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Strong US Car Sales, But Red Light Ahead for Auto ETF?

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After a bumpy start, U.S. auto sales finally picked up in late March. Thanks to rock bottom interest rates and a gradually improving U.S. economy, the momentum hasn’t slackened since then. U.S. auto sales in June 2014 posted the best annualized figure in eight years.
Beating market expectations, U.S. June auto sales rose 1.2% to 1.4 million units – a month which was tarnished by a slew of safety recalls from automakers. Overall sales increased to a seasonally adjusted annual rate of 16.98 million vehicles from 16.7 million in May. For the first half of the year, auto sales increased 4.3% year over year to 8.2 million units (read: 3 American ETFs That Saw Fireworks to Start 2014).
Auto Sales in Details
A positive growth figure from General Motors ((GM - Free Report) ), despite its negative publicity over safety recalls, was a surprising factor. The company reported a 1% jump in U.S. auto sales in June, selling a total of 267,461 vehicles, the best in the last seven years.
Safety issues continue to plague this automaker though. Since February the company has recalled 29 million cars, which exceed the number of cars sold by the company in the past three years, as per a Wall Street Journal article.
Strong sales despite the recalls were attributed to the consumer psychology of focusing more on brand names such as Chevrolet and Buick rather than the corporate name "General Motors," said John Krafcik, president of car shopping site
Other auto makers such as Nissan Motor Co Ltd, Hyundai Motor Co, Chrysler Group and Toyota Motor Corp also reported a year-over-year increase in sales.
However, June was not so pleasant for Ford Motor ((F - Free Report) ), which reported a 6% drop in sales due to a plunge in both retail as well as fleet sales. Similarly, Honda Motor Co. and Volkswagen AG sales from their U.S. units witnessed a fall (read: Car ETF in Focus on Weak Auto Earnings).
Surprisingly strong sales during June and robust figures in the first half of the year have led many analysts to forecast a bright road ahead. Increasing consumer confidence, a recovery in the housing market, improving manufacturing activity and an aging auto fleet are some of the factors behind this bullish view.
Moreover, LMC Automotive expects steady growth ahead led by replacement demand, customer interest in new models and easier car financing.
Red Light Ahead?
Despite strong sales during the first half of the year, a section of industry experts however harbor a bearish view on the world’s second largest auto market going forward. These experts have rung the warning bell and believe that America’s auto market is near its peak and could soon see a slowdown.
Consulting firm, AlixPartners LLP expects the U.S. auto market to peak in 2016 with sales of 16.9 million units, after which it is expected to fall to 15.8 million vehicles in 2017 and decline further to 15.4 million vehicles in 2019.
Rising interest rates, waning passion for driving among the new generation and a long-term trend among Americans of sticking to their old cars are some of the factors for the cloudy road ahead for the U.S. auto market. 
Once interest rates turn northward interest costs for auto loans will also rise, hitting potential car and truck buyers’ purchasing power (read: 3 ETFs for Rising Interest Rates).
Another factor that is expected to aggravate the decline is the fast growing car-sharing trend in the U.S. “Our study suggests that Americans' willingness to avoid vehicle purchases due to growing car-sharing options is higher than many have thought," as per the managing director at AlixPartners.
The consulting firm, however, expects the global auto market to remain strong and predicts a 31% increase from 2013 sales levels to 109 million over the next decade. The optimism is mainly driven by robust demand from China, the world’s largest auto market.
Private equity investors also expect a slowdown in the U.S. auto sector and are gradually shifting their trading bets to other cyclical sectors.
Unfavorable Zacks Industry Rank
The negative outlook for the U.S. auto industry can be further underscored by the fact that the domestic auto industry has an unfavorable Zacks Industry Rank, signaling that the companies in the sector are facing downward earnings estimate revisions and are thus expected to underperform the broader markets.
The domestic auto industry has a Zacks Industry Rank in the bottom 19%, suggesting a rocky road ahead in both the short and the long term. The foreign auto industry also ranks among the bottom 19%, suggesting underperformance here as well.
Auto ETF in Focus
Given the not-so-rosy outlook and an unfavorable Zacks Industry Rank, investors should cautiously trade the auto ETF – First Trust Nasdaq Global Auto Index ETF (CARZ - Free Report) (see all Consumer Discretionary ETFs here).
The ETF tracks the Nasdaq OMX Global Auto Index, giving investors exposure to automobile manufacturers across the globe.
The product holds 37 stocks in the basket with General Motors, Toyota and Ford being the top three holdings forming roughly one-fourth of total fund assets. In terms of country exposure, Japan takes the top spot at 35% while the U.S. comes in second with a 24% allocation.

The ETF has amassed $62 million in its asset base and sees light trading volume. The product has returned 4.9% in the year-to-date frame, underperforming the broader markets.
The fund currently has a Zacks ETF Rank #5 or “Strong Sell” with a “High” risk outlook. This suggests that the ETF would continue to underperform and investors would be better off to avoid this product for the time being.
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