The Kors Bears Have Retreated

 | May 27, 2014 | 2:00 PM EDT  | Comments
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I have found over the last few years that there is a misconception among retail traders and investors when it comes to contrarian trades. Mindful of the need for research and distrustful of "feeling," they believe that a contrarian trade comes from digging deeper into the balance sheet and available data than anybody else does.

Up until about a decade ago, that was the case. Data were hard to find and even harder to analyze, but "feelings" and "beliefs" were ten a penny. I don't think anybody believes that data are still hard to find. Computers can now read and analyze thousands of company reports and balance sheets in seconds. The only thing left that can give the retail investor an edge is the previously derided feeling.

Don't get me wrong; old-fashioned research is still important. Fundamentals matter and the bulk of anybody's portfolio should consist of investments in companies that have a solid record and a fairly good, predictable future. If you are attempting to juice returns with a few risky trades with potential, however, it would be somewhere between arrogant and stupid to believe that you can out-research Wall Street.

For these trades you have to rely on your gut, and my gut tells me Michael Kors (KORS) is worth shorting. Okay, it isn't just my gut.

Michael Kors (KORS)
Source: VectorVest

Throughout 2013 there was no shortage of people saying that KORS was about to collapse and put their money where their mouths were; they were all wrong. Even as short interest in the stock climbed from around 4 million shares in June 2013 to more than 12 million by December, Michael Kors just kept on beating expectations. The problem was that being bearish on KORS was, by the end of last year, anything but contrarian.

Many of those shorts have now been squeezed. Short interest at the end of last month stood at around 6 million shares, or about 3.85% of float. That is still significant, but not enough to make a drop extremely unlikely. Of course, in order for the stock to fall, there has to be a catalyst.

Wednesday's earnings release could provide that. It may not, but, in contrast to the last two quarters, KORS has been well bid over the last couple of days. In the three days prior to February's earnings release, KORS dropped more than 8% and lost 7% in the run up to November's numbers. This time, KORS has gained nearly 7% in the last three days.

That doesn't mean that earnings will be bad. What it does mean is that the reaction to good news will be muted, but to bad it will be exaggerated. For short sellers there is less risk and more potential reward than in the immediate past.

That is really the secret to contrarian trades. They are risky by nature, but by waiting until everybody has positioned themselves for an expected result, you can reduce that risk and increase the potential.

In this particular case, though, it may pay to wait until after tomorrow's earnings to establish a short position. If the numbers disappoint, then any initial drop will be just the beginning, while if they beat again it will be easy to establish a short around the previous high of $101.04. The key will be to ignore the numbers themselves. What Michael Kors has achieved over the last three months is irrelevant.

It doesn't take a genius to understand that apparel is a trendy business. A couple of years ago Coach (COH) was all the rage and the stock was priced as if that growth would never stop; the bears had been silenced. That didn't work out too well.

It could be that Michael Kors will continue exponential growth and never be subject to the ebbs and flows of fashion; it could be, but that is unlikely, and to a large extent, looks already priced in. This and the fact that a stock that has attracted sellers in the run up to the last few earnings releases is showing strength this time is enough to convince me that short is now a contrarian position. This, in turn, makes a correction more likely and shorting the stock less risky.

It may be counter intuitive to sell stock in a company that keeps beating expectations, especially based on feelings, but I feel that it would be wise.

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