We can’t always predict the facts, but we can always manage the process around them. A friend of mine who runs a $1bn+ non-Wall Street business once told me that “when things become ‘unmanageable’ it is when the facts spiral out of control faster than I can adjust my own expectations.” I like that…especially given that so much in this market is driven by changes in expectations on the margin. In looking at anything retail-related, all one needs to do is look at the ‘75% off’ signs in retailers’ windows, ‘winter clearance’ blast emails, or gloom and doom news reports about how unmanageable this holiday appears to have been. These facts beg the question as to whether this is the bottom for retail. I am absolutely far less bearish than I have been over the past two years. But my colleagues at Research Edge are getting incrementally bullish on their respective groups. Trust me, I want to be part of that club. But the facts continue to lead me down a different path.
Why? Sentiment and expectations.
Sentiment: Many people might not realize this, but short interest as a % of float in this group is now 10% -- down from 15% in late summer. It has come down at an extremely consistent clip, and has given back all the interest accumulated since the ‘The Consumer Is Doomed’ call became en vogue back in late 2007.
Is the short interest ratio still high at 10%? Yes, it probably is when combined with how Underweight long-only funds are in this group right now. But you should definitely not look at the SIR for the group 5 years back and use the 3-5% range as a benchmark. The overcapacity that has built in the hedge fund community has driven this higher. That is flushing out now, but despite the carnage, I’d challenge anybody to show me a statistic saying that there are fewer funds out there today than 5-years ago. My point here is that anything in the 10% range does not seem grossly out of whack for me as it relates to short interest – suggesting to me that the group is not particularly over-shorted right now.
Expectations: My beef is still that Analyst estimates suggest that there will be only a 50bp margin hit next year on top of the 150bp hit we’ll have seen in ’08. That’s a 200bp margin decline after a 7 year run where margins were up 6.5 points. That’s simply not realistic in a severe consumer-led recession with such meaningful industry-specific headwinds. The Street is looking for EBIT growth to bottom in 4Q08, sharply recover to a point where it is flat by 3Q09, and then revert to high single-digit growth by 4Q. My math suggests that 4Q/1Q EBIT growth expectations will prove aggressive to the tune of 10-15 points.
So what do we have? Sentiment is no longer flat-out bearish. Earnings expectations are still meaningfully too high. A saving grace is valuation, which sits at about 5x EBITDA. What’s interesting to me is that short interest is down, but so are multiples. What does this tell me? There’s lack of conviction on both sides of the trade – long and short.
I still think that this will be the year for Winners vs. Losers – as defined by earnings momentum. I like Under Armour, Columbia Sportswear, Bed Bath and Beyond, Hibbett Sports, Lululemon, Liz Claiborne, Kohl’s, Hanesbrands, Payless and Chico’s. I’d avoid, TJX Cos, DSW Inc, VF Corp, Gap, Philips-Van Heusen, Brown Shoe, Carter’s, Wolverine Worldwide, Ross Stores, Sears and JC Penney.