MorningWord 11/13/14: Retail Therapy $XRT

by Dan November 13, 2014 9:28 am • Commentary

Retailers had quite a day yesterday.  Macy’s (M) rallied 5% on weak guidance. Target (TGT) is at new highs for 2014 and only 1% away from the 52 week high made a year ago. Even under-performers like COH, KORS & KSSS, who all recently issued poor results, rallied about 2.5% each. And left for dead yoga pants maker LULU made a new 5 month high, up 5.7% on the day.

The action in the S&P retail etf XRT was impressive. After a year long consolidation between $80 and $90 it looks like it’s broken out:

XRT 2yr chart from Bloomberg
XRT 2yr chart from Bloomberg

Obviously there are some seasonal factors at play here.  For the next few weeks I see little reason to try to step in front of the retail train on either side as investors seem to want to express newfound optimism about the U.S. economy amidst lower energy prices and it would be dumb to short but at the same time it’s probably too late on the long side.  My fairly simple stance on the recent retail rally is that it is more a matter of positioning.  Investors have been crowded into retail stories that have been working like COST, HD, NKE, TJX & UA but have recently woken up to laggards like M, TGT & WMT which are valued at significant discounts.  And it hasn’t been a rotation from within the sector but likely out of energy and into broader retail, as evidence by the XRT breakout.

So echoing some thoughts in yesterday’s morning piece, bearish leaning trades just don’t screen as attractive at the moment and on the flipside long trades into the year end are like walking a tightrope with vol crashing .  For instance on Friday I took at a look at Macy’s into yesterday’s print and concluded:

with the stock nearly back to the prior highs, I suspect it will take a beat and raise for the stock to break out to new all time highs.  I have no idea if they will be able to do so, but I suspect that the stock’s recent strength incorporates a bit of the good news, and if I were the company, why not give conservative guidance in a volatile retail environment.

As for the potential downside, likely one of the reasons the stock has been bought on bad news throughout the past year is that valuation is still cheap relative to peers.  Macy’s trades at a 13.5x P/E, with expected EPS growth of 10-12% over the next 2 years.  That’s quite undervalued compared to most retail stocks and to the broader market.

So I detailed two potential trades depending on ones predisposition:

1. leaning bullish:

One for those who want to take mildly bullish stance and fade the breakout on earnings and finance the purchase of longer dated calls in anticipation of reasonable guidance and later strength into the Holiday season.

TRADE: M ($60) Buy Nov / Jan 62.50 Call Calendar for 1.00

2.  bearish, or protection against long:

TRADE: M ($60) Buy Nov 60/ 55 Put Spread for 1.30

With the stock up $1.50 to $61.50 from Friday’s post, the bearish trade was obviously a loser and the bullish trade a winner. The news wasn’t great for Macy’s but investors viewed the conservative guidance as sandbagging. Which is what I kind of suspected would happen.  But investors bought the stock anyway.  We are just in that sort of market where good news for single stocks is treated as such, and bad news is viewed as managements being “conservative”.

One final point. Market participants do seem to be behaving much more discerningly with regards to stock selection.  The high fliers that led the rally throughout much of 2013 and early 2014 have actually had a rough go of it during the recent earnings season (see FB, NFLX, AMZN, YELP, etc.).  However, stocks with cheap valuations have generally been forgiven for poor quarters (see M, EBAY, MCD, INTC, etc. with the exception of IBM).  Moreover, defensive sectors continue to be the best performers year-to-date.

Even WMT’s report today was actually a guide lower vs. the full 2014 consensus EPS expectations, but the stock is trading 2% higher in the pre-market.  WMT is another low P/E stock (on a relative basis) where investors seem content to buy it as long as the news is not disastrous.  Given the value-conscious backdrop, the “value” factors are likely to be more important than “growth” factors for stock selection in 2015.