Retail’s weakness to start 2014 has been greeted by the broader market with a fair bit of complacency. Investors have shrugged off one negative sales report after another with the view that the problems are company specific. Best Buy had terrible numbers today, and futures are only down a touch.
But as the number of negative reports pile up, it’s getting difficult to ignore the potential that the overall sales pie is gradually shrinking. So far in the first couple weeks of 2014, the following stocks have dropped some serious holiday sales bombs (with one-day stock move):
- SCSS -19%
- HGG -12%
- TCS -15%
- BBBY -12.5%
- LULU -16.5%
- SODA -26%
- GME -20%
- BBY -30% pre-market
There are a few winners (M, ANF, and COST for example), but perhaps what is most notable about the losers is the swift, drastic stock reactions. Best Buy, with this morning’s move, has shaved off almost 50% of its market cap since its high in mid-November, an amazing cut in value in just 2 months.
Consumer Discretionary has been THE market leading sector since the bottom in March 2009, almost 5 years ago. While health care has been the horse over the past year, the clear long-term leader over the entire bull market has been consumer discretionary stocks. Whether it’s been retail, media, or durable goods companies, the biggest winners have been those stocks catering to the insatiable U.S. consumer.
For the first time in a few years, we’re seeing a number of data points that could indicate that the U.S. consumer’s unending appetite might be waning. Surprisingly, the macroeconomic data in the U.S. has not indicated such a slowdown. But corporate profits are a leading indicator for the economy, while so many of the widely followed economic indicators are coincident or lagging.
Most worrying of all is the magnitude of the stock reactions. For those companies that reported picking up share during the holiday season, the stock reactions to the upside were more tepid. For those that lost share, saw sales drop, or saw margins contract (or all 3 in the case of Best Buy), the stocks were hammered.
Stocks naturally anticipate the future, so when they start to make big, impulsive moves lower, investors are not only pricing in today’s news, but potentially more negative future implications as well. If the economy is struggling, the macroeconomic indicators might not show it for 6 months. But the stock market reaction will be much earlier, and much swifter. Especially if valuations are projecting a much more rosy future, as seems to be the case with many of the retailers reporting holiday numbers.
To get a sense for the nature of expectations in the retail sector, check out the 5 year chart of XRT, the S&P Retail ETF:
This is an ETF that has gone up almost sixfold in that period. An ETF! That’s incredible. Even more incredible has been how steadily the ETF has performed, only spending several months below its rising 200 day moving average in the entire period.
Implied volatility in XRT is at 5 year lows after years of such a steady trend:
In such an environment for stocks in the sector, negative surprises have been few and far between. That’s likely the reason why the stock reactions have been so severe on disappointments over the past couple of weeks. With low implied volatility though, and a weakening fundamental backdrop, we have our eye on potential long premium strategies in XRT for protection in the coming months.