Can car stocks keep up the pace?

If you're an investor who earned high-octane returns on your auto stocks in 1998, you might want to start pumping the brakes.

Barring the unexpected, auto stocks are not likely to outperform the market in 1999, car experts say.

Their main worries:

Deep discounts. Rebates and price wars are great if you're buying a car. But they can cut into a manufacturer's bottom line, which means a potential lower return on investment. Experts expect one or two carmakers (especially giant GM) will pile on discount incentives by this summer.

Slower sales. Auto sales were red hot in January and February - at one point revving annual projections up to 17 million cars and trucks. But some analysts fret sales may run out of steam by midsummer.

Overvalued equities. Auto stock prices may be too high, having already taken this year's industry gains into account.

Despite these future concerns, the current environment in the auto sector can hardly be called unfavorable.

The US auto sector roared into 1999 in the financial-world fast lane, accelerated by low interest rates, low unemployment, minimal inflation, and solid consumer demand.

Sales of vehicles and light trucks remain robust. Both General Motors and Ford are revving up new production. GM, the world's largest carmaker, scored a 17.5 percent sales increase in February.

Last year, the industry sold 15.6 million cars and trucks, the second best year since 1986, when a record 16 million vehicles were sold.

For many investors, last year's performance turned into gold: Of the 116 key industry groups tracked by Standard & Poor's Corp., the auto sector came in 19th with a 50 percent return, outperforming the S&P 500 Index's 27 percent return.

As for this year, investment house Donaldson, Lufkin & Jenrette sees steady, but not grandstand-size returns, from the auto sector, what DLJ - in its projections - call "market performance."

Buying stock in wheels and wipers

The most attractive auto-linked gains, according to DLJ analyst Wendy Beale Needham, will come from auto suppliers. In a new report for DLJ, she concludes that the auto parts/tire and rubber segment of the industry could outperform the market in general. (See story below.)

Beyond buying direct shares in automakers and supply firms, investors can profit by taking a position in the large-cap mutual funds that tend to invest in auto-industry stocks. Index funds also usually carry the main US auto producers.

Among general mutual funds that have a heavy percentage of assets invested in auto stocks are Ameritor Industry, DFA US Large Cap Value, and Marsico Focus. (See chart below.)

Thomas Marsico, who heads up Marsico Funds remains upbeat about auto stocks: "Manufacturing costs have declined;" there are now "fewer parts" in a car, which reduces maintenance costs; individuals "are buying cars for different uses," such as recreational purposes, as well as for travel to work.

In terms of demographics, he sees a strong future buying thrust coming from the children of baby boomers, who will need cars of their own.

Finally, says Mr. Marsico, stock fundamentals are positive: Share prices trade at about nine times earnings, which means that there's long-term value. Although Marsico's portfolios currently include only US carmakers GM and Ford, he has looked overseas for gains in the past.

"I like Ford, because to me it is the best of the three US automakers; their market share seems to keep expanding," says Max Katcher, portfolio manager of Ameritor Industry Fund, which has roughly 13 percent of its assets in Ford. Katcher does not plan to add any other auto stocks at this time, however.

Robert Deere, portfolio manager for DFA US Large Cap Value Fund, sees Ford and GM as solid investments based on their low share prices relative to book value and earnings, traditional measurements of value stocks. The two stocks represent about 10 percent of his fund's portfolio.

Perhaps the best-known auto-linked fund is the Fidelity Select Automotive Fund (down about 6 percent this year). Established in 1986, the fund is useful in that it is essentially for investors with a special affinity for cars - or who like to "time the market" - says Morningstar analyst Justin Craib-Cox.

Cyclical stocks

Because auto stocks are interest-rate sensitive, they are cyclical, sometimes up, sometimes down, depending on trends within the economy. Thus, they are perfect vehicles for mutual fund "day traders," that is, investors who frequently move in and out of funds to track economic cycles.

Jim Lowell, who tracks Fidelity funds with his Fidelity Investor newsletter, recommends that his readers sell their shares in the auto fund. (He also has a "sell" recommendation on two other transportation-related Fidelity select funds, Air Transport and Transportation.)

The key to continued gains from auto stocks remains what happens to interest rates, Mr. Craib-Cox says. If rates remain about what they are now, sales should continue to do well. If rates drop, sales should be even brisker. If rates go up, then sales will likely slow - bad news for sector investors in auto stocks.