Bumpy Ride Ahead: Sell Ford, Buy Toyota, Avoid the GM IPO

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ChartProphet submit:

As General Motors prepares for its initial public offering ((IPO)), scheduled for today, now may actually be the proper time to get out of investments in the automobile sector - before they drive off a cliff.

Since the March 2009 low in global indexes, automotive stocks have greatly outperformed the broader markets. After all, since the automotive industry is highly cyclical and tends to underperform in recessions and outperform in recoveries, it is understandable how the struggling automotive companies were able to bounce back so vigorously as automobile demand returned. But with GM, Ford ( F ), and the rest of the automotive industry attracting so much media and investor attention lately, along with the uncertainty over slowing global growth and already-inflated automotive stock prices, is it time to rethink investing in companies such as Ford, which is up over 1500 percent in less than 2 years?

Take a look at the following chart:


click to enlarge

Not only are automotive stocks outperforming the rest of the market by 25 percent since March 2009, but the divergence between the two is wider than at any time since late 2007 - right at the peak before the recession. It seems these wide divergences between the automotive industry and the overall market signal short-term pullbacks, if not long-term peaks.

The questions remain:
Is the automotive industry growth sustainable? And what does it rely on?

First off, we have to remember that GM and Chrysler both went bankrupt in 2009 with Ford not far behind. Jobs were lost, the industry essentially collapsed, and people's investments were wiped out; GM and Chrysler were worthless, and Ford was now worth $1.01 a share (down from over $27 ten years prior and down from nearly $9 less than a year earlier). In other words, the US auto industry failed to compete with the rest of the world, failed to innovate its cars to keep up with consumer demand, and failed to protect its employees and shareholders. And yet, less than two years later, investors are clamoring and fighting over who gets to buy GM again. They screwed us over and now we want round two?

GM's return to the stock market is somewhat acceptable. It has returned to profitability; and, after a heavy dose of government help, it can attempt to recapture its place within the US auto industry and further expand into growing global markets. The problem, however, is that GM's IPO may be coming out exactly at the top, as the momentum that has carried the automotive industry and the overall global economies may be running out of steam (or gasoline).

3 Reasons to AVOID Auto Stocks (especially GM and Ford):

1) Massive Price Run-ups. Not only is the automotive industry up over 100 percent as a whole (as shown above), but Ford - which probably best represents the US auto industry - is up over 1500 percent in that same time.

Take a look at the chart:

Ford has not only made an almost unheard-of parabolic move up, but it has done so in less than two years - that's 750 percent a year. Add to that an almost vertical run-up in price since September and the fact that industry-leading companies (as Ford is in the US auto industry) rarely, if ever, see such huge moves up in such a short span of time- and we have huge potential for the auto industry to plummet again.

2) Buy the Rumor, Sell the News. With the vast media coverage and investor enthusiasm since GM's IPO announcement in August, all the positives may be priced in already. Ford alone is up over 50 percent since then. And with all the hype surrounding the IPO, together with GM's announcement that it was raising the IPO price significantly, it is hard to see GM or the other auto company stocks rallying much further before correcting to reasonable levels. If selling at the peak of investor excitement is the right move (which it is), then now is a better time than ever.

3) Heavily Dependent on Global Growth. The automotive industry has sprung back from the depths of the recession and investors are predicting tremendous upcoming growth. But most of the excitement surrounding the auto industry's future prospects relies heavily on increased global sales. And since the auto industry is a heavily cyclical industry that performs in correlation to the overall market, it is completely up to the global recovery whether or not the auto industry will continue on its current path. With global growth easing, European economic troubles, and China's potential slowdown, it is not hard to see how the auto industry's recovery could be derailed. And if it is derailed, you can expect auto stocks to suffer.

3 Ways to Play This:

1) Sell Ford, Buy Toyota ( TM ). With Ford stock price running up so much in the last 2 years, it's getting a little dangerous here. GM's IPO has made Ford price run up even higher because of all of the excitement surrounding US automakers. But investors seem to have forgotten about Toyota.

Take a look at the chart:


Comparing Ford, Toyota, and the S&P 500, we can see that while Ford is up about 90 percent in the past year, and the S&P gain struggling between 5 and 10 percent, Toyota is even further behind. After falling to -15 percent twice, and recently breaking out to new higher levels, Toyota may be ripe for a rally. And even if it doesn't rally, it could outperform Ford if the automotive industry sees a slowdown or if Ford sees a correction. In other words, this huge 90 percent gap in performance between Ford and Toyota should be closing soon; either Ford will move down to meet Toyota, or Toyota will catch up to Ford as its growth slows. Either way, selling short Ford and buying Toyota for protection could work out well.

2) Buy Steel. While excitement has sent auto stocks soaring, steel stocks are severely lagging behind. Since steel is used in automotives, we could expect steel companies to see bigger profits if the auto industry continues to grow. That said, buying steel stocks would be profitable if the auto industry continues its growth. On the other hand, if the auto industry struggles, we could expect steel stocks to outperform auto stocks such as Ford.

Take a look at the following chart:


Comparing Ford to steel stocks such as US Steel ( X ), Nucor ( NUE ), and AK Steel ( AKS ) or the Steel ETF (SLX), we can see the wide disparity in percent moves between Ford and the steel companies in the past 2 years. If Ford starts to struggle, it will fall faster than the steel companies and steel will outperform. If Ford continues to rally, steel companies should begin to close the huge gap. Either way, it looks as if steel is the winner here, or at least protection.

3) Stay Away. Ford, GM, and others could continue to rise, but the potential drop after such a rally may make the risk larger than the potential reward. Therefore, if selling Ford and buying Toyota or steel companies seems too risky, it may be smarter to just stay out of the auto trade until the GM IPO settles and some more clarity enters the market.

Disclosure: Awaiting Ford Shorts

See also Revenue Growth Expectations Look Rich for S&P 500 - Is the Index Overvalued? on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: AKS , F , NUE , TM , X

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