Auto sector may be entering a bearish phase


For the past two years, the bulls in the stock market have been repeating the mantra of consumption as a driver for growth. It is true that until recently the consumption story remained strong. Businesses and sectors driven by consumption continued to register healthy revenue growth even as other sectors stalled due to policy paralysis in government. That story finally seems to be played out. The key signal is the weak performance of the auto sector. Car sales and two-wheeler sales have flattened out and the industry association, Society of Indian Manufacturers (SIAM) has downgraded its sales projections for 2012-13. This could mean a change in the behaviour pattern of stocks in the auto sector.

Auto stocks have outperformed the overall market in relative terms for the last 18 months though they have had a negative return. Since January 2011, the Nifty has lost 15.5 per cent while the CNX Auto index has lost 8.5 per cent. The correlation between daily market movements and the auto index is strong at 0.85 but the daily beta of the auto sector is relatively low at 0.96. Technically speaking, the auto sector has been bullish between December 2008 and April 2012 since it bottomed out in November 2008 at around a value of 1,000. It hit a top of about 4,400 in April 2012. So it’s proved to be an excellent hedge through that period, beating the market index very comfortably.

But the sector is strongly cyclical and if it’s moving into a seriously bearish period, the relationships with respect to the market could change. The correlation is likely to remain high but whenever the auto sector has been seriously bearish, it tends to lose more ground than the overall market. That is, the beta rises.
If one is correct, the sector should be entering one of those seriously bearish phases. The sector has fairly long cycles. If it’s going into a downtrend, it could remain depressed for a fairly long period. The auto industry has a long and complex value-chain. It employs a large number of people and creates demand for everything from basic commodities to complicated electronics and it generates many service jobs, including in the financial sector. So, a slowdown here tends to have serious repercussions. This is also why the industry tends to be strongly correlated to the broader economy. The implication is that the overall economy could also get more bearish. The trader could look to find short positions in the auto sector. The long-term investor should probably be looking to reduce exposure. If the monsoon fails, as seems likely, the problems will be more marked.