Nobody Needs A Hummer
A Technical Look at Auto-Related Stocks
by Martin Goldberg CMT. January 29, 2004
About 18 short months ago it appeared that the US auto manufacturers were in serious trouble. The US economy was in the midst of a soft patch, and it appeared as if automobile demand was turning down within a slumping economy. US automakers were facing pension liabilities that were magnified since they already had highly leveraged balance sheets. At the time, it almost seemed that the only thing that would help the automakers was a government bail out. However, in a short amount of time, the stocks of the US automakers and other auto related companies staged an impressive comeback. This was fueled by the growth in the Asia Pacific region as well as continued robust sales in the US aided by economic stimulus from the government. In this article, I take a technical look at key stocks related to the Automobile industry.
There are many "moving parts" in the auto sector that makes it difficult to thoroughly evaluate the stocks. One such notable moving part is the significant boost to US auto sales resulting from a federal tax deduction for some purchases of gas guzzling trucks and SUVs. According to the Bozeman Chronicle (Montana) (emphasis added by Martin) (1):
"As part of a $350 billion economic stimulus package passed in May 2003, Congress quadrupled to $100,000 the amount business owners can deduct in the first year when they purchase a qualifying vehicle. The quirk is, the vehicle has to weigh at least 6,000 pounds. But almost every pickup and most SUVs meet that threshold, said John Wendt, a sales manager at JC Billion in Bozeman. Self-employed folks like real estate agents, consultants, doctors and lawyers all are finding advantage in the tax break. "We've had quite a number of people buying expensive SUVs and pickups," Wendt said. "They've been advised by their accountants to do that." Wendt said the sales staff doesn't suggest people buy an SUV for the tax break. "Obviously we're not tax accountants," Wendt said. But sales people don't have to bring it up, he said. People are showing up armed with the tax information and ready to buy big SUVs like the GMC Yukon, he said. "It's pretty incredible that you can write off what you can," Wendt said."
The Bozeman Chronicle captures the essence of what's going on. Although qualifying people can only deduct the fraction used for business (wink), this is a perfect example of "displacement". The government, via a tax break, is paying people who would otherwise drive smaller and more fuel-efficient vehicles to buy larger gas-guzzlers, which also happen to have higher profit margins. The tax break is good for the automobile manufacturers, bad for the taxpayers. It's good for the oil companies and bad for the ecology. It's bad because it makes the US more dependent on foreign oil. It's bad for drivers of smaller vehicles, since these 6,000+ pound vehicles are a danger for other motorists in smaller cars. On the surface it’s good for the doctors, lawyers, consultants, real estate agents and others who make this entirely discretionary purchase versus a more suitable smaller vehicle. Or is it? The savings reduced cost resulting from the tax deduction of the Cadillac, Lincoln, Lexus or Hummer SUV is likely offset by the higher maintenance and gasoline costs. But many qualifying Americans are flocking to the new car dealerships anyway to stroke their egos by purchasing these large wagons. And the auto companies are doing a great job of feeding the strange desire that makes such a purchase appealing to many Americans' psyche. For example, the Hummer television commercial airing during the NFL playoffs immediately comes to mind, featuring the song "Happy Jack" by The Who. But no matter what mental baggage potential Hummer customers may carry to their dealerships, it is clear to me that nobody needs a Hummer.
Whether you like the tax law or not, the recent good times in the auto sector as well as the hunger for all stocks trading in public markets over the last year has done wonders for automobile-related stock prices. The recent broad stock market runup has reduced pension liabilities for automakers and parts manufacturers. The stock market indices are back to levels seen in 1999 on the way up, and 2001 on the way down. This surge has resulted in a tremendous improvement to old economy pension funds. In summary, the stocks being higher are making the pension funds worth more, which makes the stocks go up, which makes the pension funds go up more. This is a perfect example of "leverage". Another important question is, when will these pension funds sell stocks to lock in profits so that the underlying auto companies can get back to earning money in their core businesses and reduce their company's dependence on an overvalued and speculative stock market? These companies know better than anyone that leverage is good on the way up and horrible on the way down.
These are the questions that I would like to address from a technical perspective:
- Are auto companies good long-term investments?
- Will the recent good times for these companies' stocks continue?
- Automobile Manufacturers
Following are the long-term charts of the prominent US (including Daimler Chrysler), and Japanese car companies.
As you can see none of the charts above present a very compelling long-term investment profile. I have the following observations regarding the charts above:
General Motors (GM) & Ford (F): The current downtrends appear to be intact. Intermediate up trends are also overextended. Daimler (DCX): Its downtrend appears to be broken; but current up trend is overextended. Toyota (TM): Toyota is in an intermediate up trend after almost doubling since March of 2003. It's currently at the base of a previous "mania-run" that concluded in spring of 2000. (The Toyota-made Lexus was and is a popular vehicle with technology stockholders of that era as well as today.) Honda Motor (HMC): Honda Motor has been in a trading range since 1999 between 15 and 22.5. It is now at the top of that trading range. A breakout from the area of 22.5 would likely be successful in today's stock market. Buying on breakouts has proven to be a successful strategy since March 2003. Nissan (NSANY): Nissan appears to have had a good run off of a solid base at about 15, to its current level of over 22. It is now in a basing pattern.
- Auto Parts Manufacturers
Following are the long-term charts of some prominent auto parts manufacturing stocks including Lear (LEA), Magna (MGA), Visteon (VC), Delphi (DPH), Johnson Controls (JCA), and Dana (DCN):
With the exception of Johnson Controls (JCI), all of the stocks have the potential (from past history) to be heartbreakers. Johnson Controls however, has done well for its long-term shareholders, with a minimum of heartbreak. Its excellent long-term performance deserves a closer look from a shorter-term perspective.
The healthy and consistent linear up trend suggests that this is an up trend worth trading. At the moment it’s a bit overbought; however, a buy order near the trend line would present a good risk/reward ratio. Stating the obvious, it’s going up!
- Auto Parts Retailers
This sector is a recent Wall Street darling. This fact by itself is a good reason to be skeptical! Lets look at some long-term charts within this sector, including AutoZone (AZO), Pep boys (PBY), O’Reilly Auto Parts (ORLY), and Advance Auto parts (AAP):
Since 2001, these stocks have been doing quite well. The strongest long-term chart is AutoZone, which has greatly rewarded its long-term shareholders. By contrast, some long-term shareholders of Pep Boys are probably thinking about getting out "even", although it has, what appears to be the most bullish short-term chart in the group. Is the honeymoon over for the auto parts retailers, or will it continue strong? As illustrated in the chart below, auto parts retailers have rewarded their shareholders well over the last year.
Below are more detailed technical analysis of the recent leader of the group – Pep Boys, and the recent laggard – AutoZone.
Below is a one-year daily chart of Pep Boys.
At first sight, a classical technical analyst would note that Pep Boys appears to be in a healthy up trend. However, a look below the surface via the MACD histogram appears to be telling a less obvious but much different story. There is an excellent description of moving average convergence/divergence (MACD) in Dr. Alexander Elder's, Come Into My Trading Room.
Pep Boys appears to be flashing "The Strongest Signal" indicating it as a "sell" (see Page 106):
"(The strongest signal) occurs rarely, only a couple of times per year on the daily charts of most markets, but it’s worth waiting for because it is the strongest signal in technical analysis. That signal is a divergence between the peaks and bottoms of price and MACD-histogram. A divergence occurs when the trend of price highs and lows goes one way and the trend of tops and bottoms in MACD histogram goes the opposite way. Those patterns take several weeks or even more than a month to develop on the daily charts. A bearish divergence occurs when prices rise to a new high, decline and then rise to a higher peak. MACD-histogram gives the first sign of trouble when it breaks below its zero line during the decline from its first peak. When prices reach a higher high, MACD-histogram rises to a much lower high. It shows that bulls are weaker and prices are rising simply out of inertia and are ready to reverse."
The appearance of the "strongest signal" would suggest that people long Pep Boys consider selling at least part of their position. Those hesitating selling their "winner" may want to revisit the longer-term chart of Pep Boys. It has always been a heartbreaker, and old habits die hard. Short sellers may wish to short this stock with a stop loss at the 52 week high. As illogical as it may seem, if Pep Boys were to violate "the strongest signal", and break out to a new high, a long position would then be the correct trade with very good potential for aggressive traders. Elder makes a very strong technical case for that trade in the reference above.
Below is a 13-month daily chart of AutoZone (AZO).
The long-term up trend of AutoZone has been decisively broken, and suggests AutoZone may be a good short sale. Let's look at a shorter-term (6-month) chart of AutoZone.
After breaking the neckline of a head and shoulder pattern, like many stocks in the current market, AutoZone "rose from the dead" and low sits near the bottom of the downward gap it made after its disappointing earnings report in early December. While shorting in this market is difficult since buyers seem to be hungering for all stocks, it may be worth taking a short position in AutoZone stock. A logical stop loss would be slightly above the low point of the gap, at about 85.
A Final Note
Is there any thing new in the auto industry?
"The Senate Finance Committee plugged the loophole in a little-noticed provision in a broader corporate tax bill that it approved last month. By raising the weight limit to 14,000 pounds, enough to disqualify even the gargantuan Hummer H1, the committee figured it would save the Treasury nearly $1.3 billion over 10 years. But that bill is far from passing the full Senate, and the House Ways and Means Committee has not considered a comparable measure." (2).
I think that if it appears that the 6,000-pound vehicle tax loophole may be plugged soon, the rally cry from auto dealerships will be, "Get your Hummer while you still can claim the deduction". This should be good for a couple more good quarters which is all Wall Street needs to pump up these stocks to an excessively optimistic herd.
Summary and Conclusions
- The auto industry has been aided by demand from Asia and tax breaks that encourage some Americans to buy gas-guzzling vehicles such as Hummers, instead of what they really need. This is at the expense of other important public objectives including a rational energy policy.
- Auto industry pension funds have been at least been partially saved by the recent stock market bull run. This has leveraged their stock prices.
- Auto and auto parts manufacturers are having an intermediate term rally consistent with the broader market. History has shown many of these stocks tend to be long-term heartbreakers, though. The chart of Johnson Controls (JCA) includes long, intermediate, and short-term healthy bullish patterns. The linear up trend may be traded from the long side.
- Auto parts retailers are showing some weakness. Pep Boys' (PBY), daily chart is showing hidden weakness, which is illustrated by a comparison of the price action with the MACD histogram. AutoZone (AZO) has a broken up trend, and may be traded from the short side with a stop loss.
Please note that since this article was drafted early this week, Pep Boys has dropped a bit, and now can be considered "oversold". I would therefore not consider PBY to be at a good point of entry for a "trade". As Greenspan would say, "You can afford to be patient." However, the longer-term technical signals discussed above I feel, have likely been confirmed for Pep Boys. It probably has seen it’s top. An updated chart is below:
Disclosure – Martin is short Autozone and Pep Boys.
All of the markets have moved since about 2 O'clock pm yesterday based on Mr. Greenspan's use of the phrase, "can be patient" versus "for a considerable period". Just think about that for a moment, knowing that you're retirement savings and your kids' college savings may invested in vehicles whose prices change significantly based on mere talk such as this.
All of the indices were not looking very well today; but at 2 pm Washington D.C. time it appeared as if organized support came in (right on its normal schedule). In total, stocks ended the day pretty much even on some of the highest volume of the year. Since New Years, the only day that the NASDAQ did not trade well over 2 billion shares in a day was this Monday's wonder rally. Bonds rallied at the end of the session. Precious metals got trampled, as gold closed the day at a headline-making $399.50 an ounce, and silver was pounded back to $6.23 an ounce. Their charts are below:
The intermediate up-trendline (from mid-October) in gold has been broken. But silver sits right on the current trendline. It's a buying opportunity for silver bulls. Gold. I don't know. (I'm sure glad I got fundamentals on my side.)
The dollar was up and now sits on its resistance trendline.
Have a great evening!
2. A Tax Loophole Big Enough to Drive an SUV Through, Boston.com, by Jonathan Weisman, Washington Post, 11/9/2003
© 2004 Martin Goldberg