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The auto sector’s joy ride in 2015, which continued in 2016, has been somewhat subdued in 2017. Not only that, the auto industry is undergoing a transition, courtesy of changing consumers’ preference toward SUVs and crossovers, and the necessity for manufacturing electric vehicles.

According to IHS Markit forecast, total global light vehicle sales will reach 93.5 million units in 2017, up 1.5% from 2016, with most of the global growth coming from China.

In fact, automakers across the globe are partnering with local companies in China, the biggest car market in the world, where sales of electric vehicles are anticipated to increase. Renault SA (RNLSY - Free Report) and Nissan Motor Co., Ltd. (NSANY - Free Report) have partnered with Chinese automaker Dongfeng Motor Group Co to manufacture battery-powered automobiles in the Chinese market. Ford Motor Company (F - Free Report) announced a joint venture to manufacture electric vehicles in China. Also, General Motors Co. (GM - Free Report) and other automakers have shared their plans of manufacturing electric vehicles in China.

On the other hand, automakers bore the brunt of expenses related to safety recalls and negative currency effects. Massive recalls related to Volkswagen AG’s (VLKAY - Free Report) emission scandal and Takata Corp’s defective airbag inflators have been hurting the auto sector in recent times. Rising delinquency rates in auto loans are expected to hurt sales in the future.

Zacks Industry Rank – Positive Outlook

The distinctive attributes of the auto industry prompted us to have a dedicated sector for the industry in our database. The automobile sector is one of the 16 Zacks sectors, unlike the S&P classification, wherein autos are part of the Consumer Discretionary sector. The S&P has 11 sectors compared with the 16 sectors for Zacks.

At the expanded classification level, the Zacks Auto sector is divided into six industries: Auto-Domestic, Auto-Foreign, Auto-Original Equipment, Auto-Replacement Parts, Auto-Internal Combustion Engines and Rubber - Tires. The level of sensitivity and exposure to the different stages of the economic cycle vary for each industry.

We rank the 265 sub-industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups — the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank.)

The current Zacks Industry Rank is #111 for Automotive - Domestic (placing it at the top 43% of the 250 plus Zacks classified industries), #6 for Automotive - Foreign (placing it at the top 2% of the 250 plus Zacks classified industries), #49 for Automotive - Original Equipment (placing it at the top 19% of the 250 plus Zacks classified industries), #111 for Automotive - Replacement Parts (placing it at the top 43% of the 250 plus Zacks classified industries), #24 for Automotive - Internal Combustion Engines (placing it at the top 43% of the 250 plus Zacks classified industries), #213 Rubber - Tires (placing it at the bottom 17% of the 250 plus Zacks classified industries).

Looking at the exact location of these industries, one could say that the general outlook for the auto industry is ‘Positive.'

Sector-Level Earnings Trend

The auto sector is expected to contribute 2.0% to the total S&P 500 earnings in 2017. This is more than double its 0.9% market cap weight in the index at present.

Looking at the second-quarter 2017 results of the auto sector, earnings decreased 0.3%. Auto sector earnings are expected to decline 17.3% in the third quarter of 2017 but projected to rise 16.7% in fourth-quarter 2017.

Total revenue declined 4% year over year in second-quarter 2017. Revenues are expected to decline 2.3% in the third quarter of 2017 but edge up 0.2% in fourth-quarter 2017.

Earnings for 2017 are expected to decline 3.7% compared with 2016. Also, revenues for the year are expected to go down 4%.

For more information on earnings for this sector and others, please read our latest Earnings Trends report.

Bottom Line

The auto sector is currently has a lot of opportunities at the same time is facing challenges. While attractive financing options and impressive vehicle launches are driving sales, slowing sales growth in the United States, rising auto loan defaults and high levels of safety recalls act as dampeners.

At this juncture, we recommend stocks such as Continental AG (CTTAY - Free Report) , PACCAR Inc (PCAR - Free Report) and Fox Continental Holding Corp. (FOXF - Free Report) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Continental has a long-term growth rate of 7.9%.

PACCAR has a long-term growth rate of 10%.

Fox Factory has a long-term growth rate of 14%.

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