Stock Exchange: Reading into Retail Moves

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods – including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some earnings season ideas, please join in!

Review

Our last Stock Exchange looked at consumer discretionary spending. If you missed it, a glance at your news will show that the key points remain relevant.

This Week – Amazon Apocalypse in Retail?

Amazon (AMZN) made waves again last week with its announcement that it would partner with Sears (SHLD) to sell Kenmore branded appliances. The announcement sent shares of competing appliance sellers like Best Buy, Home Depot, Lowe’s, and Whirlpool tumbling (BBY, HD, LOW, WHR) while bolstering Sears. Best Buy and Home Depot have acquired a reputation with some as being relatively ‘Amazon-Proof’, and for investors with such opinions these moves may represent a opportunity. It’s worth noting that Whirlpool is one of the main manufacturers of parts for a variety of Kenmore products, although it remains to be seen if it’s 30+ year partnership with Sears will survive.

Between its purchase of Whole Foods Market (WFM), filing a trademark for a prepared meals service (bludgeoning Blue Apron (APRN)), and freshly announced partnership with Sears, Amazon is attracting a lot of attention from the punditry and even some from regulators. Barron’s cites Reuters’ report that The FTC recently opened an investigation, as part of its review of the company’s purchase of Whole Foods, into claims by Consumer Watchdog that Amazon uses deceptive discounting practices.  The word ‘antitrust’ continues to be whispered with increasing volume, and more and more with a bone to pick are finding this to be the moment to pile on with. The same day the FTC announced its investigation, David Kahan, CEO of Birkenstock Americas fired off a letter to the company’s retail partners accusing Amazon of “Modern Day Piracy” and attacking “All Brands”. The letter accuses Amazon of running Birkenstock’s blockade of sales to it by buying from resellers instead, and warns retail partners to steer clear or risk ending their relationship with the German shoe company.

Rupert Hargreaves’ piece published earlier this week on ValueWalk, does an excellent job examining some of the concurrent dynamics affecting brick and mortar retail. It isn’t pretty.  He covers the precipitous drop in retail traffic over the summer, how consumer behavior with private-label credit cards and store closures exacerbate each other’s effects, and the major disadvantage brick and mortar stores face in having to deal with issues like shoplifting and robberies. For more, you’ll have to check out his article. While retail stores are closing and laying off workers, Amazon is hiring, listing 50,000 full time positions across its fulfillment network nationwide.

Expert Picks from the Models

We’re joined again by one of our favorite guest experts on the stock exchange: Blue Harbinger (also known as Mark Hines) who we were lucky enough to have for last week’s edition of The Stock Exchange as well. Blue Harbinger specializes in independent investment research, and we’re glad to have his thoughts again this week.This week’s picks happen to center around retail, similar to last week’s focus on related discretionary spending and luxury goods.

Holmes: This week I like L Brands (LB), the fashion retailer. This stock’s dip since January is the sort of set up I like to see when sniffing out a good deal. From the chart below you can see LB is below both its 50 and 200-day moving averages, and has received support at the $43-level. The price moving above the 50-day average at $49.81 would be encouraging. With limited downside and plenty of upside potential, I hope I’ve brought the humans a solid pick.

BH: L Brands is a profitable business but it has a lot of debt, and retail will be challenged going forward. In particular, L Brands has exposure to “B and C” brick and mortar retail stores, and these spaces will be challenged as the proliferation of online retail continues.

H: What are B and C stores? I have to admit I’m not familiar with these terms, or the details of L Brands’ capitalization structure. I do know what works for me, however, and this is it! Plus, I’ve read that Victoria’s Secret and Bed Bath & Beyond customers, L Brands’ flagships, are some of the most loyal in retail. That’s good, right? Loyalty has to count for something…

BH: I do believe the company’s brands give it some competitive advantage and allow for premium pricing (Victoria’s Secret and Bath & Body Works account for over 90% of total L Brands sales). However, sales fell 6% in June, below consensus estimates, and this feeds into the narrative that all “brick and mortar” stores are going to get “Amazoned.” I don’t necessarily believe this narrative is true (plenty of prime location stores will continue to do just fine), but the company’s plans to increase exposure (including “less-than-prime” retails spaces) is concerning. L Brands spends a lot of money maintaining its stores and training its employees in order to provide an exceptional customer experience, but brand preferences change over time and less foot traffic to some of its expensive locations doesn’t bode well.

Some investors may be lured in by L Brands low price-to-earnings ratio, but I suspect it’s low for a reason (i.e. business is facing challenges).

BH: Given the choice between L Brands and RH, L Brands seems much healthier, but realistically I am not interested in investing in either one.

H: Take RH up with  RoadRunner, it’s his pick this week, and was Athena’s a few weeks ago. While I can’t speak for the bird or our resident goddess, I’m comfortable sticking to my pick, and my method works for me.

Felix: Broadcom (AVGO) is my pick for the week. While it may be hard to see the value of a stock that looks like it’s already on a tear, I’ve done my homework on this one. Put plainly, I think it has a long, long way to go. Take a look at its 12 month chart and you’ll see what I mean. Although I’m focused on the chart, I still know there’s long term growth in semiconductors to beat the band, and the company has excellent cash flow. Broadcom is showing me it can keep this up.

BH: I like the amazing long-term growth potential of the semiconductor industry, and in one way or another Broadcom is going to be a part of that (Broadcom differentiates itself as a leader in the design of new capabilities and products where high margins are believed to be attainable). However, I have a variety of near-term concerns ranging from the fiercely competitive semiconductor industry, to the company’s high valuation multiples, the delay of the big Brocade (BRCD) deal, and the fact that Broadcom almost has more cash flow than it knows what to do with right now considering its target 50% free cash flow payout ratio (i.e. dividends and share buybacks) which isn’t necessarily all that bad of a problem to have.

F: It doesn’t sound like all that bad of a problem to have at all… It’s not usually the sort of thing I focus on, but you’re making me think this is an even better pick than it seemed at first glance. It has its hands in so many industries in the technology sector! I like the diversification.

BH: It also has some concentration risk with Apple/Foxconn (more than 10% of revenue in 2016). Further, it’s a high beta stock thereby subjecting investors to market price volatility, and the technology sector to which it belongs probably cannot keep rallying forever.

In a nutshell, this might be a good Rip Van Winkle stock to sleep on for the next 10 years because if you can avoid stressing out over the volatility then your future self will probably thank you for owning it.

F: It’s precisely long term holding that I’m interested in, although a little shorter than 10 years. While you might think the volatility would bother a fussier investor like me, I take solace in my method and don’t let it bother me.

Road Runner: My pick of the week is Restoration Hardware (RH). Regular readers probably remember that Athena picked RH a few weeks ago. It’s nice to think I came across the same pick as a wisdom goddess, but by a completely different method! Unlike Athena, I look for stocks that are at the bottom of a rising trading channel, and if you look at the chart below you can see why I like RH. It’s been in a steady rising channel since early March, and is at the bottom of the channel again at 71.60. I expect the price of RH to continue to rise back above $75, but will only hold the position so long.

BH: I don’t like RH (formerly known as Restoration Hardware). This luxury home furnishings company just completed an extraordinarily aggressive share buyback program (they bought back nearly 50% of the shares outstanding in less than six months), and that drove the price way up (it more than doubled) and the valuation (price-to-earnings) is way up too.

RR: I don’t care about valuation, share buybacks, or other fundamental aspects, but I can appreciate that RH isn’t the pick for everyone right now.

BH: According to Stock Rover, however, next year’s sales growth forecast is only around 6%. The recent actions of the company seem very aggressive (especially since they used some expensive debt to buy back the shares). The market also believes there’s something odd going on with RH considering short interest has risen dramatically to an enormous 63.2%. Further, it’s concerning that RH’s cost of capital is higher than its return on capital, which basically means it is destroying value for each new dollar it invests. And considering RH could suffer significantly (they could have liquidity problems) under even a slight recession, this stock just seems expensive and risky. Perhaps management has something interesting up its sleeve, but I am staying away.

RR:  You’re chasing down the wrong things to convince me, I look at the chart and like what I see! Our readers are probably more interested in RH’s large short interest or their cost of capital being higher than its return on capital than I am. Thanks for the warning that it might be an ACME Brand trap, but for my purposes it’ll be just fine! How about you Oscar, what have you got?

Oscar

Oscar: I don’t have anything new this week. As Jeff reminds us to not reach when opportunities are not in our wheelhouse. Sometimes the wisest thing to do is nothing at all. Besides, it gives me more time to watch the games. Athena told me to let you know she’s out again this week, and that she’ll report in when she has a new idea. She sure seems to have good ideas for vacations!

Conclusion

Although news of investigations, acquisitions, and cries of impending doom can unsettle investors, it’s important to remain calm and not adjust their methods hastily or in fear:

  • Don’t reach! If the market climate does not fit your trading methods, it is better to wait than to reach for unsuitable trades. For those with particular views on a few large retailers, the market just gave them a nice opportunity to express those views. Volatility is an opportunity if you’re patient!
  • If the unusual volatility creates an opportunity, be ready to hit it out of the park. It’s harder to do this if you have little dry powder available.

There will always be winners and losers in disruption. It is a tale as old as time. For patient and prudent investors there will be myriad opportunities to profit from the rise, and fall, and rise of online retail behemoths, resilient retail, and the entire cast of characters.

Here is a summary of the cast of our own characters. Find your own favorite!

Stock Exchange Character Guide

 

Character Universe Style Average Holding Period Exit Method Risk Control
Felix NewArc Stocks Momentum 66 weeks Price target Macro and stops
Oscar “Empirical” Sectors Momentum Six weeks Rotation Stops
Athena NewArc Stocks Momentum One month Price target Stops
Holmes NewArc Stocks Dip-buying Mean reversion Six weeks Price target Macro and stops
RoadRunner NewArc Stocks Stocks at bottom of rising range Four weeks Time Time
Jeff Everything Value Long term Risk signals Recession risk, financial stress, Macro

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Stock Exchange: Sizzling Summer Picks in Discretionary Spending

The Stock Exchange is all about trading. Each week we do the following:

  • Discuss an important issue for traders;
  • Highlight several technical trading methods – including current ideas;
  • Feature advice from top traders and writers; and,
  • Provide a few (minority) reactions from fundamental analysts.

We also have some fun. We welcome comments, links, and ideas to help us improve this resource for traders. If you have some earnings season ideas, please join in!

Review

Our last Stock Exchange took a deep dive into the earnings season. If you missed it, a glance at your news will show that the key points remain relevant.

 

This Week — Consumer Discretionary Spending Heats Up

Our experts are picking up on this week’s theme in a big way. From luxurious cruises to hip new threads, our technical indicators suggest there’s something driving levels on consumer discretionary spending. Derek Benedet of seeitmarket.com had an interesting take. Let’s review some traditional causes behind increased spending:

While these points are accurate, Benedet goes on to note that the patterns of spending are very different. Traditional retailers may find difficulty attracting discretionary spending in a way that Tesla or Urban Outfitters may not. Let’s ask the experts:

Expert Picks from the Models

We’re joined again by one of our favorite guest experts on the stock exchange: Blue Harbinger (also known as Mark Hines). Blue Harbinger specializes in independent investment research, and we’re glad to have his thoughts this week. Let’s get down to it.

This week’s picks happen to center around luxury goods and discretionary spending.

Oscar

Oscar: This week, I bought into my custom Leisure, Lodge, and Cruise sector. PEJ is a close approximation. Stocks in the sector have been hanging around the same level since December, but there’s been enough volatility that I can see an upside. Check the 200-day moving average on the chart below.

Despite the up and down movement, the 200-day moving average has continued the steady rise past the compensation for November’s pop. Beyond the trend, a popup near the $43 mark in the next two to four weeks would provide a solid exit point for me.

Blue Harbinger: Unless you are aware of some short-term exploitable market-mispricing anomaly, I do NOT like this ETF. The PowerShares Dynamic Leisure & Entertainment ETF (PEJ) charges a fairly high fee, it has a high turnover ratio, its price can trade at unpredictable premiums and discounts to its net asset value.

O: A grim assessment, but I’ve got my own stocks in the same sector. Is that inherently wrong?

BH: Well this is based on a goofy, undiversified and concentrated index that seems to have been developed as a marketing ploy to get retail investors to invest in something that lines the pockets of the PowerShares people.

For starters, it only holds 30 stocks, and they’re concentrated in the Consumer Discretionary sector (79%) with the remaining holdings (21%) in Industrials. According to the PowerShares website, the index is described as follows.

The Intellidex Index is designed to provide capital appreciation by thoroughly evaluating companies based on a variety of investment merit criteria, including: price momentum, earnings momentum, quality, management action, and value. The Underlying Intellidex Index is comprised of common stocks of 30 US leisure and entertainment companies. These are companies that are principally engaged in the design, production or distribution of goods or services in the leisure and entertainment industries.

In my assessment, this index is likely based on some rickety quantitative screen, that is heavy on sounding good to the marketing people, and light on empirical evidence.

O: Understood. I can’t spill too many secrets – all I can say is I’m confident that I’ve managed to strike a better balance on my own.

Athena

Athena: I’ve got a hot one today: Tesla (TSLA). As many people know, I like to buy stocks when they’re in the midst of an upswing. Usually they’re lesser-known names, although I’m happy to make an exception in this case. Let’s check the chart:

This stock is prone to significant upswings, and is currently recovering from a correction earlier this month. Considering the rapid pace at which this went up to $375, I have no qualms at all about buying in at $328.

Blue Harbinger: Athena, I love Tesla’s vehicles. They’re high quality, attractive-looking, very efficient, and they’re environmentally friendly. I also like what Elon Musk is doing with batteries and solar power. However, as an investment opportunity, Tesla is not attractive. Aside from no net income, Tesla trades at a price to sales valuation multiple that is far above other automakers, as shown in the following chart.

Tesla’s high price to sales multiple is a reflection of the market’s very high expectations for the company. However, any slip-up (for example production delays) could send Tesla’s price much lower. Also, competition in the electric vehicle space continues to grow as Tesla’s peers continue to work on new electric vehicles as well as new batteries too.

A: What do I care about price to sales multiples? The market loves the cars as much as you do. Is it so inconceivable that a bit of good news might lead to exuberance?

BH: I don’t know if the market is heading in that direction. It’s worth noting that Tesla’s short-interest is very high, as shown in the following chart.

For a company with a relatively small amount of sales, negative net income, and growing competition, its $55 billion market capitalization is simply too rich and too risky.

A: That all sounds very compelling, but I just don’t invest on that basis. I’m sticking with this one for another two weeks, and looking for another 10% pop.

Holmes

Holmes: I’m getting into Coscto (COST) this week. What a deal! This stock has been trading below $155 this month, but it’s spent the vast majority of the past year well above that same mark. See for yourself:

That 50 day moving average – despite its strong resemblance to a roller coaster – tells me this stock is undervalued. The stretch from January to June alone should be enough to convince anyone of the same.

Blue Harbinger: Costco isn’t a horrible investment, but its best days of growth are in the past, and the company will be challenged to keep customers as excited as they have historically been. Costco’s physical locations as well as its shopping club concept are not new, and they will face challenges going forward. For example, the recently announced interest by Amazon to purchase of Whole Foods drove Costco’s price lower last month, and it may actually mark the beginning of an industry shift where shoppers (and investors) are no longer as excited about Costco as they once were.

H: Well, that would explain the recent drop. Anything else I should know about?

BH: Yes. Costco’s already significant market penetration will make it challenging for new Costco locations to open because the most attractive demographic locations have already been targeted, and new locations could lead to some attrition at existing locations.

For some perspective, according to data from StockRover, the per annum EPS growth rate estimate for Costco over the next 5-year is 5.6%. Not an extremely high rate, but one that will likely be challenging to achieve. Further still, even after the recent price decline, Costco’s price-to-earnings ratio isn’t all that attractive relative to its historical valuation, as shown in the following chart.

I’m not suggesting Costco is at risk of an imminent collapse, but it’s certainly not the great growth opportunity it once was.

H: That makes a lot of sense for long term investors. Regular readers know my timeframe is much shorter. Hey, maybe the market will decide this Amazon deal wasn’t the death knell for all other retailers after all.

Felix

Felix: Urban Outfitters (URBN) looks extremely uncool right now, and to me that’s the coolest thing about it. The month and a half long lull is signalling a bottom to me. As a longer-term investor, that’s a very important factor. Have a look at this chart of the past 12 months:

I’ll admit this does not read as a success story, though I still think it provides a useful entry point. I could easily see some recovery back up to the $22 mark, especially with my extended timeframe.

Blue Harbinger: Urban Outfitters is a well-run business with very limited growth opportunities and no competitive advantage. The company’s premium brands (Urban Outfitters, Anthropologie, BHLDN, Terrain and Vetri) will face challenges in staying relevant, and this is a stock I’m are not interested in owning.

At first glance, the stock might appear attractive because of all the share buybacks, zero long-term debt, and very low price-to-earnings ratio.

However, the average five-year EPS growth estimate according to StockRover is negative 1.6%, and management expects the number of stores and square footage to grow very little.

F: You’ve been pretty rough on all our picks this week. Maybe we should start calling you the Harbinger of Doom.

BH: Alright, alright. Here’s something positive. The company does expect to grow through its direct-to-consumer channel and wholesale (Free People) business, but these currently make up a small portion of sales, and their viability depends, to a large extent, on the brand’s ability to stay relevant.

I don’t believe the brands will become irrelevant overnight, and because the business is well-run, I don’t expect Urban Outfitters to completely disappear anytime soon. However, I do believe margins will continue to be pressured, the brand value will erode over time, and despite the recent price declines and low valuation multiples, this is not a stock I am interested in owning.

F: Okay, that’s fair. I can’t say much other than I like current prices as an entry point, and that I would be looking for a long-term holding. If the mullet can make a comeback, then surely we could see new growth out of Urban Outfitters…

Conclusion

Favorable conditions for discretionary spending are bringing consumers around to household names that have been en vogue as of late. In fact, this may be the first week where our models have gravitated to these kinds of trendy companies.

Thankfully, we have Blue Harbinger here to talk us down from the hype. Each of these selections might give the human investor pause. It’s the model’s job to follow its technical indicators carefully, and to remain consistentStock Exchange Character Guide

 

Character Universe Style Average Holding Period Exit Method Risk Control
Felix NewArc Stocks Momentum 66 weeks Price target Macro and stops
Oscar “Empirical” Sectors Momentum Six weeks Rotation Stops
Athena NewArc Stocks Momentum One month Price target Stops
Holmes NewArc Stocks Dip-buying Mean reversion Six weeks Price target Macro and stops
RoadRunner NewArc Stocks Stocks at bottom of rising range Four weeks Time Time
Jeff Everything Value Long term Risk signals Recession risk, financial stress, Macro

Background on the Stock Exchange

Each week Felix and Oscar host a poker game for some of their friends. Since they are all traders they love to discuss their best current ideas before the game starts. They like to call this their “Stock Exchange.” (Check it out for more background). Their methods are excellent, as you know if you have been following the series. Since the time frames and risk profiles differ, so do the stock ideas. You get to be a fly on the wall from my report. I am usually the only human present, and the only one using any fundamental analysis.

The result? Several expert ideas each week from traders, and a brief comment on the fundamentals from the human investor. The models are named to make it easy to remember their trading personalities.

Getting Updates

We have a (free) service for subscribers of our Felix/Oscar update list. You can suggest three favorite stocks and sectors. Sign up with email to “etf at newarc dot com”. We keep a running list of all securities our readers recommend. The “favorite fifteen” are top ranking positions according to each respective model. Within that list, green is a “buy,” yellow a “hold,” and red a “sell.” Suggestions and comments are welcome. Please remember that these are responses to reader requests, not necessarily stocks and sectors that we own. Sign up now to vote your favorite stock or sector onto the list!

Identifying “Hard” Data

During recent weeks, much of the punditry has suggested a sharp difference between “hard” and “soft” data.  The former seems to show sluggish economic growth while the latter paints a more optimistic picture.  The general distinction seems to be that surveys are “soft” and other data are “hard.”   Results are rather arbitrarily placed in one group or the other.

Test Your Hard Data IQ?

Since reliance on surveys seems to be the acid test, let’s try a little quiz.  Which of the following reports use surveys, and which do not?

  • Payroll jobs
  • ISM manufacturing index
  • Wholesale inventories
  • Retail sales
  • Unemployment rate
  • Labor participation rate
  • PPI
  • ISM non-manufacturing index
  • Consumer confidence or sentiment
  • Business optimism
  • Durable goods orders
  • New home sales
  • CPI
  • Building permits
  • Personal income and spending
  • The decennial census of U.S. population
  • Existing home sales
  • JOLTS report
  • Business inventories
  • Housing starts
  • Regional Fed indexes – Chicago, Empire State, Philly Fed, Dallas, etc.

Before going on, please make sure that you have indicated “survey” or “non-survey” for each of the reports above.

Criticism of Survey Data

Most of the survey critics dismiss such data as “soft” and undependable.  This is often an assertion that surveys always involve speculation about future behavior.  Without exception, the survey critics do not include anyone who has actually designed or administered a survey.  A real expert would know that most of the complaints are treated on day one of the methods class.

Please consider this obvious example.  Suppose we ask someone, a month before an election, for whom they intend to vote.  Now suppose we ask in an exit poll.  The respondent might still give an inaccurate answer in the latter, but logic suggests it will be more accurate than the first.  Logic is confirmed by results.

Try this example.  We ask a purchasing manager if he/she is ordering more this month than last.  Or if prices paid were higher?  It does not involve speculation – just an honest report of facts.  Suppose we ask a Chinese purchasing manager the same question.  Are we just as confident of the answer?

Many questions are carefully worded to make it easy to give an honest answer.  It is a technique taught in the classes.  Most of the critics have never looked at the actual underlying surveys or considered the issues.

Quiz Answer

All the reports listed above involve the use of surveys.  All of them.

Many pundits pick and choose data to support their viewpoints.  The “hard versus soft” meme is the latest such effort.  Here is a test.  The choice of classification has been very loose and arbitrary.  Despite this, it has been taken seriously by nearly everyone.

We have seen many new fans of the Atlanta GDP Now tracking.  It showed weak growth in the first quarter.  During the second quarter the early returns are 3.5% to 4%.  Many sources will react by finding a new favorite indicator.

Investment Conclusion

The economy has a better footing than most sources allege.

Your decisions will be better if you rely upon sources that are intellectually honest in the consistent use of data.