Auto Sector Reaches Roadblock, Now What?

JC Parets
July 3, 2020

One of the things that really caught my attention during our Monthly Chart Review for June was that the Nifty Auto Sector is approaching resistance on an absolute basis, as are some of the sector's largest components.

In this post, I want to dig into the sector and identify if there's still opportunity in the sector on the long side.

First, let's take a look at the Nifty Auto Index weekly chart on an absolute basis. Prices briefly broke below support at 5,200 in March and quickly reversed, sparking a rally towards resistance near 7,000 where we sit today.

This is a multi-year level of resistance, so we're likely to see some consolidation after a 57% rally off the March lows. For now, 7,000 is the line in the sand. If prices are above that, then Auto's can see further upside towards 9,300, but below 7,000 then there's too much downside risk and opportunity cost in being aggressively long the sector.

Click on chart to enlarge view.

Given the three largest components of the Nifty Auto Index comprise 51% of its weighting, we want to be paying close attention to their action.

Right now, two of the three of them are stuck below major levels of resistance as well. Bajaj Auto is above 2,500 already, but Maruti Suzuki is stuck below 6,600 and Mahindra & Mahindra is stuck below 580. It's going to be very difficult for the index to make further upward progress if its two largest components cannot break above these levels.

On a relative basis, the Nifty Auto Index vs Nifty 100 Index ratio is breaking out of a 2-year downtrend line, but still faces a major hurdle of resistance near 0.73. So while the sector can continue to outperform the broader market in the short/intermediate-term, if bulls want to see sustained outperformance then this ratio needs to be above the 0.73 level.

One final chart that gives the bullish case some pause is the relative performance of an Equally-Weighted version of the Nifty Auto Index vs the traditional Cap-Weighted Nifty Auto Index, which made new all-time lows in March and has yet to recover.

This downtrend suggests that breadth within the sector is weak, meaning that the average component of the Nifty Auto Index is faring much worse than its largest components...and has since late 2013. Bulls in the Auto sector want to see upside participation expanding, not deteriorating if there's any hope for a new multi-year uptrend in absolute and relative performance to develop.

To conclude, there remains opportunity in the sector on the long side, particularly given our bullish view on equities as an asset class. The Nifty Auto Index is approaching resistance near 7,000 on an absolute basis, suggesting a pause in the short-term is likely. The catalyst for further gains would be a breakout above resistance in the sector's two largest components, Maruti Suzuki and Mahindra & Mahindra,

Despite the overall bullish action of the sector and Equities as an asset class, the relative performance of the Equally-Weighted Nifty Auto Index suggests that not all stocks in the sector are participating in the rally.

As a result, we want to be very selective and own stocks with strong relative performance and positive momentum characteristics across multiple timeframes. By doing that, we can simultaneously position ourselves to limit our downside should the sector fail here and continue its downtrend AND benefit from further upside in the event that the 7,000 level in Nifty Auto is broken to the upside.

In looking for these stocks we also don't want to constrain ourselves to the 16 holdings of the Nifty Auto Index, which primarily hold Large-Caps. The entire Nifty 500 has 32 stocks in the Automobile Industry, so it's important to consider all of them when identifying how best to take advantage of this theme in the market.

And given our Mid/Small-Cap Resurgence thesis, we're looking specifically for opportunities in those Mid/Small-Cap names which are not represented in the Nifty Auto Index.

First, let's start with stocks we've highlighted in the past that we think still present an opportunity at current levels or on a pullback.

Eicher Motors was one of our "short squeeze" setups and has been working well. As long as prices are above long-term support/resistance near 14,800, then the bias is higher towards 23,000 and eventually back towards its all-time highs near 32,000. It's also worth noting that the stock has been stuck in a 5-year range relative to Nifty Auto, but has improved slightly as of late.

Maharashtra Scooter is another one of our short squeeze candidates that's working well. As long as prices are above 2,075, the bias is higher back towards 3,100, then its all-time highs of 4,850.

On a relative basis, the stock is trying to stabilize above its long-term trendline after pulling back from its extended trend late last year. If its outperformance is going to accelerate, this seems like a logical level for that to happen, particularly with momentum diverging positively.

Suprajit Engineering is another one of our Small/Mid-Cap resurgence names. As long as prices are above 135, that failed breakdown and bullish momentum divergence remains intact, targeting 215 on the upside.

On a relative basis, the stock has also gotten back above a critical support level near 0.0195. If prices are above that, it's difficult to be bearish.

Jamna Auto had the same type of failed breakdown and momentum divergence setup. As long as prices are above 30, that thesis is intact and targets 49.

And on a relative basis, the stock has stabilized above support near 0.0039 and is working its way higher.

Balkrishna Industries was part of our "big bases" series and is now breaking out to new highs. As long as prices are above 1,275, this breakout is intact and we want to be long with a 1,640 target. It's also worth noting that the stock is also hitting new all-time highs relative to the Nifty Auto Index.

Another big base we discussed was Escorts India Ltd. As long as prices are above 1,000, this breakout is intact and we can be long with an initial target near 1,385. The stock is also hitting new all-time highs relative to the Nifty Auto Index.

Hero MotoCorp Ltd. was highlighted during our conference call against the 2,325 level (daily chart not shown). Our view there was that if prices were above 2,325 then there was further upside and if below, then we had to get out of the way. The stock has continued higher, and as the weekly chart shows, can be bought on weakness towards 2,200 with a target near 3,400.

The stock is also hitting its highest level since 2014 relative to the Nifty Auto Index, a significant breakout that suggests continued outperformance is likely ahead.

Below are our new trade ideas in the sector.

Motherson Sumi is at a critical level here. If prices are above 91 then this failed breakdown is intact and targets the next major resistance level near 160.

The stock also put in a failed breakdown on a relative basis and should continue to outperform as long as this ratio is above long-term support/resistance near 0.013.

TVS Motor Co. is also back above its major support/resistance level near 310. As long as prices are above that, weakness can be bought with an ultimate target back at its all-time highs near 800.

On a relative basis the stock has performed in-line with the Auto Index, correcting through time as opposed to price. This bodes well for the stock long-term and suggests we should be looking for an eventual breakout to new all-time highs over the long-term.

Last, but not least, is CEAT Ltd. The stock confirmed a failed breakdown and bullish momentum divergence by getting back above support near 800. As long as prices are above that level, we can look for an initial target of 1,300.

Much like TVS Motor Co., CEAT Ltd. has spent a lot of time consolidating gains relative to the Nifty Auto Index and looks ready to move higher once again. As long as prices are above 0.010 then the long-term bias remains positive.

Overall, a lot of the opportunities we outlined over the last few months continue to work. Any weakness in these stocks toward their risk-management level can be viewed as a buying opportunity. Given many of these stocks have reversed multi-year downtrends, our expectation is that they push back towards their all-time highs over the long-term...particularly if we are right about this being the start of a new bull market in stocks as an asset class.

We'll take it one step at a time though and respect our initial targets and risk management levels, seeing how these setups and the broader market develop in the weeks/months/quarters ahead.

For now, these represent the best opportunities in the Auto space for our timeframe.

Thanks for reading and please let us know if you have any questions.

Allstarcharts Team

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