Are Auto Stocks Running Out of Gas?

Auto sales have been on a roll lately as vehicle demand has now swung back to pre-recession levels.

The Wall Street Journal on Sept. 5 summed up the industry's current situation quite well with its headline, "U.S. Car Sales Soar to Pre-Slump Level". The purchase of 1.5MM new vehicles in August solidified a month that was up an astounding 17% from a year ago as all the major carmakers saw double digit growth.

The Fed's Beige Book, released as a precursor to the Fed's Open Market Committee meetings, agreed that the auto industry is on solid ground as it found economic growth "remained modest to moderate, led by demand for cars and housing-related goods."

Share prices of most of the car companies meanwhile were up across the board in the first week of September with Ford (NYSE:F) up over 5%, Toyota (NYSE:TM) up 4%, and General Motors (NYSE:GM) up over 6%. Newcomer on the block, Tesla (NASDAQGS:TSLA) was the lone outlier, down for the week, but up 354% YTD as expectations for the company remain extremely elevated.

So, should you buy these equities or the auto ETF, the First Trust Global Auto Index Fund (NYSEARCA:CARZ)?

The Technicals are Strong

The chart below of CARZ (NYSEARCA:CARZ) sure looks good. The ETF that tracks global auto stocks has been in an uptrend since 2012 and has also been outperforming the S&P 500 (SNP:^GSPC) over the same time. This relative strength means it has been a better investment than the S&P 500 over the last year.

To see larger chart image, click here. That outperformance continues today, but has started to wane somewhat as the bottom portion of the chart shows the relative strength has recently been tested. However, as long as its price action can maintain above these two trendlines, CARZ will remain in an uptrend.

CARZ owns all the major carmakers and (see table below) and the froth of this sector is perhaps no better reflected than Tesla (NASDAQGS:TSLA) now being a top 10 holding. Wall Street's casino players have driven up Tesla's market value to $20 billion. That makes Tesla larger than Fiat-Chrysler (F.MI) and Peugeot-Citroen combined!

Looking at the holdings, all the major car company stocks have been rallying. But after such a strong run it is only natural for the trend to end at some point.

Watching the trendlines on the first chart above will warn of a trend that is ready to lag the S&P or even turn down. For now, though, the trend remains up, but for how long?

Buy when there is Blood

Are you willing to pay 60% more for the car companies today than you would have last year? Essentially that is what you are doing if you buy CARZ at $38 today (it was trading for $23 less than a year ago). CARZ is in an uptrend, but how do we know if that trend will continue?

Baron Rothschild's famous quote, "the time to buy is when there is blood in the streets" is a saying that hints at the contrarian nature of investing, suggesting the best time to buy something is when that entity is least liked.WATCH: The Phony Housing Recovery

Warren Buffett added to the contrarian's arsenal of investing philosophies when he said in a similar light, "You pay a very high price in the market for a cheery consensus".

These two contrarian takes are built around the same thought process but are essentially opposite one another.

Rothschild's quote talks of buying when things look dreariest whereas Buffett's quote hints at the upper extremity of cheery outlooks. In other words, Buffett's quote talks about the peaks (times to sell) whereas Baron Rothschild's speaks of the troughs (times to buy).

Wearing the Contrarian Hat

Given the extremely positive outlooks and general assumption that the auto market is doing as good as ever, Buffett's quote seems most appropriate here. No doubt the consensus is cheery and taken solely from the contrarian standpoint, it is likely you would be "paying a high price" for autos right now.

After such a bullish run accompanied by such cheery outlooks, a contrarian would want to look for problem areas, and there are many to be found.

The same Wall Street Journal article from above mentioned that many construction companies have been "snapping up high margin pick-up trucks". I see a major problem with this as homebuilder equity prices (NYSEARCA:ITB) are down significantly since May, mortgage applications have recently collapsed, and interest rates put even more pressure on potential homeowners. In short, the homebuilders (NYSEARCA:XHB) run may be over, and the same may be true for the rise in pick-up truck sales.

Another interesting fact concerning autos is the recently announced data from Experian Automotive that auto leases are at all time highs with 28% of all auto financings going toward leased vehicles. This compares to just 18% of all auto financing pertaining to leases three years ago.

If the auto recovery is on such a good fundamental footing, why do more consumers feel the need to lease instead of buy? An AutoNation dealer in Florida explained that consumers are looking for the lowest monthly payment possible and thus are turning toward leasing instead of owning.

Finally, auto loans are now averaging 65 months in length (compared to the historical norm 60 month auto financing), another record high, with some auto loans now created at 97 months.

Edmunds puts this stat in perspective as their data shows the average loan length has crept up over the past decade from just under 5 years to now over 5.5 years as 38% of car loans in 2012 came with terms in excess of 5.5 years. This stat will only swell as almost 20% of all new vehicle loans issued between April and June had terms that were between six and seven years. Buy Now, Pay Later

It seems the bullish auto run is being driven as much by financing as it is by demand and could potentially blow up in the face of the dealers (just as financial engineering helped doom the housing market and mortgage lenders).

Extremely bullish sentiment surrounding the car companies it is likely the trend is nearer its end than its beginning.

If you own CARZ, a breakdown of its trend shown in the chart will likely be your warning that the auto run has reached its end, similarly to the homebuilders run that just ended in May.

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