Should You Steer Clear Of Auto ETFs And Stocks?

After registering the first annual sales decline since the financial crisis last year, the auto industry has been struggling with weak sales this year. This is especially true as car sales dropped 2% year over year to an annualized 17.08 million units in February, after rising 1.2% in January. The weak performance came on the heels of lower discounts.

Of the six major American and Japanese automakers, Ford Motor F and General Motors GM posted the biggest sales decline of 7% each, followed by declines of 5% for Honda HMC, 4% for Nissan Motor NSANY and 1% for Fiat Chrysler FCAU. Toyota TM saw an increase of 4.5% in its sales last month. General Motors and Fiat Chrysler have a Zacks Rank #2 (Buy), while the other four automakers have a Zacks Rank #3 (Hold).

The only pure play auto ETF is the First Trust NASDAQ Global Auto ETF CARZ. It offers global exposure to the 34 auto stocks by tracking the NASDAQ OMX Global Auto Index. It is a large-cap centric fund and is highly concentrated on the top five firms – Honda, Toyota, Daimler, General Motors and Ford – with a combined 38.6% share while other firms hold no more than 4.38% of assets. In terms of country exposure, Japan takes the top spot at 25.9% while the United States and Germany round off the next two spots with at least 19% share each. CARZ has a lower level of $20.8 million in AUM and trades in a small average daily trading volume of about 5,000 shares. The product charges 70 bps in fees per year and has a Zacks ETF Rank #3 with a High risk outlook, suggesting some room for upside.

What Lies Ahead?

The year 2018 seems to be a challenging one for automakers, with many market experts expecting auto sales to fall below $17 million. A strong economy, low unemployment, increasing consumer confidence, higher spending, fuel-efficient and technologically enriched vehicles, and low financing rates and gasoline prices will continue to fuel the industry.

Strong earnings expectation is an added boost as the sector is expected to return to growth. For the full year, earnings for the sector is expected to growth 0.8% and revenues are expected to rise 2.7% versus a decline of 2.2% and 1.6%, respectively, last year.

The tax reform will provide a lift to U.S. sales but at the same time also encourage rate hikes, which will make financing of new vehicles expensive. Trump's intention of imposing heavy tariffs on imported steel and aluminum would be a big blow to the industry as it would increase the cost of auto production. Notably, the auto sector accounted for 26% of demand for steel in the United States in 2017, behind the construction industry, at 40% of demand in 2017, according to data provider Statista.

Further, the shift in consumers, preference from passenger cars to more profitable pickup trucks and SUVs, as well as longer usage of vehicles will continue to be a drag on sales. The average age of vehicles on the road has climbed to 11.6 years from 8.8 years in 1998.

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