Despite recent weakness, the retail equity sector has more room on the downside reports Landon Whaley.
We initially activated recommendation to short the retail sector (our Retail-iation macro theme) on July 23, 2018, and profitably traded it during the second half of 2018. The beginning of 2019 saw a huge disconnect between the price action in retail stocks and their bearish Fundamental Gravity, but that all changed during May. However, despite the recent cascade lower, there is plenty of downside remaining in the SPDR S&P Retail ETF (XRT) and more broadly in individual retail stocks. Remember, the real earnings crush doesn’t occur until companies report for Q2, Q3, and Q4 2019.
The Big Picture
We described the overall trend in retail sales to start the year as “herky-jerky,” and that remains an adequate description. After bouncing from December’s recessionary +1.6% growth rate to +2.9% in January, headline retail sales growth fell back +2.2% in February before once again jumping higher in March. The latest report showed that in April, headline retail sales growth fell back once again to just +3.1%.
More importantly, the retail sales control group is showing a similar preference to head south. The control group’s annual growth rate is the most critical aspect of any U.S. retail sales report because it’s used in the actual calculation of U.S. GDP. Despite the high information ratio embedded in the control group’s growth, the Old Institution routinely ignores it. Luckily for you, we don’t and can report that the control group’s growth rate also slowed once again in April, marking the seventh month of slowing data since the control group peaked at +5.5% in May 2018.
Despite both components of U.S. retail sales being “one step forward, one step back” here in 2019, the big picture trend could not be more evident. Retail sales growth has been slowing for 10 months and is 53% below its July 2018 peak. The more critical control group’s growth rate has been in a downtrend for 12 months and is 47% below its peak growth in May 2018.
The big picture is clear, and the corporate-level picture is as vivid as a Van Gogh.
Earnings = Crash
The month of May was not kind to retailers announcing Q1 2019 earnings. Kohl’s (KSS) announced missing earnings by 9.6% on May 21, net income by -9.9% and EBITDA by -6.5%. The Street doesn’t like it when a company misses expectations like this and has the gall to guide lower in its outlook. Kohl’s stock was punished with 13.9% intraday decline, and as of Friday’s close has now dropped 21.6% from its May 20 close.
Nordstrom (JWN) saw a similar fate on May 22 when they announced a 46.6% earnings miss with a 46.4% miss on revenue estimates and a 17.2% miss on EBITDA. Nordstrom’s stock got whacked 10.8% intraday and is down 17.3% from its May 21 closing price.
These companies aren’t alone; they’re just the latest casualties of Retail-iation.
Couple this earnings reality with the fact that 41,000 retail workers have been laid off this year, which is a 92% increase over the number of layoffs through the first five months of 2018. Heck, even Walmart is closing 11 stores this year!
As we’ve been long documenting, Retail-iation is likely to be a multi-year macro theme. The big picture is bearish, the corporate level is already bearish, and will only get more bearish as we traverse corporate earnings for the final three quarters of 2019.
The Bottom Line
Last month, we concluded our update saying, “…there have not been any economic data points or financial market developments that have challenged the viability of this macro theme.” You’ve gotten substantially paid on the short side of retailers over the last month. Let this be a lesson not to abandon a macro theme simply because markets don’t cooperate for some time. As long as the data confirms the viability of the theme, you stick with it and properly risk manage trades associated with it.
This approach is how we’ve successfully shorted XRT on three separate occasions this year, two during the disconnect and once in May when XRT realigned with Retail-iation.
The June playbook remains the same: be opportunistically short U.S. retailers, or out entirely.
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