The big risk right now is that the only buyers have started to pull in their horns!  Stock buybacks, which have helped power the 7-year-old bull market, are showing their first signs of retreat in at least three years.  Share repurchases are tracking at a 21-month low in March, according to respective data from S&P Dow Jones Indices and TrimTabs.  If the trend continues, that would mark a major trend shift.  Companies have been using reductions in share count as a way to boost earnings profiles, raise stock prices and reward corporate executives.  The programs have been seen as a major driver of the market rally, though the extent of the effect has come under scrutiny in recent months.  The most recent trend shows that buybacks have dwindled to $23.5 billion in March, just a month after hitting a 10-month high of $94.6 billion.  S&P500 companies have committed more than $2.7 trillion to buybacks since the market bottomed back in March 2009.

Why are stocks in the auto sector trading at such cheap valuations?  The top U.S. auto companies such as GM and Ford as well as Canadian auto parts companies such as Magna and Martinrea are trading at 6-8 times earnings and 3-5 times operating cash flows.  Investors are clearly not comfortable with the outlook after annual production in North America has increased by over 50% from the 2008 lows.  They believe that auto sales for this cycle have peaked.  Some of this belief comes from the performance of bond issues that are backed by auto loans.  One such example is a bond issue called Skopos Auto Receivables Trust 2015-2.  The bonds were built out of subprime auto loans and sold in November. Through February, about 12% of the underlying loans were at least 30 days past due.  In another 2.6% of loans, borrowers had filed for bankruptcy or the vehicles had been repossessed.  Those borrowers are at the outer fringe of the auto market. Still, the high level of missed payments for loans made so recently is a warning sign for an industry that needs every customer it can get to keep sales increasing at a record pace.  The early delinquency rates seen in the debt issue from Skopos are in line with those for several similar bond deals from other lenders around the same time.  About 12% of the loans backing bonds sold in November by Exeter Finance Corp., another Dallas-based subprime lender, were more than 30 days delinquent through February.  Loan payments have been slipping as well for the broader group of subprime borrowers who make up a big slice of the auto market. The 60-plus day delinquency rate among subprime car loans that have been packaged into bonds over the past five years climbed to 5.16% in February, according to Fitch Ratings, the highest level in nearly two decades.  What seems to worry investors most is that what is driving record auto sales is not the economy, but record auto lending.  Demand for auto debt has led lenders to systematically loosen underwriting standards, resulting in higher loan delinquencies.  While most analysts have shrugged off talk of a subprime auto-loan bubble, the increase in defaults does cast a bit of a pall on the outlook for future auto sales!

Finally, we continue to have worries about the banking system in China and believe that the economic problems in China are deeper than most investors realize.  They cannot make a significant adjustment to economic growth, because they already have enormous excess capacity.  Almost 50% of their GDP comes from investments.  That is way above even the worst of the Japanese bubble.  At its peak, government and private investment in Japan totalled 33% of GDP in 1990.  The bulk of those investments are very unproductive, often referred to as ‘ghost cities and factories’ and ‘bridges and rail systems to nowhere.’  Moreover, most of these investments have been financed via a ‘shadow banking system’ where lenders have yet to accept the write-downs of their loans.  The reality of these issues may finally be coming to light.  The Bank of China said losses on bad loans, which rose 22.5%, to 59 billion yuan, have dragged down profits.  The bank, now the fourth-largest worldwide, said non-performing loans rose over 20% in the past quarter to 1.43% of total loans.  Standard & Poors rating agency cuts its outlook on China’s AA- credit rating to negative from stable. The move suggests a downgrade is possible in the coming weeks.  Stay tuned; the real losses on these loans could be substantially higher!

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