Whenever you notice people have stopped applying common sense to their investment decisions, it might be a good time to go looking for an exit.
Here’s something you might not have noticed today:
So that’s Santander Consumer and it’s down sharply after announcing it would delay reporting Q2 results due to ongoing discussions with accountants. Here’s the official statement:
“The Company is in discussions with its current and previous independent accountants regarding certain accounting matters, primarily related to the Company's discount accretion and credit loss allowance methodologies.”
As you may or may not know, the company was until recently chaired by Blythe Masters, a legend in the industry and the mother of the credit default swap. She stepped down earlier this month to focus on her interests in blockchain.
The reason we mention that is because as the mother of the credit default swap, Masters knows a thing or two about securitizing assets. Well do you know what Santander Consumer does? They securitize subprime auto loans. Have a look at their latest offering:
(Source: Company report)
What should stick out there is that 44% of the car loans in the collateral pool that back the notes are to borrowers with FICO scores below 600 and 15% of the loans in the collateral pool were made to borrowers with no FICO score at all!
That is the exact same thing that happened in the lead up to the financial crisis, only this time around, the people buying this paper are helping to finance a used Honda Civic for waitresses rather than McMansions for exotic dancers.
Circling back to where we began, that’s what we mean when we talk about the absence of common sense. If you’re in the securitization business, bundling used car loans to people with no FICO score is absolutely a bad idea. Now you’ve got accounting problems and who knows what else going on “under the hood,” so to speak.
If you think that’s a failure on the part of investors to recognize an example of common sense being abandoned wholesale, it’s nothing compared to investors’ haphazard attitude towards the broad market.
We saw a headline earlier today that read as follows: “The Bear Thesis Is Dead, The Bulls Are In Control.” Consider that and then have a look at the following chart:
(Chart: Goldman)
There we are trading at 18 times forward earnings. Do you know how many times outside of the tech bubble we’ve traded above 20X over the last 40 years? None. Zero. Here’s Goldman:
“The current 75% P/E multiple expansion cycle is unlikely to continue. [The] already extended P/E multiple of 18x represents the 88th percentile of historical valuation.”
Meanwhile, this is what the economy looks like in historical context:
(Chart: Goldman)
And as you can imagine, anemic economic growth leads to anemic sales growth:
(Chart: Goldman)
Here’s Goldman again in case that chart isn’t clear enough:
“During the last 10 years, S&P 500 revenues have expanded at an annualized pace of 2.9%, nearly the slowest pace in history.”
Now obviously, that shouldn’t bode well for corporate bottom lines but fortunately, the denominator in the P/E equation is amenable to manipulation. So if you can just “adjust” that figure a bit higher with some combination of financial engineering and non-GAAP shenanigans, well then, your stock looks that much cheaper. Unfortunately however, even those tricks aren’t working any more as evidenced by the fact that we’ve spent the last four quarters in an earnings recession.
In terms of common sense, it’s safe to say that “Elvis has left the building” on this market. If he found an exit, you can too.
Happy trading.
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