Auto stocks are on a roll

GRAND BLANC, Mich. (MarketWatch) � Even if the stock market bull sees his shadow in February, auto stocks will continue to roll in 2012.

In most market environments, correctly forecasting the economic cycle is a key to success. For example, is the economy on a sustainable upswing, has it peaked and run out of steam, or has it bottomed and is now recovering? Practitioners spend much of their time analyzing these fundamental questions.

Whenever the stock market gets it wrong, a tremendous opportunity can be created. The anticipation of an economic downturn that fails to materialize opens the door for investors to scoop up stocks in unfairly penalized industries, particularly those in cyclical sectors such as the automotive industry, before those stocks recover to their fair value.

TRADING STRATEGIES: February

Will the bull see his shadow?
Trading February's loopy markets.

� Hulbert: The groundhog won't see any bears
� Extra: Should gold bugs buy miners or bullion?
� Kudla: Auto stocks are ready to roll
� Kacher & Morales: Precious metals looking up
� Kahn: We are living in a material world
� Lowell: Fear and leap year
� Hodges: Find opportunity in Europe deja vu
� Hogan: Bulls are tethered by Greece

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Omar Aguilar, chief investment officer at Charles Schwab, tells MarketWatch's Jonathan Burton investors are transitioning to a search for growth from a flight to quality. /conga/story/2012/02/trading-strategies.html190512

Fundamentally, the automotive industry has enjoyed a healthy renaissance from its darkest days in 2008 and 2009.

Once burdened with unsustainable levels of debt on the balance sheet, and continual market share losses to the Asian car makers, both General Motors GM � and Ford Motor Company F � have reversed their fortunes in both of these key areas. GM has emerged from bankruptcy reorganization and is delivering on its commitment to repay its government bailout funds. Ford has reduced its automotive debt by more than $20 billion in the last two years, lowering its interest costs by more than $1 billion annually. Top line growth is ticking higher. Ford passed the two million unit sales mark in 2011, the first automaker to sell more than two million of its namesake brand in one year since 2007. The Ford Escape SUV hit record sales in 2011, while the Ford F-150 pickup truck was the nation�s top selling new vehicle.

So the recent sales numbers are encouraging, but can they be sustained? There�s plenty of room for optimism, given that the industry is coming off a four to five year stretch of relatively weak unit sales, and the resulting pent-up demand will eventually need to be satisfied. The average annual auto replacement rate is 15%, but the average age of cars on the road hit an all-time high in 2011 at 11 years old. The replacement rate is expected to grow to 20% in 2012 and average more than 25% over the next four years. Total North American light vehicle sales industry-wide came in at 12.8 million in 2011 and could grow to between 13.5 million and 14 million in 2012.

Naturally, the Detroit car makers will be graded primarily by their ability to maintain and grow their share of the market. Old perceptions that Toyota and Honda are leaders in producing high quality fuel efficient vehicles have been turned around by their engineering counterparts at Ford and GM, who more than ever understand both the consumer and the competition. Toyota in particular has seen its once pristine reputation decline in recent years. Vehicle resale values, a true bottom line for many consumers and a primary metric to compare the auto makers, point to this recent improvement in quality.

Another encouraging sign was Ford�s decision to reinstate its dividend, to $0.05 quarterly, starting in March. As an investment theme, dividend paying stocks gained in popularity during last year�s tumultuous market where above-average yielders held up nicely. Given that the low yields on Treasuries and CDs are likely to be with us for awhile, it�s likely that offering investors a dependable cash yield will enhance interest in their stock. Ford�s willingness to resume the dividend also demonstrates that the company has confidence in its cash flow.

With the growing list of positives for the industry, one would assume that the stocks in those companies would have been climbing in anticipation of the cyclical upswing that lies ahead. In fact, the opposite is true. Shares in Ford declined by 36% in 2011, while GM lost 45% for the year. Both were brought down not by what�s happening within their organizations, or within their industry, but by negative headlines out of Europe and by speculation that the economic environment was bound to worsen. Thus far in 2012, economic data has confirmed that the worst case scenario is not likely to materialize, and both stocks have outperformed market averages in the opening weeks of the new year. Even if much of the recent rally is a result of the improving macro economy, the improving company and industry fundamentals will help sustain interest in these companies� shares.

David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found at www.mainstaycapital.com. Disclosure: Clients and employees of Mainstay Capital Management may hold the securities mentioned in this article in their investment portfolios. The securities mentioned may not be suitable for some investors, based on their tolerance for risk or their investment time horizon.