Retailers: Holding the Key Vote?
By Frank Barbera CMT. February 10, 2009
So the big announcement has been made, with the Obama Administration and Treasury Secretary Timothy Geitner unveiling a more then 1 Trillion dollar proposal for a comprehensive rescue of the nation’s ailing financial system. Geithner's proposal will entail making new capital infusions into struggling banks with the government forming a partnership with private capital to invest in troubled banks. In this vein, Geithner’s so-called ‘aggregator bank’ would be funded with between $250 to $500 billion in government funds with some of the money potentially coming from the pre-existing $700 billion Troubled Asset Relief Program (TARP). In addition to creating a ‘bad bank,’ the Treasury will issue fresh capital to ailing financial institutions, along with programs for distressed homeowners and new consumer lending programs with consumer business loans allocated between $20 and $100 billion dollars. As Geithner made his case, using the fractional reserve measure of 10-to-1, in theory $100 billion in new lending capital for banks could create 1 trillion in eventual new loans. Of course, it is anyone’s guess as to whether these proposals will be enough to turn the bearish tide which judging by the stock markets sharp sell off after the announcement, led lower by a sizeable decline in bank stocks, seems to be very much open to debate.
At a recent speech in Las Vegas, Nevada at the TD Ameritrade National Investment Conference, former Fed CEO Dr. William Poole spoke about a guarded view as to the longer-range effects of recent proposals. In his talk, former St. Louis Fed CEO Poole acknowledged the current problems and the need for action, but leaned toward the view that recent proposals could have serious ‘knock on’ negative inflationary outcomes when seen in the rear view mirror, two to three years down the road. For the Fed, draining out all of the excess liquidity that was created in recent months, without throwing the economy into yet another economic melt down will be at best, an ultra finely tuned procedure, while at worst, the funds may never be removed and could ignite serious inflation down the road.
To be sure, the deflationary funk still appears to be live and well, as bond yields turned lower today while stock markets declined, seemingly unable to sustain a rally for more then a few days. We note that after advancing last week and holding up on Monday, heading into the Tuesday announcement, traders moved in and “sold the news” today which is classic bear market behavior. As former colleague and credit analyst at FNN Ed Hart used to say, “We will only know in the fullness of time.”
We are always on the look out for signs of potential change, and usually change occurs on the extreme margin. What might be a good leading indicator for us to watch closely just in case these government elixirs actually begin to work? Well, in surveying today’s wrecked financial landscape, the two areas that might be the best ‘recovery’ gauge could be two of the areas hit far worse then everything else, namely, the financials and the retailers. In the case of the financials, one over-riding concern comes from the idea of increased government ownership, with an attendant vastly higher quantity of government regulation dominating the entire industry. In the case of the financials, the epic nature of the current collapse virtually guarantees a kind of quasi-nationalized outcome where financial sector profitability will be reigned in and heavily regulated for years to come. For the financials, this one looks like a ten year ‘time out’ with big brother watching vigilantly over every move and the entire sector behaving like a government utility for some time to come. As a result, we focused our recent attention on the Retailers, which are also devastated as a result of their ultra sensitivity to consumer spending. Now before going any further, we are in no way making the case for an imminent return of strong consumer spending. As readers to my column are aware, I believe the current recession and housing down turn will probably be with us for some time, and indeed, I would not be surprised to see the S&P and the DJIA breaking down to new multi year lows in the days and weeks ahead.
However, longer range, their will likely be some recovery, as like a rubber band, the economy has a tendency to snap back from over-extended extremes. In my view, there will be no return to the manic glory days of excess consumer spending probably in our lifetime, as the excess seen in recent years were a once in every three or four generation event. Yet, a long “U” or “L” shaped recovery could eventually take hold, with a period of sluggish economic growth (1 1/2 - 2%) taking shape potentially in late 2010, 2011. As always markets can be expected to move out in front of the broad economy, and to that end, when a more important low does take shape, it may well be some of the retailing stocks which throw a spotlight on the trend change.
To that end, I thought I would spend this week doing a little walk down memory lane of Retailing Stocks and Recessions. In the chart below, I show the great bear market of 1973-1974 for the Retailing stocks of that day. Back then, names like J.C. Penney, Dayton Hudson, Sears, Black and Decker, Avon Products, Woolworth's, May Department Stores, Caldor, Gimbels, Alexanders and Marshall Field’s were prominent on the national stage. As can be seen in the chart below, the major recession of 1973-1974 which was brought on by the first Arab Oil embargo, saw a number of these major retailers tumble between 65% to 90% with various indices of the retailing sector declining between 60% to 80%. Among some of the larger retailers in the 1970’s, May Department stores fell 70.67% high to low, Sears fell 65%, J.C. Penney fell 63.90%, Woolworth's fell 89.93% with high flying Avon Products down 85.80%.
Above: a look back in time to the 1970’s with the GST Retailing Index down nearly 90% from the high in 1973 by the end of 1974. Top clip is the Retailing Index, lower clip is the Relative Strength Ratio of the Retailing Index versus the S&P 500.
Yet, if we ‘zoom in’ a little closer at the chart of the Retailing Sector (see below), which uses a logarithmic computation to achieve an ‘Unweighted Index,’ we can see that as the bear market waned on; near the final lows, it was the Retail Sector that began to suddenly outperform with the Relative Strength Ratio of the Retailers taking out its November 1974 peaks well before the S&P.
Above: SPX on top clip, Retailing Index – middle clip, R/S Ratio of Retailers to SPX in lower clip. At the bottom of the bear market, the R/S Ratio of the Retailers versus the S&P reversed up quite dramatically and took out the November 1974 peaks a few weeks before the equivalent move on the S&P.
Importantly, the same phenomenon also took place at the bottom of the 1981-1982 stock market recession bear. Here the S&P continued to press to new lower lows, falling to a multi-year low in August 1982.
Yet, as can be seen in the chart above, even as the S&P (top clip) fell to new multi-year lows in August 1982, the Retailing Index did NOT confirm with a lower low, and instead held ABOVE the prior low seen in February 1982. Looking at the R/S Ratio of Retailers to the general stock market in the lower third clip, we see an even more pronounced pattern of underlying improvement had been at work for several months. Following the steep recession of the early 1980’s, the next serious recession was seen during the Gulf War in 1990-1991. Here again, the Retailing Index began to improve in consistent fashion well before the final stock market lows and actually managed to move up on a relative strength basis even as the stock market indices sold off strongly in the first few weeks of the 1991 new year.
Above: The 1990-1991 recession experience, where Retail Stocks saw the relative strength ratio (lower clip) moving up, even as the S&P and DJIA sold off during the first few weeks of 1991.
Another important episode also took place following the 1987 stock market crash, a time when many feared that the crash was signaling the beginning of a major depression. As can be seen in the first few months of 1988, the Retailing Index relative strength ratio was able to move above its 100 day moving average two weeks ahead of the DJIA and SPX.
Above: 1987 Crash experience Retailers versus the Stock Market.
In the end, it seems that Retail being such an obvious victim of any pull back in consumer spending tends to cause it to overshoot on the downside, and then turn up in surprising fashion once sentiment finally begins to change at the end of a recession. In fact, it seems that at nearly every turn, Retailers were either ahead of the broad market or at worst coincident with the broad market in reversing strongly to the upside. With this in mind, we now look at the current snap shot of the Retail space. As can be seen by the histogram chart below, the vast majority of specialty retailers have tumbled sharply during the course of the recent recession/bear market. In arriving at the figures plotted, we calculated the distance from the five year peak to the recent Q4 2008 panic lows, where we see that once again many names have seen their share price erode by 50% or more.
Above: Measuring from the five year high to recent panic low, many well known retailers have seen their share price crushed by 50% or more.
Next, we observe the present relationship between the Retail Sector and the S&P Index. As can be seen, at present both the Retailers and the S&P are below the 100 day (or 20 week) moving average. At the same time, the Relative Strength Ratio of the Retailers is also below the 20-week average, but by a much smaller degree. In my view, this throws an interesting spot light on the gravity of “what comes next.” Either prices for the major averages will begin to lift with the Retailers also improving, or some kind of failure pattern will develop. At the present time, it would not take much in the way of upward movement on behalf of the Retailing Index to see the Retailing versus S&P relative strength index move back above the 100 day moving average. While many votes will be cast, “Yeah” or “Neah” in the days ahead on the merits of the Obama Administrations economic/banking relief acts, we would submit that one of the more important ‘votes’ will be that of the Retailing shares. If they can begin to outperform from here, that could be an indication that confidence is slowly improving. Alternatively, if the Retailers ‘roll over’ and begin making new lows on both an absolute and relative strength basis, that would be a strong ‘no vote’ in my view, and would likely suggest a lot more downside action still ahead.
Above: Retail Stocks versus the Stock Market 2006-2009.
On the technical front, I believe that the bias going forward is likely already pre-disposed to a downside bias with several key indicators seemingly ready to turn down. If this outcome does indeed take place, it would suggest that both the recession and the stock market bear have a long way to go. In the next chart, I show my Retailing Index along with the McClellan Summation Index for Retailers. In this instance, my universe includes 50 specialty and main-stream retailers. Notice that while the Summation Index has been rising over the last 8 to 10 weeks, in recent days the index has congested up and is now only a bit above its rising 20 day moving average signal line.
Above: GST Retailing Index and McClellan Summation Index for Retailing Stocks.
So far, the Summation Index has only managed to move up into the same zone as was seen at other bear market peaks during the course of 2007 and 2008. In my view, if the index reverses below the 20 day average and then moves below zero, the dashed horizontal line, it will suggest that a fresh down trend is underway which would be very likely to make new lows. In addition to the Summation Index, I also maintain a cumulative volume index which so far has not shown much in the way of robust buying interest. Even as the retail stocks have tried to rally in recent days, this gauge has been drifting off and is now not that far above last year's panic lows. A series of new lows in this indicator in the days ahead would also be a bearish signal suggesting more pain ahead.
Above: GST Retailing Index – 50 stocks with Cumulative Up to Down Volume
Above: the 2007 to 2009 Bear Market in Retail Stocks (thin line) rebased to the 1973-1974 mega bear market in Retail Stocks.
As I looked more closely at the 2007-2009 experience in comparison to the 1973-1974 experience, I decided to line up the two markets for a full comparison chart. At present, the current bear market in Retail Stocks has now been in force for 425 trading days, versus 507 trading days for the 1973-1974 bear. That means that on June 2nd, 2009, precisely 82 days from now, the current bear market will equal the length of the 1973-1974 experience. By itself, that tells us that (a) the bear market could run for another few months, but (b) the bear market in terms of time is now getting to be quite mature.
On a price basis, in order to match up with the scope of the 1973-1974 bear, the current market would still need to decline, get this, an additional 45.67% with the final down phase of many bear markets often the most violent. It is also possible, and I would argue even likely, that since today’s underlying economic fundamentals are much more severe then those seen in 1973-1974, (obliterated banking system, low savings rate, huge debt hang over ratios etc…) that the duration of the bear market may run well past June and end up approximating something seen in the Great Depression where prices stayed in bear market mode for an incredible stretch of 665 trading days. By the score, the current decline lasting 425 days would only be 63.90% of the total duration and would not reach 665 days until January 8th, 2010. That outcome would allow for a lot more pain.
Using some even longer term Fibonacci retracements and GANN angles, I believe that a downside resolution from here making new lows in the next few weeks could send our Retail Index from current values near 178.20 to levels closer to the 80 to 100 zone implying an additional 50% downside risk in most large scale retailing names over the next 10 to 11 months. If that extreme downside target window is approached later this year, that could leave the GST Retailing Index down on the order of 80% or more from its June 4th, 2007 peak at 418.11. In that event, investors eyeballing the surviving names could be looking at a unique, perhaps once in a lifetime type buying opportunity with high returns for years to follow.
Above: GST Retailing Index with downside target window (see dashed lines) in the 80 to 100 zone, basically a depression type outcome for the Retailing names.
As a final note, last week I wrote about a number of companies in the retail space that were reporting new store closures in the coming year. Unfortunately, our data for Pacific Sunwear and
Lane Bryant were in error, and that some of the closures mentioned were for 2008, or were for other than the primary store brands. We apologize for the error and wish to thank our diligent readers for their assistance in helping us to try and always get the facts straight.
That’s all for now,
© 2009 Frank Barbera