Britannia Radio

There's More Pain Ahead for This Group of Stocks By Frank Curzio, editor, Penny Stock Specialist Retailers are "officially" in a bear market. That's what CNBC reporter Matt Nesto said last week. And he's right. A bear market is defined by a 20% drop in a stock or index from its peak. Matt was referring to the Morgan Stanley Retail Index (MVR). As you can see from the chart below, the retail index – which includes the largest retail stocks trading in the U.S. – is down 21% from its April 26 high. Retailers have enjoyed a big rise off their November 2009 lows. The MVR Index is up 140%, outperforming almost every sector in that timeframe. It also outperformed the S&P 500 by 100%. The only sector with a better performance is gold. Taking a closer look at the sector, retailers were quicker than most companies to cut costs when the recession hit. Better inventory management and layoffs helped push the bottom line (earnings) higher. This offset massive slowdowns in the top line (sales) from 2007 levels. Wall Street praised strong earnings. Companies like Saks, Macy's, and Office Depot jumped between 200% and 400% from their November 2009 lows as profits rebounded. But today, the party is over. It will be difficult for most retailers to reduce costs from these levels. After all, there's only so much inventory and employees to cut. With fewer ways to decrease expenses, companies will have to rely on strong sales growth. Based on the terrible economic data over the past few weeks, I can't see that happening as consumers are tightening up their wallets. Energy prices are rising. Higher oil and gas prices raise the cost to transport goods. Also, higher gas prices will keep more shoppers from driving to malls. On the global front, China's decision to let its currency rise against the dollar is bad news for retailers. It means imports from China will cost more. According to international trade firm Panjiva, eight of the 10 largest importers from China are retail companies, including Wal-Mart, Lowe's, and J.C. Penney. And I don't need to explain the slowdown in sales from European nations. These negative trends are already seeping through in earnings announcements. Two weeks ago, Best Buy reported weaker than expected earnings. The largest electronic retailer in the U.S. said sales of televisions, DVDs, and games were much weaker than expected. Also, expenses surged. Last week, Bed Bath and Beyond lowered its earning guidance for next quarter. Management said, "The consumer continues to face economic challenges." Nike also lowered its earnings guidance last week. The largest manufacturer of athletic shoes and apparel said, "Currency changes and input cost inflation will put significant pressure on our reported top and bottom line results for 2011." I expect more retailers to lower earnings guidance starting early next month. That's when earnings season begins. Most retailers are still up more than 100% from their November lows. Based on fewer cost cuts, higher energy prices, and currency headwinds, I expect most retailers to give some of those gains back. Some vulnerable names here are Amazon.com, Urban Outfitters, and Best Buy. Also in the danger zone is the S&P Retail ETF (XRT). Good investing, Frank Curzio

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