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Is "Low-End" Retailing Making a Comeback?

(June 28, 2011)

Dear Subscribers and Readers,

First, I apologize for the tardy commentary.  I was at a friend's wedding yesterday—and so did not get a chance to finish our usual weekend commentary.  I promise I will come back with full force this upcoming July 4th weekend!  Let us now begin our commentary with a review of our 13 most recent signals in our DJIA Timing System:

1st signal entered: 50% short position on October 4, 2007 at 13,956;

2nd signal entered: 50% short position COVERED on January 9, 2008 at 12,630, giving us a gain of 1,326 points.

3rd signal entered: 50% long position on January 9, 2008 at 12,630;

4th signal entered: Additional 50% long position on January 22, 2008 at 11,715;

5th signal entered: 100% long position SOLD on May 22, 2008 at 12,640, giving us gains of 925 and 10 points, respectively;

6th signal entered: 50% long position on June 12, 2008 at 12,172;

7th signal entered: Additional 50% long position on June 25, 2008 at 11,863;

8th signal entered: Additional 25% long position on February 24, 2009 at 7,250;

9th signal entered: 25% long position SOLD on June 8, 2009 at 8,667, giving us a gain of 1,417 points;

10th signal entered: 50% long position SOLD on March 29, 2010 at 10,888, giving us a loss of 1,284 points.

11th signal entered: 50% long position SOLD on April 27, 2010 at 11,044, giving us a loss of 819 points;

12th signal entered: 50% long position initiated on May 21, 2010 at 10,145;

13th signal entered: 50% long position SOLD on December 15, 2010 at 11,487, giving us a gain of 1,342 points; the DJIA Timing system is currently in a neutral position.

Let's face it.  Starting with the Fed's “QE2” policy, any positive effects brought on by the Fed's quantitative easing have benefited higher-income/net worth families than lower-income/net worth families.  This is no surprise, as the Fed's QE2 policy has brought on a resurgence of inflationary fears; even while helping the stock market.  Inflation, especially within energy and food, tends to hit lower-income consumers the most; while the benefits of higher stock prices tend to accrue to high net worth consumers.  Not surprisingly, same-store retail sales for May reflected this—as high-end retailers such as Nordstrom (JWN) and Saks Incorporated (SKS) experienced higher-than-expected same-store sales growth of 7.4% and 20.2%, respectively.  Meanwhile, lower-end retailers, such as Kohl's (KSS) and J.C. Penney (JCP) only reported same-store sales growth of 0.8% and negative 1.0%, respectively.  Interestingly—even within Wal-Mart (WMT)—consumers at Sam's Club (with a higher income demographic of $75,000 to $80,000) experienced a same-store sales growth of 4.2% during the first quarter; while Wal-Mart US (with a lower income demographic of around $45,000) experienced a same-store sales decline of 1.1% during the same quarter.

WMT, in particular, has experienced negative same-store sales growth for the last nine quarters.  Management has emphasized that achieving positive same-store sales growth is a priority; although no timetable was given (management did respond by cutting SG&A for the last six quarters).  That said, WMT's same-store sales decline is slowing down, and management seems to be making progress through a broader line-up and offering more consistent every-day low prices (as opposed to its confusing “Hi-Low” pricing experiment last year).  Obviously, the combination of a failed offering/pricing strategy and an inflationary environment has hurt the stock price.  This is evident in the following 5-year weekly chart showing the stock price of WMT, as well as its relative strength (lower panel) vs. the RTH (the retail HOLDRS), courtesy of

Note that WMT's relative strength vs. the RTH peaked in late 2008 and has followed a downtrend ever since.  This trend is also evident in WMT's relative strength vs. Nordstrom (JWN), as shown in the following weekly chart, again courtesy of

With the recent decline tampering of energy and food prices over the last several weeks—and given WMT's management realization of its failed pricing/line-ups strategy last year—I believe WMT's same-store sales growth may turn positive during the third quarter, assuming energy and food prices remain tame (which is our base case scenario).  A positive same-store-sales growth in 3Q of this year would exceed the expectations of most analysts.  Should crude oil prices decline to the $80 to $85 a barrel area this summer, I expect WMT's management to announce a better-than-expected forecast of 3Q earnings in the 2Q earnings conference call.  With a dividend yield of 2.8%, WMT looks compelling, although I would not buy at today's price of $52.29 a share.  My inclination is to wait for a further correction to $50 a share or lower.

Let us now discuss the most recent action in the U.S. stock market using the Dow Theory.  Following is the most recent action of the Dow Industrials vs. the Dow Transports, as shown in the following chart from January 2008 to the present:

For the six trading days ending June 27, 2011, the Dow Industrials rose 39.20 points, while the Dow Transports rose 100.64 points.  Given the rise in both Dow indices over the last six trading days, the market is no longer oversold on a short-term basis.  Therefore, while a further bounce is possible this week, I urge subscribers to remain cautious.  Given the combination of weak technical and liquidity conditions, the market action will remain tough this summer. We remain neutral in our DJIA Timing System as we take a wait-and-see approach, for now.

I will now continue our commentary with a quick discussion of our popular sentiment indicators – those being the bulls-bears percentages of the American Association of Individual Investors (AAII), the Investors Intelligence, and the Market Vane's Bullish Consensus Surveys.  The four-week moving average of these sentiment indicators increased slightly from a reading of 4.3% to 4.4% for the week ending June 24, 2011.  Following is a weekly chart showing the four-week moving average of the Market Vane, AAII, and the Investors Intelligence Survey Bulls-Bears% Differentials from January 1999 to the present:

After peaking at 30.8% (its highest reading since late February 2007) in late January, the four-week MA declined to 4.4% last week—near its most oversold level since late September last year. Despite this oversold condition, however, it still isn't as oversold as it was during the correction last summer.  We will retain our neutral position in our DJIA Timing System, as we don't believe the market has bottomed yet (although a short-term recovery is very likely).

I will now close out our commentary by discussing the latest readings of the ISE Sentiment Index.  For newer subscribers, I want to provide an explanation of ISE Sentiment Index and why it has turned out to be (and should continue to be) a useful sentiment indicator.  Quoting the International Securities Exchange website: The ISE Sentiment Index (ISEE) is designed to show how investors view stock prices. The ISEE only measures opening long customer transactions on ISE. Transactions made by market makers and firms are not included in ISEE because they are not considered representative of market sentiment due to the often specialized nature of those transactions. Customer transactions, meanwhile, are often thought to best represent market sentiment because customers, which include individual investors, often buy call and put options to express their sentiment toward a particular stock.

When the daily reading is above 100, it means that more customers have been buying call options than put options, while a reading below 100 means more customers have been buying puts than calls.  As noted in the above paragraph, the ISEE only measures transactions initiated by retail investors – and not transactions initiated by market makers or firms.  This makes the indicator a perfect contrarian indicator.  Since the inception of this index during early 2002, its track record has been one of the best relative to that of other sentiment indicators.  Following is the 20-day and 50-day moving average of the ISE Sentiment Index vs. the daily S&P 500 from May 1, 2002 to the present:

The 20 DMA increased from 100.3 to 105.1 last week, although it is still close to its most oversold level since late July 2010.  Similarly, the 50 DMA is also at a highly oversold level. While the oversold conditions in this indicator suggests the market could rally in the short-run, the fact that our other sentiment indicators is not as oversold is troubling—and suggests caution is warranted when purchasing stocks, especially given the weak technical and liquidity conditions.  We will remain neutral in our DJIA Timing System, and will take a wait-and-see approach, for now.

Conclusion: On an income (flow) level, U.S. households have likely bore the greatest pain of the deleveraging process, although there still needs to be more deleveraging on the balance sheet (stock) side.  This will happen as the cyclical bull market in global equities is still in place (although the market action will likely be tough this summer); and as U.S. income levels rise and unemployment declines throughout 2011.  Of course, the proportion of income that flows to debt payments will increase should the Federal Reserve raises rates—and because of this, I do not expect the Bernanke-led Fed to raise rates anytime soon.  The peripheral countries in the Euro Zone, however, are a different story.  In the meantime, the U.S. stock market should rally in the short-run, but I continue to expect a tough summer for U.S. stocks.  We remain neutral in our DJIA Timing System, for now.  Subscribers please stay tuned.

Signing off,

Henry To, CFA, CAIA


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