I am fairly certain that whatever type of market participant you are (active, passive, or have merely a viewer of financial TV) then you have heard the statement “the stock market is a discount mechanism”. What this means is that current stock prices incorporate a good bit of future expectations. There is no take it to the bank method to make money off of this sort of wisdom but there are examples where price action of an index/sector or that of its components can be fairly telling about what’s to come. For example, a week ago in this space, I took a quick look at the breakout in retail stock etf XRT (MorningWord 11/13/14: Retail Therapy) despite some high profile earnings disappointments from COH, KORS, KSS, GPS, ANF (to name a few):
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:
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.
Despite that observation last week I have been unable to take a more bullish position on retail stocks, both as a trader, and as a pundit. On numerous situations over the last couple of weeks on CNBC’s Fast Money and Options Action I have found myself taking the other side of what I have perceived to be overly optimistic near term sentiment that is largely driven by seasonal factors. It is my strong belief that we are likely to see the most promotional holiday selling season on record, coupled with the fact that Apple (AAPL) is likely to take a huge chunk of the big budget items with sales of new larger iPhones and Beats headphones and speakers.
Yesterday’s action in Lowe’s (LOW) and Target (TGT) was astounding. Both stocks massively outperformed the implied moves, and the 4 and 8 qtr averages, with LOW closing at new all time high, and TGT about 1% away.
LOW up 6.37%:
TGT up 7.39%:
Oh, and the runaway breakout in WMT last week to all time highs was fairly epic:
So what is this price action discounting? I think it is safe to say that all three stocks have seen their earnings multiples expand with just slightly better incremental financial results coming off of a period of very poor sentiment.
While I have been very wrong as a pundit to voice negativity about chasing some of these stocks into and out of Q3 results (Macy’s 2 weeks ago, with Best Buy today’s example), I assume Q4 holiday sales on a gross basis will be as good as it gets for a while. I suspect margins will be atrocious, and Q1 commentary on the space will be one of tempered forward expectations for the first half of 2015.
If the stock market is in fact a discounting mechanism, then the stellar holiday sales are probably already priced into most of the stocks making new all time highs, with valuations stretched above a market multiple. So if you are chasing runaway breakouts when the news flow and sentiment can’t be better (heading into a make or break season) it could be time to discount that enthusiasm, recognizing the potential for a post holiday hangover. Oh and one more thing, remember the weather in Q1 and the number it did on Q1 GDP, well things aint shaping up a whole lot better with the polar vortex in the Northeast and so we can expect to hear that excuse once again.