I am a big fan of Costco (NASDAQ:COST) stores and I am almost always bullish Costco stock. But since I am not a perma-bull, I am not blindly recommending that people buy it now.
Today’s message is one to raise caution but not alarm. Simply put, I believe that there will be better entry points into this great stock for new investors. It would be best to wait out at the risk of missing the next bit of upside and avoid the potential unknown downside.
The last time I wrote about COST stock, I called for investors to buy the dip that the China tariff headlines caused. Back then we had a good base and an excellent economic backdrop. Now we are at completely the opposite end of the scale. Yesterday we learned that 15 million Americans continued to file unemployment and the GDP is shrinking. This by no means should be an invitation to set new records in the stock market.
Things seem healthy because of several artificial and temporary factors. The U.S. has deployed unprecedented fiscal and monetary programs propping up a crippled economy. The Fed is committed to keeping us awash with liquidity — that’s the monetary part — and the White House is providing the fiscal spending. The stimulus will soon end which will create a hole in the economy. If that’s the case then stocks are too expensive up here.
Costco Stock Is Not Expensive
When I caution against valuation, I don’t mean that COST stock is exorbitantly expensive, because it’s not. A 41x price-to-earnings ratio (P/E) is tolerable especially for an outfit of this caliber. The bloat comes from the overall exuberance that exists in the entire stock market. Equities on Wall Street have recovered the entire quarantine correction and more, while the economic fundamentals are still worse than ever.
Soon enough the bulls on Wall Street figure out that main street is still struggling. Then they will need to realign their lofty expectations with the underlying reality.
The “E” in P/E has a way of shrinking if money gets tight in the hands of our people. And that is why I recommend exercising patience for those looking for new positions in COST stock. This is nothing against the company because they have been excellent at executing their plans. They are one of two major retailers that have figured out how to successfully fight Amazon (NASDAQ:AMZN). Walmart (NYSE:WMT) is the other one. Year-to-date they are both up twice as much as the S&P 500.
The Real Threat to COST Stock
The White House website states that “consumer spending is roughly 68 percent of GDP”. We also know that there is a ton of free stimulus money flooding the economy right now, so spending is artificially high.
The politicians are late with the next stimulus package and the longer they take the smaller it will be. Besides, after the election, both sides will have disincentives to continue any stimulus and the gravy train will end. The U.S. consumer could be headed into a cash crunch which will ripple through our economy. If and when that happens, all equities will fall, even the ones dubbed “Covid-19 stocks” like Costco and Zoom (NASDAQ:ZM).
If the unemployed do not come back to work they will find themselves short on funds and will crimp spending abruptly. So far the quarantine wounds are covered with gauze, but soon enough we will find out if the wounds have festered or healing.
I appreciate the efforts of the U.S. Federal Reserve in keeping liquidity in the market. However they have gone overboard with the jawboning efforts. Mr. Powell is choosing to change the measurement tools with regards to inflation and unemployment because they are not getting the results they expected.
Costco Can Continue to Win
The stock broke out from $322 per share in early July and has since filled its target objective. In the process it has established a set of higher-lows and higher-highs that formed a tall rising wedge. Those are susceptible to sharp corrections and without warning.
COST stock should retest the neckline from which it broke out. Therefore I expect a six to 10% correction and that would not change the bullish outline. If I’m long the stock for the very long term then I can ignore these comments. But if I’m looking to open a new position, I see no reason to rush before a dip.
The stock needs to transfer out of weak hands and into fresher ones. It rallied 30% from the bottom and that is tiresome, especially in the face of adversity that killed almost all other brick-and-mortar retailers. The run on toilet paper and cleaning supplies helped but a lot of the kudos fall on the management team.
How to Get Long Now and Leave Room for Error
If I’m forced to commit long Costco at this point I would rather sell October $305 puts and collect $2.50 in premium. This way I can be long now, leave room for a correction, and not even need a rally to win. In fact, the stock can fall 11% and I still wouldn’t lose any money.
Costco operation is not the cause for my worry as much as the entire stock market as a whole is. Much of the buying is happening in sectors that are frothy. The NASDAQ has been setting records either on the back of massive mega-caps rallying 12% like Netflix (NASDAQ:NFLX) did on Wednesday on no news, or on the back of hopeful companies like Zoom that have a price-to-sales of 120x.
I appreciate the potential of technology but it has reached ridiculous levels. Eventually these stocks will have to fall because nothing goes on forever. That’s the bigger threat to the Costco stock price. If these frothy stocks fall they will drag the whole market with them.
Nicolas Chahine is the managing director of SellSpreads.com. Join his live chat room for free here. As of this writing, he did not hold a position in any of the aforementioned securities.
