Dear Bottarelli Research Reader,
This week, we received two major warning shots. Both were aimed straight at retail stocks, but their resounding “bangs” are being heard loud and clear by the larger markets.
First let’s set up the backdrop for you. Then, we’ll show you the warnings, the damage they’re doing, and how to make a quick 25% to 50% return off the entire situation.
But before doing anything, make sure you’re ready for this week’s earnings reports that start today. Not prepared yet? Bottarelli Research Options can help you trade these upcoming announcements.
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Now, back to the warning shots. The first one starts with retail, which has been running hot and hard – gaining some 92% over the past 24 months, as illustrated on the chart of the Discretionary Retail SPDR (XLY – NYSE).
And why not? With consumer confidence supposedly returning to “Pre-Great Recession Levels” (illustrated below), consumers are supposedly seeing more jobs and rising house values.
That should all translate into rising sales and profits at the mall, right?
Unfortunately, this whole retail situation is not quite that straightforward.
We’ve been questioning these figures for months. Why should folks be so fat and happy when most of these new jobs only pay half of what they used to, are part-time, and don’t come with any benefits?
Don’t believe us? Just look at these wage statistic from the U.S. Bureau of Labor Statistics.
Unfortunately, quantifying the economic value of “happiness” has been about as easy as nailing down a blob of mercury. But now, we finally have hard numbers instead of general suspicions.
According to another veteran pollster, Gallup, U.S. consumer spending has actually remained largely flat – if not a little down – over the last three months.
Apparently Gallup thought to ask 14,000 Americans a neglected question: “Excluding house payments, car loans and regular bills, how much did you actually spend?”
The answer was $90 in May and June, and $89 in July (as illustrated below).
Now that’s a fact you can nail to the wall!
The Summer Splurge Evaporates
We already know that formerly upside-down homeowners are finally getting out from under their killer mortgages. Folks also bought a lot of cars and trucks over the past few months because their old clunkers were dropping dead.
But apparently, the big spending explosion that was supposed to go down when real estate built up some excess value again just isn’t happening.
Instead, families are setting common-sense budgets and sticking to them.
While I personally think this is great news, the boutique t-shirt and jeans shops down at your local mall were really counting on a big, back-to-school splurge.
Unfortunately, a National Retail Federation survey of 5,635 consumers back in early July already showed that back-to-school spending is expected to slow from last year’s record.
Spending this fall on k-12 students is expected to drop 12% to $26.72 billion from $30.31 billion last year, with families of school-age children spending on average $634.78.
That’s down from $688.62 last year.
According to NRF President and CEO Matthew Shay…
Macroeconomic issues including the still sluggish job market and payroll tax hike are depressing spending somewhat, with half of American consumers saying they have begun to focus more on needs than wants. The biggest issue on the minds of retailers is how we are going to get the economy moving forward again. There remains a great deal of uncertainty. They aren’t making big purchases.
This brings us neatly around to that second warning shot…
Theory Yields to Hard Facts
So far, we’ve been talking polls and economic theory. But this week, we heard from an actual retailer that’s desperately trying to gear down expectations so it doesn’t get slaughtered on announcement day.
I’m talking about American Eagle Outfitters (AEO – NYSE), who warned on Tuesday of disappointing sales of women’s merchandise and weak store traffic.
AEO management noted that the market is “highly promotional” and became even more so in July, forcing it to deepen and widen its profit-eroding discounts to clear inventory.
The upshot? Profits were likely to be half what analysts have been forecasting.
After pushing these stocks on retail investors for years, analysts are finally getting the message. Janney Capital, Brean Capital, and B. Riley all downgraded AEO to either “Neutral” or “Hold,” and Janney went on to cut the entire specialty clothing sector from “Neutral Weight” to “Underweight.”
Brean Capital’s Eric Beder put it this way…
The entire teen space was under material inventory pressures that were exacerbated by colder weather and a limited “pent-up demand” as the quarter progressed. The start of the third quarter has been equally as challenging. We believe the level of price cuts has remained above prior levels in August. We do not believe this margin and price compression will ease as we head to the heart of the back-to-school season.
And then, Janney’s Adrienne Tennant warns of…
A highly competitive promotional environment and weak consumer. The sector may face multiple contractions. A still-weak consumer environment could potentially put EPS at risk for the remainder of the year.
By the time the dust had settled, AEO had lost more than -17% in a matter of minutes.
The Current Situation
We saved the Dow Jones Industrials (DJIA) chart for last.
In it, you can see that AEO’s startling news is clearing out some of the technical confusion.
On the upper chart, price is rolling over at resistance at the top of trend, as predicted last week.
And on the lower chart, the MACD is now showing absolutely no daylight between the two signal lines, indicating that last week’s “Hold” is now changing to a “Warning.”
In fact, only the lagging Accumulation/Distribution indicator is still reading buy — which meshes neatly with that overbought retail sector chart we showed you at the beginning of today’s newsletter.
Frankly, there are still dozens of retail stocks begging to be shorted right now.
We’ll go after a particularly weak retailer in this week’s Bottarelli Research LEAPS alert.
If all goes as planned, we anticipate this trade to give us 25% to 50% gains within a few weeks at most.
As always, the charts tell all.
Sincerely,
Adam Lass
Bottarelli Research Newsletter
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