What's Driving The Auto Sector?

Daimler AG (Pink: DDAIF) and Volkswagen AG (Pink:VLKAY). And though it’s not included in the stock chart, rival German luxury automaker BMW (Pink: BAMXY) has had a similarly rough ride.

What gives? Why have German engines been sputtering when American and Japanese continue to purr?

Thanks Daimler!
I take particular interest in this because Daimler is an open recommendation of the Sizemore Investment Letter and my pick in InvestorPlace’s Best Stocks of 2013 contest. The stock’s recent underperformance has caused me to fall from as high as third place to my current lowly spot in seventh. Ouch.

Japan's Hot
There are a handful of factors at work here. First, Japanese stocks have massive momentum right now due to the perceived bullishness of Prime Minister Shinzo Abe’s reflation policies, and this is benefitting Toyota (TM) and Honda (HMC). I see this ending badly -- see Japan is Running Out of Time -- and I would not recommend having any long-term positions in Japanese stocks. But for the time being, Japanese equities are hot, and I expect Toyota and Honda to follow the broader Japanese market.

Cheap Americans
Secondly, with the U.S. economy showing signs of life, General Motors (GM) and Ford (F) have been rallying in hopes that this will translate into a sustained rise in domestic auto sales. It also helps that GM and Ford are two of the cheapest stocks in America at the moment, trading at 6.4 and 7.8 times expected forward earnings, respectively. And their recent outperformance has come after a year in which both had pretty modest returns relative to the S&P 500.

Location, Location, Location
But the biggest reason for Daimler’s underperformance of late is that the maker of the iconic Mercedes Benz has the misfortune of being domiciled in Europe. The past month and a half have not been kind to investors in European stocks. The inconclusive Italian election—which saw anti-austerity parties make massive gains in the polls—raised the possibility that all of Mario Monti’s progress over the past year was about to be reversed.

Spanish Prime Minister Mariano Rajoy is embroiled in a corruption scandal that is weakening his government at exactly the time when strong leadership is needed most. And Spanish growth forecasts released this week were worse than investors had hoped.

Thanks Cyprus!
And to top it all off, the Cyprus bailout, which should have been simple and straightforward -- turned into a confidence-crushing publicity disaster that has sent European stocks into a tailspin.

Right now, the “Draghi Put” is being tested. European Central Bank President Mario Draghi promised nearly a year ago to “do whatever it takes” to save the euro, and this did wonders for market confidence. As bad as the recent sell-off has been, without the Draghi Put in place it would have been orders of magnitude worse.

But what does it mean going forward? If the bank runs spread from Cyprus to other crisis-hit countries, the ECB will provide whatever emergency liquidity is needed. And concerns that deposits at weaker banks might be at risk of confiscation in the event of a bailout should actually help larger, more stable banks such as Spain’s Banco Santander (SAN).

Watch The High End
I have some concern that fear of asset seizures will cause higher-income European drivers to postpone buying a new Mercedes for a few months. But in the case of Daimler, this is a relatively minor concern. Western Europe accounts for only about a third of sales, and sales have remained remarkably steady throughout the turmoil of the past few years. If the chaos of last year didn’t run Daimler off the road, then neither will the fallout over Cyprus.

The key to Daimler’s success lies further east. If Chinese and emerging market demand remains strong, Daimler could easily post another year of record sales. Yes, I said “another.” Despite all of the euro-zone related drama last year, Daimler enjoyed a record year for sales in 2012.

Sentiment-Driven Volatility
At this stage, investors face the risk of short-term, sentiment-driven volatility in Daimler, but the risk permanent or long-term loss is miniscule at current prices. Use today’s volatility as an opportunity to accumulate more shares.

Disclosures: Sizemore Capital is long DDAIF

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