The Auto ETF Is Driving Smoothly, But Concerns Linger

The First Trust NASDAQ Global Auto Index Fund (NASDAQ:CARZ) is higher by nearly 3.9 percent in 2017 and robust sales are playing a pivotal role in the recent success for the lone exchange traded fund dedicated to the auto industry.

Last week, Jefferies upgraded Ford Motor Company (NYSE:F) saying the automaker's bad news has been more than dissected in the last six months and sufficiently priced-in. Ford's above average exposure to light and medium duty work vehicles, most of them sourced in the United States, which bodes well in an environment of infrastructure spending, Benzinga reported.

General Motors Company (NYSE:GM) and Ford, the two largest U.S. automakers, combine for about 15 percent of the roster in CARZ.

IHS Markits sector PMI data show worldwide auto industry production rising at its fastest rate in just over six years in recent months, with production surging again in January amid strong order book growth, said Markit in a recent note. Inflows of new orders into the autos and parts sector rose at the start of the year at the fastest rate since early 2011; a period when post-recession incentives were boosting car sales globally. The recent upturn in sales and production represents a marked contrast to the stagnation and decline seen during the early months of 2016.

While the presence of the Detroit Three looms large in CARZ, the ETF reflects the global nature of the auto business as U.S. firms are just 23.7 percent of the ETF's weight, below the 33 percent allocated to Japanese automakers.

Japanese and German automakers combine for 52 percent of CARZ, underscoring the point that this ETF is potentially exposed to currency risk. One issue is that CARZ isn't currency hedged so it lacks that kicker to fully exploit dollar strength. Second, and equally important, is dollar weakness, a scenario which can pinch foreign automakers that count on the U.S. for significant portions of their revenue.

Selling costs are also rising, an issue investors should be aware before considering CARZ or individual auto names,

Selling costs are also rising, but at a much reduced rate compared to input costs. The differential between selling price and input cost inflation has consequently indicated the greatest squeeze on auto company operating margins since early-2011 in recent months, adds Markit.

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