The US auto industry is coming apart at the seams, says Eric Roseman. The ‘Big Three’ are bleeding profusely, and face bankruptcy without a government rescue. If one of General Motors (NYSE:GM), Ford (NYSE:F) and Chrysler is allowed to fail, Eric says the stock market will crash through its 2002 lows. This means investors should stay underweight stocks for the time being.

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In 1955, U.S. manufacturing was approximately 55% of the nation’s GDP. Today, manufacturing is barely 15% of GDP as the United States and other industrialized countries continue to transition to service-based economies. Unfortunately, the backbone of American industry is now coming apart at the seams and desperately hungry for a government bailout.

In 2004, I predicted that one of the Big Three auto companies would fail in a few years. Though not a bold forecast by any measure - the autos were long bleeding before 2004 - my target back then was Ford. At the time, I plugged put options on Ford Motor and made a profit on that trade; now I wish I had purchased long-term LEAP put options. Ford in July 2004 traded north of $13; today, Ford Motor (NYSE:F) fetches just $1.76.

Ford’s stock price chart starts to resemble everything else…

Detroit is home to America’s Big Three auto companies. It’s also home to one of the worst contractions in manufacturing activity accompanied by seemingly never-ending losses.

General Motors (NYSE:GM), Ford and Chrysler are bleeding profusely and need emergency cash funding right away. Of the three, General Motors is headed into bankruptcy first unless the government comes to the rescue.

The world’s second largest car company (Toyota is now #1), GM has just enough cash to last until January at the latest. Chrysler and Ford probably have enough funding for another 6-12 months. Beyond that period, it’s Game Over.

Bailout Bonanza

The scope of Washington’s bailout reach is now extending: mortgages, banking, investment banking, insurance and now auto manufacturing. Pretty soon it might extend to the airlines, real estate companies and who knows, maybe even every industry that comprises the S&P 500 Index. This whole bailout thing is totally out of control.

Should the government let the Big Three fail? Combined, these three goliaths employ more than 300,000 people worldwide with most of that total in the United States. The pressure is on the government to bailout the autos. Paulson isn’t too keen on extending TARP to the auto companies but Obama certainly is. I reckon Detroit’s odds of obtaining a bailout are pretty good.

With the economy showing no signs of bottoming as we shortly conclude a miserable 2008 for investors it would only seem prudent to remain underweighted stocks. The market shows no convincing ability to bottom; every major rally is met by big selling as investors eagerly grab short-term gains to raise cash.

This recession will be a long, drawn out affair, probably lasting throughout 2009, possibly 2010. Housing is at the core of this secular bear market. I don’t see housing bottoming or at least stabilizing until at least mid-2009 with inventories still rising in Q3. Mortgage rates, which declined following the initial Paulson Fannie Mae and Freddie Mac government guarantee in September, have since risen again. Mortgage rates must come down.

It’s now time for America to become thrifty again. The correlation between a rise in the savings rate and corporate earnings growth is negative. Earnings expectations remain too bullish for 2009 and must still be revised lower. Earlier this fall I had expected a rally following the post-October 9 crash; thus far, the Dow is up just 7% off its low for the year or 42% off its October 2007 high. Now I’m beginning to think we might test fresh lows and soon.

Equity Markets in line for another Beating

The Dow will test its October 2002 low of 7,286. In my mind, there’s no way this bear market is not as severe as the 2002 debacle. It’s much worse.

Should stocks decline another 15% from current levels the Dow would sit 57% off its best level in October 2007 but still about 30% above the trough of the 1932 lows. From October 1929 until late 1932, the Dow collapsed a cumulative 86%. I doubt we’ll see that sort of spectacular decline; yet it’s pretty likely that a 42% peak-to-trough loss thus far won’t kill this bear.

If one of the Big Three is allowed to fail, watch out. That would trigger another crash. The market is drunk, expecting another industry bailout. Let’s not disappoint Mr. Market.

Source: The Beginning of the End for U.S. Auto Manufacturing