If You Like to Invest, Know this About Retail Stocks...Today

After taking a couple inquisitive clients through the mall for one of my “Retail Stock Picking in Real Life” bootcamp sessions, I left feeling they were missing the big picture. Sure, many specialty apparel retailers are not aggressively promoting new merchandise post back to school, and clearance items are at a minimum (though more elevated at Macy's and Sears, especially the latter). And yes indeed, the mall is still popping with color as to send a subliminal message to the consumer: “buy me, I know that you know I am not in your closet.” These are the simple observations inherent to most of the mall runs I have done this month. Now we have begun to receive the typical survey driven holiday season projections, while retailers on balance appear to be more open to adding minimum wage payroll compared to last year. Though on this topic, if you drill into the buzzy press releases, a good plenty of the hiring is for distribution centers, call centers, or something related to online…not the sales floor. Great example of how technology is changing labor scheduling and consumption habits. Do I have a feeling in my gut that holiday 2012 will be stronger in terms of sales and profits for retail in versus 2011? Yes. They key pattern of 2012 is that consumers are splurging when the season forces them to stampede the mall or navigate an online store (no longer a “website”). It's also important to be mindful of how consumers are spending: combination of savings dip, a plastic card swipe, or holding a mobile phone up to a scanner. In other words, payment method usage is broad-based enough as to suggest anemic income and average workweek growth are not the sole determinants of spending, it's the totally monthly expenditure report (refinance activity has helped) plus the feeling of being in a better financial position over two years into the recovery (home values and stock prices higher). Nonetheless, as an investor looking to dance in the retail stock sandbox, be cognizant of a few realities. #1: Earnings expectations have run following two stronger than expected sales seasons, in addition to the well-documented, improved outlook for cotton costs. What this means is that the market anticipates next to no psychological impact on U.S. consumers from the election outcome and fiscal cliff. Mr. Market believes the trends are his friend regarding 2012 spending patterns. Last week I moved to short-term bearish on retail, suggesting to exit top picks Foot Locker (FL) and Dick's Sporting Goods (DKS) and go on the offensive by shorting Decker's Outdoor (DECK; original call September 12). In my eyes, retail stocks are deserving of a valuation adjustment in the present that will hopefully free up opportunities as third quarter earnings season in November begins. The thesis at that time, should it occur, would be part valuation and part positioning ahead of first half 2013 dividend increases/share buyback plans. #2: If you look at the price target assumptions on the Street based on 2013 earnings, the upside incorporates (relative to current levels) a multiple above the historical average plus earnings above the mean. Basically, rosy scenarios in play. However, using more rationale assumptions, the downside risk trumps the upside potential on many names (which is why I suggested to exit Dick's Sporting Goods). We too cool for school analyst folk apply this phrase: “unfavorable risk reward ratio.”