Profit From Falling Retail Sales

The Crash That Killed Christmas
A Taipan Publishing Group Strategy Report
By Sara Nunnally, Senior Research Director, Taipan Publishing Group

The warning signs were there… We told you about them… If you didn’t listen, now’s your chance to grab the last “Holiday Cheer” before the party sours like last year’s eggnog.

No Virginia, there isn’t a Santa Claus. At least not this year.

We saw this storm brewing a while ago. In fact, we warned you about it… in early September. We said, “Take a look at some of these ‘depressing’ numbers.”

It started when we noted that real consumer spending fell 0.4% in July, the biggest drop since June 2004; personal income fell 0.7%, the biggest drop since August 2005; and Real disposable incomes fell 1.7%, making for the second straight large monthly drop at the time.

And look at this run: the Producer Price Index for Finished Goods climb 1.4% in May, 1.8% in June and 1.2% in July.

And things have gotten much worse since then.

The U.S. Department of Labor reported that the Producer Price Index for Finished Goods fell 2.2% in November, seasonally adjusted. This decrease followed a 2.8% decline in October, a 0.4% drop in September and a 0.9% fall in August.

And with retail sales dropping 1.8% in November – off for five months in a row – retailers have a difficult choice: raise prices and lose sales, or sit on prices and lose profits. There simply is no way no around this.

The Weakest Retail Sales Season in Decades

When the National Retail Federation (NRF) released its latest forecast for this year’s holiday shopping season, with sales growth expected to be at the slowest rate in over six years, it sent a shockwave through retail stocks.

The NRF announced it was looking for a miniscule 2.2% increase year-over-year in gross dollars taken in. Factor in inflation (as best one can considering how badly Washington has botched this figure) and we are actually looking at a significant decline in both units moved and profits retained.

The NRF wasn’t alone in its concern for the damage this sector is about to absorb. Retail analysts from both Deloitte LLP and TNS Retail Forward are both on record calling for this fall and early winter to deliver up the weakest shopping season since 1991.

And where does that leave retail shares? Screwed to the wall, my friends, screwed to the wall.

What Happens When Consumers Don’t Spend?

American consumers drive two-thirds of this economy, and when they cut back, look out.

But reports show that consumers are cutting back… in a big way. Things are going horribly this season already. Macy’s Inc. said it lost $44 million in the third quarter as sales at the department store retailer fell more than 7%. Consumer electronics retailer Best Buy Co. slashed its fiscal 2009 guidance on fears that consumer spending will erode even further. Circuit City has filed for bankruptcy. And so has KB Toys, which plans on closing its stores after a “sudden drop” in sales in the past two months.

The thing is, everyone is counting on consumers. So what happens if they don’t show up?

Of course, this fear has retailers slashing prices, and the bloodletting has been happening since well before Thanksgiving. Wal-Mart offered 10 popular toys for $10 in October, Toys “R” Us has touted its “lowest prices of the season” and Gap Inc. offered 30% off in mid-November.

But that’s nothing compared to recent offers of half-price deals and two-for-one sales, along with online retailers dangling free shipping.

Retailers aren’t moving their inventory, so they’re cutting their prices. And they may have to mark down prices even more… and that means even less padding on the bottom line.

Even Black Friday (traditionally the start of the holiday shopping season) couldn’t save the numbers for November. Last year, the Black Friday weekend accounted for 10.1% of total holiday sales, according to ShopperTrak, up from 9.5% in 2006 and 9.3% in 2005.

Yes, Black Friday retail sales this year were up 3% over last year. But, as I mentioned earlier, November overall retail sales fell 1.8% in November. So, those Black Friday sales weren't enough.

With the U.S. consumer feeling the effects of a troubled economy, and banks becoming stingier that the Grinch himself, stores will be in for a rough ride the rest of this holiday season.

Crashing Stock Prices Thanks to Falling Retail Sales

Already, analysts are “marking down” retail stocks. J. Crew has been cut from “hold” to “sell” by Needham & Co and Brean Murray, Carret & Co.

In fact, at the time of this writing, this retailer’s share price has dropped an amazing 75% since the beginning of the year.

And get this: Insiders at Williams-Sonoma have been selling shares like mad. On Monday, November 24, chairman and CEO W. Howard Lester announced he was selling 33% of his stake “to satisfy collateral requirements under lines of credit.” This sale follows a one million-share sale in October, and has analysts incredibly worried about the health of the company.

And like J. Crew, Williams-Sonoma’s share price is also down – off 71% so far this year at the time of this article.

Looks like Christmas isn’t going to even have a pulse this year...

Consumers Shopping on the Clearance Rack

So what’s a consumer to do? With Nordstrom’s shoppers flocking to discount retailers and dollar stores, how in the world can we grab even the smallest slice of “Holiday Cheer?”

Well, you could protect yourself by purging these stocks from your portfolio... but with 81% share-price drops in less than a year, the damage might already be done.

Fortunately, there are other ways to capitalize on this pain.

You could single out these struggling retailers and either short them outright, or play put options on them… Or…

Many of these struggling retailers can be found on the Standard and Poors Consumer Discretionary SPDR (XLY:NYSE). And while the XLY has already cut itself in half over the past five months, the dismal outlook has set up another 50% loss this holiday season.

The simplest way to make some Christmas Cash would be to play put options on this ETF.

There are a number of ETFs that follow this model, like the Vanguard Consumer Discretionary ETF (VCR:NYSE), the SPDR S&P Retail ETF (XRT:NYSE), the PowerShares Dynamic Consumer Discretionary ETF (PEZ:NYSE), and many others.

Make no mistake, though… the U.S. consumer will be highly discerning, and extremely budget-conscious. They will be looking for the best deals around, even as they cut back their wish lists.

If there isn’t a sudden turnaround and consumers start showing up this holiday season, this market flop will go down in history as the “Crash that Stole Christmas”.

Playing these ETFs with bearish put options may be your last chance to grab a slice of “Holiday Cheer.”

Editor’s Note: If you're looking for another way to profit along with some safety in today's turbulent market – look into a program we call the "13F Disbursement Plan." It allows you to legally skim money from Wall Street firms that have gotten obscenely rich at the expense of ordinary folks like you. This plan could even add $4,570 to $11,450 to your bank account every month, courtesy of the U.S. Government.

Interested? Well, we've prepared a Special Report with all the information you need to get in on this opportunity. You can download your copy of the 13F Disbursement Plan report right now.

Originally published December 17, 2008.

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