The Day Ahead: Subliminal Messages From the Retail Garden

 | Aug 02, 2012 | 8:30 AM EDT
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The week has worn on my psyche, for some odd reason. If I were a stock, you would probably want to short Soz, Inc. into the weekend. Assorted notepads are strewn about the office, a majority with colored arrows branching from a center circle labeled "Da Fed." Others consist of musings on individual companies -- you know, those pesky breathing organisms that, on an earnings call, neglect to mention the Federal Reserve exists. I can already see what this weekend will hold: Yet another couple of days spent in self-hibernation, trying to decode the world.

Nonetheless, give me your hand and let's walk together to the garden that is the retail sector. We received a bunch of developments Wednesday evening from specialty-apparel retailers, and these will either go reported as being very good or very bad. Don't stay on the surface here, friends; retailers are sending the investing masses subliminal messages (or they are to me, anyway) in front of the back-to-school and holiday-selling seasons.

Oh and, on the topic of the holidays, you want to use second-quarter performance by individual retailers as a guide to stock selection in this zany sector. If a retailer is voicing its business has "increasing momentum" amid "pulled-back promotions," these are in-your-face signs of differentiating factors in which to invest -- or, if you want to sound cool, "playable themes." The reason these are positives is that, despite an economy that the Fed so eloquently confirmed as downtrodden Wednesday, winning is being done.

Subliminal Messages From the Retail Sector

There are stark performance differences between a company like American Eagle Outfitters (AEO) and one like Abercrombie & Fitch (ANF), even aside from the international component in each. The reason is that domestic consumers are reallocating their spending among companies, instead of spreading it around. Teens or their parents spend less at a Best Buy (BBY) or Darden (DRI) restaurants and allocate those saved funds to wear now apparel in peak periods.

Winning retailers, like American Eagle or Hot Topic (HOTT), are running roughshod on profits vs. peers due to lean inventories. This creates a couple offshoot economic realities. First, retail management teams want to keep the profitable times rolling, really having their story stick out to investors in a limp economy, and they'll continue to plan orders cautiously (hmm, see the weak new-order reads in manufacturing reports). That, in turn, has negative ramifications for manufacturing, truckers, logistics and railroads. Is it any small wonder these companies are raising prices aggressively? They have to offset sluggish volume trends somehow.

Second, retailers will spend the third quarter working through excess merchandise at competitive prices, much in the mold of the dreadful tales of Abercrombie & Fitch and True Religion (TRLG), which both had horrendous inventory planning. For Abercrombie, this has triggered a curtailment in international store openings and will probably set off an acceleration in domestic store closures. There are negative economic ramifications, here, as well -- for instance, fewer workers and need for small businesses to maintain stores. All in all, economists would label this stuff a "vicious circle" or a "negative feedback loop."

In the spirit of being an actionable stock dude, I am still negative on Abercrombie & Fitch. I can't make the case to buy in, given the likelihood of a downgrade in the company's long-run operating-margin projections when it reports full results later this month. I am warm to playing something similar to American Eagle in what will be a positive earnings call, and I wouldn't go near True Religion with a 10-foot pole. Dollar General (DG) is on my radar as a hedge on any perceived Wal-Mart (WMT) earnings disappointment.

One more point on the Fed: The double use of the word "will" in the final paragraph sure was a powerful force, huh? Let's cut to the chase -- the Fed has been priming the market for a September ease for months. The rally from the June lows could very well reflect, at least partially, a September Fed move. Yet it remains difficult to be long anything, with defensives nearing an overbought situation. It's also still challenging to make short-term trades on names you would bet your life on following extensive research -- and usually, prior to an earnings report.

Blame eurozone politics and structural damages in the periphery countries. Clarity on one of these two will have to be found before fundamental rot in multinational income statements stands to stabilize. Thinking the political aspect will have to shift first.  

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