Where do car stocks go after Detroit? It all depends on China

  • By Al Root,
  • Barron's
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Automotive executives from companies like General Motors (GM) and Ford Motor (F) wrapped up their business with investors at the North American International Auto Show Wednesday just as the expo opens to the public. Many car companies offered initial 2019 guidance and made comments about China, tariffs and, well, cars.

The $2 trillion automotive business is one of the industries that makes the economic world go round. And when auto makers catch a cold (i.e. light vehicle sales slow down), many other industries sneeze. That’s why it behooves investors to pay attention to Detroit in January.

Coming into the week, Wall Street was cautious. Many analysts expected weak guidance and worried that trade fears and China’s slowdown would keep a lid on automotive stocks. Those two issues dogged the sector most of 2018 and shares underperformed. The price-to-earnings ratio for car companies has fallen from around 11 times estimated earnings a year ago to about seven times estimated earnings today.

There was some good news this week. General Motors’ recent guidance pleasantly surprised investors its stock jumped 8% last Friday. Ford’s guidance Wednesday wasn’t all that bad either, according to Deutsche Bank analyst Emmanuel Rosner. “Ford initiated a solid 2019 outlook, calling for revenue, [operating earnings] and operating cash flow all higher versus 2018,” he wrote. Wall Street had expected Ford revenue to decline.

Still, Ford stock dropped 6% Wednesday, though it remains up 8% year to date. Overall, automotive stocks are up about 1% over the past week and 10% year to date. It seems investors’ worst fears aren’t being realized after all.

Investors worried that losses would pile up for the industry as car sales declined. The ability to keep earnings flat in a down market would be something new for the automotive industry, which typically hasn’t able to stem the losses in that situation. That history may keep a lid on automotive valuations, but progress on trade and Chinese stimulus could be a catalyst for the sector later in 2019.

The same can be said for most industrial stocks. Trade fears and the Chinese economic slowdown are dominating investor sentiment, and the industrial sector is down 13% year over year.

The automotive executives offered some insights into China. Ford CFO Robert Shanks told investors, “we expect [Chinese] industry volumes to be down modestly with a stronger second half of the year.” He added, ”this assumes the U.S. and China avoid the expansion of higher tariffs in new categories of goods, with broad policy stimulus measures expected to provide a backstop to Chinese growth. We aren’t assuming any stimulus actions targeted specifically to the auto sector.” Ford expects global industry volumes to flat in 2019.

So, Shanks is expecting Chinese stimulus to help boost growth. Many executives likely share that hope. However, a flat global market does mean that many companies will be looking to control costs and rein in spending.

About trade, Ford executive VP and president of global markets James Farley offered, “we are going to localize the new Explorer that you saw this week in China, boosting our profitability and improving, and protecting against the tariffs.” Most government are very sensitive to where local cars are built so Ford’s strategy doesn’t represent a dramatic supply chain shift.

It seems like China—and the related trade tensions—are the only question that matter these days. That means the direction of many stocks in 2019 are dependent first on what happens in Sino-American trade talks. Even the effectiveness of the Chinese monetary and fiscal stimulus seems to be predicated on what happens with trade.

That may be frustrating for investors, but the good news is that, based on the company outlooks, the economic slowdown appears mild. And if the trade war is resolved, then investors could stop worrying about global macroeconomic factors and get back to worrying about individual companies.

And given their starting valuations, automotive and industrial stocks should head higher.

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