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A Bullish View of Volkswagen: No Bugs in This Strategy


Weak rivals in the US and EU and refined production strategy leave VW to battle with Toyota for global crown.

No industry has gone through more upheaval in the past five years than the auto industry, and as we begin to emerge from the worst of this phase in global economic growth, the details of the new landscape for automakers are becoming clearer. In that new landscape Volkswagen (PINK:VLKAY) is emerging as the dominant auto producer in the world. Only Toyota (NYSE:TM) in my opinion stands a reasonable chance of stopping the German juggernaut.

Part of VW's success will be the complete implosion of its European counterparts like Peugeot (PINK:PEUGY) and Renault (PINK:RNSDF). Volvo's (PINK:VOLVY) profits just dropped 85% in the quarter on weak sales. GM (NYSE:GM) has been trying to figure out what to do with Opel but even if it stays it will be a much smaller brand. Toyota's never been a big player and Ford (NYSE:F) is sinking fast with sales dropping 15.5% in its latest earnings release. Nature abhors a vacuum, and so do German engineers. Volkswagen's market share in Western Europe has risen from 22% to 24% this year and should easily push to 30% while its rivals figure out how to compete.

VW is winning in Europe on having a better overall value proposition that the competition. The arbitrage between the health of French, Spanish, and Italian banks versus what VW can procure from German ones for customer financing emerged as a huge selling point in recessionary Europe last year. In China VW's sales have grown in response to the boycotting of Japanese automakers after the Senkaku/Diaoyu island dispute which could easily escalate.

The currency arbitrage will improve Toyota's ability to compete with VW. In the US, the weaker yen only further entrenches Toyota's growth prospects. The same is true around Southeast Asia where Japanese brands are already dominant -- not just Toyota but Nissan (PINK:NSANY), Suzuki (PINK:SZKMF) and Honda (NYSE:HMC). But Volkswagen is using its massive cash position and very strong balance sheet to push a new level of efficiency that will have far-reaching effects on the entire development and deployment cycle of a new model. It's called MQB and the beginnings of it have already been seen in the sheer speed with which the Golf platform has been refreshed in recent years -- four times now since 1999.

MQB is a system designed to streamline how engines, transmissions, and chassis are designed and deployed to minimize and eventually eliminate the different parts needed between brands. So, while now a Turbo Golf and a Tiguan share the same chassis and engines, how they are fitted together is different, and that results in an explosion of part SKUs that have to be designed, approved, tested, fitted, built, and stocked. It is more than just a simple re-badging of one car and calling it another, however. It is an acknowledgment that the old way of building cars is not only inefficient but uneconomical given the post-credit bubble world we are living in.

I'm a huge fan of simplicity, because it can cut through the noise and expose the heart of a problem/situation. Today, cars are too complex. Rules on what can go in them change too quickly as does consumer demand. Energy prices are becoming more volatile which weighs heavily on car design. Simplifying the basic systems in a car creates an enormous opportunity to respond to future trends. For this reason alone I have to be very bullish on VW.

Looking at VW's stock, I see a number of things. First it is trading at a very low multiple of 3.6, much of that from booking the acquisition of Porsche (PINK:POAHY) in the 3Q of 2012. Even though operating margins that period were soft, given the extreme fear in Europe, selling more cars at thinner margins should be considered a victory. In the above monthly chart the shaded area is a two-year consolidation period from in which the stock broke out. It has not looked back, closing every month near the top of that month's range and creating high probability setups for the next month. Currently in February we are seeing a fifth one of these setups in a row.

In my book, The BIG Trade: Simple Strategies for Maximum Market Returns, I describe exactly how to define and trade these types of setups. We have not seen a break in February of either the January high or low. Because of this the stock has given no indication of either wanting to move higher or lower. We will have to watch to see what happens. For this month there is a 70.4% chance that if VOWG moves to $170.60 it will break through $175.65 – January's high. Conversely, there is a just a 26.1% chance given the moves made so far of it violating the January low. So, your odds are 3:1 in favor of bullish continuation of some amount. If it does break higher the rally has a 92% chance of continuing without violating January's low.

My approach to trading dispenses with traditional technical analysis and focuses purely on whether the next bar will break higher or lower. Adjusting your time frames adjusts your expectations over that time frame. The statistics quoted here are based on VW's past performance over the past 49 months. Things like market sentiment and other factors weigh on how I would handicap these probabilities.

Lastly, VW looks to be weakening on a weekly basis. I tend to use 2-bar reversal patterns to decide on my exit point on a trade. This rally in VW from a weekly basis began in August. I will set my stop at the low of the last up bar (No. 1 on the chart). Since that bar there have been 2 down bars, the last one violating bar No. 1, but not closing below it. Since the probabilities on a monthly basis are still very bullish, I would be willing to overlook an intra-week move that violates my stop. But the stock is in a bearish posture for the week. With the odds likely that the stock will not violate this past week's previous high or low because of this week's volatility I would feel comfortable holding and watching the week unfold. But if I were trading VW here I would be cautious and short-term bearish.

Short-term bearish signals that can be traded with precision create great chances to take a position at a better value or add to a current position. This would be my recommendation on VW, trade the weekly chart now and accumulate shares for a long-term position.
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