Stocks that rise before earnings often trade down when they report, even if the reports are good. This is not news, but today it seems to mystify investors. Why are retailers in general, and Home Depot (HD) in particular, so weak? Perhaps Home Depot's quarterly report is not as good as people initially thought. Perhaps HD has peaked. I've heard those questions several times already.
I am going to stipulate that Home Depot reported a terrific quarter. It didn't matter. The stock has had a magnificent run, with the last bit tacked on right ahead of the quarterly report.
I blame this sell-off on the run-up that started last week. Macy's (M) stock was an astounding success, even though the guidance it announced on the earnings call was nothing to write home about.
In retrospect, the retail world was rocked last week when Macy's stock went up despite a cut in its forecast. That's not supposed to happen. When it did, investors attributed the rise in stock price to a consumer that is stronger and more willing to spend on the holidays, because of lower gasoline prices and a better labor market. After the run in Macy's stock, everything in the retail world rallied. If a stock doesn't fall when the company cuts forecast, when is it ever going to? In this light, retailers seemed like a safe haven.
Hedge funds short the stock of a company ahead of earnings, and they expect to get paid when they see a cut in the company's forecast. That stock almost always drops, but nobody got paid on Macy's. The stock rallied instead of getting hammered.
Market players became very complacent, and all fear about retailers dissipated after that event. People bought the Market Vectors Retail ETF (RTH) with reckless abandon. Their beliefs were affirmed when Walmart (WMT) reported a better-than-expected number, even though it hardly raved about holiday sales.
Today, with the stocks galloping, some people are saying that Home Depot has peaked. Merrill Lynch downgraded Macy's, saying that its earnings growth has peaked. Urban Outfitters (URBN) reported a hideous quarter. All of these contribute to an apparent funk in retail that doesn't reflect the reality accurately. After a tremendously disappointing number from its flagship store, Urban Outfitters talked about how the mall is no longer as exciting as it used to be, and that the stores have lost their pizazz.
"It is no longer sufficient to build a store, stock it with tables and racks and wares, and open for business," Urban Outfitter's CEO Richard Hayne said on the conference call. "Clearly, the consumer's growing affinity for direct-to-consumer shopping has somewhat tempered her need to shop in stores. Physical shopping trips, particularly to undifferentiated malls, are becoming less frequent."
Hayne said that people seem to prefer the ease of shopping online.
"The store experience must become a performance with the energy and a precision of a Broadway play," Hayne said.
That's a very high bar. Those who have read the call transcript definitely want to sell all the retailers, except those that really get Haynes' view. Gary Friedman at Restoration Hardware (RH), for example, gets it. To a lesser extent, so does Nordstrom (JWN), with its charged air of enticement and service.
Is it really true that malls are finished? All the weakness in Urban Outfitters was in its flagship. The Free People and Anthropologie brands did great. Could it be that Haynes was making an excuse for an underperforming division? How do we explain the strength of mall stalwart L Brands (LB), if the mall is such a letdown?
I find no cautionary lesson in this episode. With the tailwinds of low gasoline prices and higher employment, stocks can run too much into the quarterly report. In retail, if you execute well, your stock will recover after the decline. That's why I think Home Depot's stock will eventually recover. If you don't execute well, your stock goes down and stays down.