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Are Auto ETFs Headed for Trouble Despite Robust July Sales?

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U.S. automotive remained one of the hottest industries with sizzling sales in July on big summer discounts and incentive programs. In fact, July 2014 was the strongest month for auto sales since 2006 (read: 2 Hot Summer ETFs Surging to #1 Ranks).

This is especially true as auto sales rose 9.1% year over year to 1.4 million, lifting a seasonally adjusted annual rate to 16.48 million units. Strong pent-up demand, improving labor market, payroll gains, a plethora of new models, lower interest on auto loans, need of replacement of aging vehicles, and increasing consumer confidence contributed to the big jump in auto sales.

Auto Sales in Focus

Five of the six major automakers reported strong sales growth led by Chrysler, which saw 20% growth in car sales. Sales for General Motors (GM - Free Report) , Ford Motor (F - Free Report) , Toyota (TM - Free Report) and Nissan (NSANY - Free Report) were up 9.4%, 9.6%, 11.6% and 11.4%, respectively. Resurgent demand for sport-utility vehicles and crossovers contributed to the robust figures. On the other hand, Honda (HMC - Free Report) sales fell 4% year over year in July.

Jeep was once again the bestseller brand for Chrysler. Strong sales of Camry and Corolla sedans led to a double-digit growth for Toyota while two small cars – Sentra and Versa – drove sales at Nissan (read: Best and Worst ETFs of July: Emerging Markets Soar, Commodities Fall).

What Lies Ahead?

It seems that U.S. auto sales will continue to climb albeit at a slower pace for the rest of the year given favorable macroeconomic trends and some geopolitical issues. U.S. economic growth has been warming up after freezing 2.1% in the first quarter despite tension in Ukraine, Middle East and Gaza. The economy clearly accelerated to 4% in the second quarter, getting the better of market expectations (read: Safe Haven ETFs to Evade Geopolitical Tensions).

The labor market is strengthening, industrial and manufacturing activity is picking up, and housing market is improving gradually. This is particularly true, as the U.S. economy added more than 200,000 jobs for six consecutive months this year, marking the longest streak of addition since the mid 90s. Further, consumer confidence is at the highest level since the Great Recession began.

If this wasn’t enough, interest rates still are at lower levels in spite of their recent rise. This lower rate will likely remain in the foreseeable future even after the Fed wraps up QE in October. Gasoline prices have also been relatively stable over the past few weeks, favoring the fundamentals of automakers.

How to Tap?

Given the solid car sales and the continued optimism in the auto industry, investors could focus on the only pure play in the space – First Trust NASDAQ Global Auto ETF ((CARZ - Free Report) ) – that tracks the NASDAQ OMX Global Auto Index (see: all the Consumer Discretionary ETFs here).

Holding 37 securities in its basket, the fund is highly concentrated on the top 10 holdings with 60.3% of assets, suggesting that company-specific risk is high and the top 10 firms dominate the returns of the fund. The four prime automakers – Toyota, Ford, Honda and General Motors – occupy the top four positions with roughly 8% share each, closely followed by 6.8% allocation in Daimler (DDAIF). Other firms hold less than 4.5% share.

The ETF has a definite tilt toward the large cap stocks as these account for 89% of assets. In term of country exposure, Japan takes the top spot at 36.1% while U.S. and Germany round off the top three positions with 23.8% and 17.6% share, respectively.

CARZ is under-appreciated and ignored by investors as indicated by its AUM of only $59.6 million and average daily trading volume of just under 15,000 shares. The product charges 70 bps in fees and expenses. The fund is leading the consumer discretionary space from a year-to-date look, gaining 1.4%.

Though the short-term outlook for the auto ETF is encouraging, the long-term outlook remains bleak given a Zacks Rank of 4 or ‘Sell’ with High risk outlook. This suggests that some pain might be in store for this fund, especially given concerns over the timing of interest rates hike, and threat of energy price rise due to ongoing violence in Libya, Ukraine and Iraq (read: Guide to Oil Commodity ETFs).

Additionally, the U.S. automotive industry has a poor Zacks Industry Rank in the bottom 36%, indicating rough trading in the coming months.

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