Orient Securities Company Limited has published a research report noting that the automobile sector is currently underweighted by active funds, with a significant decline in allocation during the second quarter of 2026. The firm expects that as domestic demand for passenger vehicles improves in the second half of the year, the sector's allocation from active funds is likely to rise.

From an investment strategy perspective, the auto sector has experienced a prolonged adjustment in the second quarter, which has fully priced in market expectations of weakening domestic demand and declining profitability. The report forecasts that domestic auto sales will see marginal improvement in the second half of the year, while exports are expected to continue their positive trajectory. This environment should lead to a valuation recovery for several companies. Orient Securities recommends focusing on the entire vehicle and auto parts companies with strong overseas exposure, as well as select oversold passenger vehicle stocks.

Active fund allocation hits a five-year low

Data shows that in the second quarter of 2026, the allocation to the auto sector among the top ten heavy holdings of active funds fell to 1.9%, a decrease of 2.2 percentage points quarter-on-quarter. This marks the lowest level in five years. Since the first quarter of 2015, the average allocation to the auto sector by active funds has been 3.6%. The second quarter figure is 1.7 percentage points below this long-term average. The market value of the auto sector as a proportion of the entire A-share market stood at 3.3%, resulting in an underweight position of -1.3% for the sector, a decline of 1.4 percentage points from the previous quarter. The report suggests the current low allocation and rapid decline set the stage for a potential increase in fund allocation as domestic demand improves.

Passenger vehicle and auto parts holdings drop to historical lows

Driven by factors such as the phase-out of new energy vehicle subsidies, intensified industry competition, and rising raw material prices, active funds began significantly reducing their positions in the passenger vehicle sector from the third quarter of 2025. The allocation ratios from the second quarter of 2025 to the second quarter of 2026 were 1.1%, 0.3%, 0.2%, 0.4%, and 0.1%, respectively. The allocation to passenger vehicles in the second quarter of 2026 has hit a new historical low. Meanwhile, the allocation to the auto parts sector by active funds in the second quarter was 1.3%, down 1.4 percentage points quarter-on-quarter. Orient Securities believes the market has now fully priced in the pessimistic outlook for the passenger vehicle sector. With the sector's fundamentals expected to improve marginally and fund allocation at a trough, the sector presents an attractive investment opportunity at a turning point.

Domestic sales seen bottoming out, exports to maintain rapid growth

According to data from the China Association of Automobile Manufacturers (CAAM), domestic passenger vehicle sales in the first half of the year totaled 8.287 million units, a decline of 24.3% year-on-year. This weakness was driven by a combination of factors, including demand being pulled forward by policy changes, weakening consumer sentiment, and a marginal increase in international oil prices. In contrast, passenger vehicle exports in the first half reached 4.4324 million units, a surge of 72.0% year-on-year. This robust growth was supported by automakers actively expanding into overseas markets and rising oil prices boosting demand for new energy vehicles abroad.

Orient Securities expects that supported by a low base, the fading impact of policy transitions, and the ramp-up of new vehicle models, domestic passenger vehicle demand will see marginal improvement in the second half of the year. The year-on-year decline in domestic sales is expected to gradually narrow. Simultaneously, as automakers diversify their export destinations and localize production capacity, export sales of passenger vehicles are projected to continue their strong growth in the second half.

Key stocks to watch

Passenger vehicle-related targets include: BYD, Geely Automobile, SAIC Motor Corporation, and Anhui Jianghuai Automobile Group Corp., Ltd..

Auto parts-related targets include: Yinlun Machinery Co., Ltd., Xinquan Automotive Trim Co., Ltd., Tuopu Group, Zhongyuan Neipei Co., Ltd., Daimei Auto Parts Co., Ltd., Changzhou Xingyu Automotive Lighting Systems Co., Ltd., Henan Feilong Auto Parts Co., Ltd., Sichuan Chuanhuan Technology Co., Ltd., Weichai Power Co., Ltd., Shenzhen Kedali Industry Co., Ltd., Sanhua Intelligent Controls Co., Ltd., Huayu Automotive Systems Company Limited, Jiangsu Mould & Plastic Technology Co., Ltd., Rongtai Precision Technology Co., Ltd., Fuyao Glass Industry Group Co., Ltd., Zhejiang Aokadi Auto Parts Co., Ltd., Jingwei Hengrun Technology Co., Ltd., Bethel Automotive Safety Systems Co., Ltd., and Desay SV Automotive Co., Ltd..

Risk factors

The report lists several risks, including a macroeconomic downturn impacting auto demand, fluctuations in upstream raw material prices, and pressure from price wars among automakers.