Stocks sank sharply on Monday afternoon after spending most of the day hovering around the flat line. Although there did not appear to be a clear catalyst for the downside stock trading, there’s been a steady drumbeat of concerns raised about valuations after retail chains began to report weak holiday sales.
The culprit for the holidays was apparently department stores’ manic attempt to kill each other with promotional pricing. It was a good old-fashioned price war in the malls that left very few brick-and-mortar stores with anything to brag about. The main beneficiaries were online retailers, such as Amazon (AMZN), which stood above the fray.
Naturally, the worst performing sector Monday was consumer discretionary, which includes the retailers, along with apparel makers and the like. Ubiquitous teen apparel chain Express (EXPR) was one of the biggest losers, down 4.6%. The company lowered Q4 2013 guidance after a more difficult than expected holiday season was followed by weak traffic in January as well. Lululemon Athletica (LULU), which falls into both categories as a retailer and an apparel maker, found its stock trading by 16.6% lower after lowering Q4 earnings, revenue and comparable store sales estimates.
LULU is a classic cautionary tale of a company that exploded as the centerpiece of a fad, which was women’s high-end yoga clothing, but forgot about taking care of its base as it expanded. Its problems with overly sheer clothing last year was only the tip of the iceberg, as the company lost touch with the women who had made it an apparel phenomenon. It lost customers to excellent and lower-priced imitations made by competitors Under Armour (UA) and Nike (NKE), and it has been a downhill slide ever since. LULU is basically the Blackberry (BBRY) of apparel makers, as it lost an incredibly rich, deep franchise in the blink of an eye after becoming overly complacent with its position.
Elsewhere in the world, there was actually good news out of Washington, D.C. Congress is close to a deal on $1.1 trillion spending bill. Although there were still disagreements over funding for health care reform, reports suggest that negotiations seem to be making progress. The current stop-gap spending measure will expire Wednesday, and Congress will likely have to pass a three-day extension to prevent another shutdown and provide time for the bill to pass.
One piece of news that put a chill on investors was a comment by Atlanta Fed President Dennis Lockhart that he supports “similar tapering steps” to the one taken in December if the central bank’s positive outlook plays out. He also stated that he would not be surprised if real GDP expanded this year at the upper end of his current view of 2.5%-3.0%. He noted that if all goes as expected, there is a policy transition underway from a QE world to a post-QE world. It appears that investors were not that crazy about envisioning a post-QE world because the stock trading momentum wanted and equities began to fall soon after his remarks.
Lockhart’s comments are important because they give the market the inspiration to think about what life would be like without the Federal Reserve providing extraordinary support in the form of record-low interest rates and Treasury purchases. One argument making the rounds is that the entire 2013 rally could come undone if QE3 goes away, interest rates rise, the economy falters and inflation rises. Admittedly, these are not likely to all happen at once, but this is what is in bears’ minds.
My own view is that retailers’ troubles during the holidays, combined with the weak jobs report last week, could be a window into a side of the U.S. economy that was not very evident last year during the market’s grand advance. Lower-income people are not enjoying the same gains as middle- and upper-income people are. That is showing up in lower spending and lower labor participation rates.
This may become a serious concern later in the year, and perhaps sooner. But, for now, in terms of stock trading, I expect at least a modest rebound from the currently oversold conditions. So, I am not going to offer any short sells or puts at this time. Once the oversold condition is relieved, we can see how far the indexes rebound, and, if they stay shy of the 2013 close, it will be time to batten down the hatches on the long side and play the market as a bear.
That’s an exciting prospect, should it occur, as the market goes down faster than it goes up. Top prospects on the short side will be specialty retailers like Chico’s FAS (CHS), as well as oil giants like Chevron (CVX).
For now, I have my buy list studded with familiar names like Johnson & Johnson (JNJ).
JNJ is the mother of all pharmaceutical stocks, and has a large medical device and consumer staples business, as well. Shares have spent the first part of January in the lower half of their Keltner Channel, but then bolted to the top. Shares are still oversold on a 14-day Relative Strength Index (RSI) basis, however, which means there should be a lot of kinetic energy in them. Because the shares have been under pressure, and volatility in the broad market is low, the options are pretty cheap.
Recommendation: Buy the JNJ February $92.50 calls at $2.75 limit. Once you’ve established a position, set up to sell half at my initial target of $3.50, and the second/final target will be $5.50.
Keep in mind that JNJ is expected to report earnings on Jan. 21.
Jon Markman operates the investment firm Markman Capital Insights. He also offers a daily trading advisory service, Trader’s Advantage, and CounterPoint Options, a service that helps individual traders make steady, consistent profits with volatility-related instruments.
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