. The Redbook index of same-store sales declined 0.2% vs the same week in 2022. It was the second week in a row of YoY weekly declines. Of course, ex-inflation the decline is larger. Put a fork in the consumer.
Existing home sales for June were down 3.3% from May on a SAAR basis (seasonally adjusted, annualized rate) and down 18.9% YoY from June 2022. Not seasonally adjusted existings fell 17.2% from June 2022. I think that metric is a cleaner indicator of the demand for used homes because it isn’t cluttered with statistical hocus-pocus. The Chief Goon for the NAR, Larry Yun, remarked that falling sales are a product of low inventory. Yet, new home-builders are sitting on a record amount of inventory with plenty of supply of finished new homes nationally. Moreover, the months’ supply of used listings rose to 3.1 months, up from a 52-week low of 2.6 in March, 2.7 in 2022 and 2.3 in 2021.
It would be more accurate for Yun to just admit that the average potential homebuyer just can not afford to buy a home if they are renting or move-up to a better home if they own their home (more like, rent it from the bank). And now that the Fed loosened up financial conditions in the banking system to prop up regional banks, home prices are quite “sticky,” further exacerbating low affordability conditions. In June the average price of a used home was $410k, up from $361k in January 2023 and up 3.3% from May. $410k is the second highest average price ever for used homes.
I have been pounding the table on Autonation (AN – $150) as short for a while. I reiterated that call two weeks ago as the stock was cresting at $180. AN’s share price was hammered for $21.81 (12.33%) Friday despite posting the customary earnings “beat.” Revenues basically were flat YoY for the quarter but the gross profit on new and used vehicle sales declined due to heavy price discounting. Operating income dropped 3.7% and net income plunged 27.6%. Part of the reason for the hit to net income is the Company’s interest expense more than doubled YoY (floorplan financing, which is short term-based rates and general debt expenses).
Management said that it expects profit margins to continue falling as the Company attempts to maintain unit sales via discounting, with fewer vehicles sold at the sticker price. Though new vehicle revenue increased by $345mm YoY (12%), this was more than offset by the $432mm decline in used car revenue (17%). Autonation further said that it expects used car prices to fall further in Q3 (on average, used car prices are down 17% YTD). Inventory continues to balloon as sales slow. Currently new vehicle inventory is at 26 days of supply, up from 19 days at the end of 2022. Used vehicle supply is 35 days vs 31 days at 2022 year-end. Lower inventory turns also hurts profit margins.
With AN’s market cap nearly doubling since the beginning of October 2022 in the face of deteriorating business fundamentals, it was just a matter of time before the stock chart served up a daily candlestick like the one on Friday. I mentioned in last week’s issue that I was looking at August or October puts. I ended up buying October $155’s on Monday and added to the position on Tuesday nearly a dollar lower in price. Little did I expect that the puts would be at the money this quickly. I sold half Friday morning but I plan to hold the rest for a while. If the stock trades higher from the current level, I’ll likely invest in some even longer-dated, further OTM puts. I see no reason why this stock shouldn’t retrace back to $95 or lower by year-end.