Accounting Fraud Tactics
Let's explore why position sizing is the key factor to consider in trading and investing.
PREPARED BY: Chris Stanford
DATE: 10/23/21
TOPIC: Shorting Retail Stocks
In the present climate, the professional investment community is progressively focused on inflation. The best-performing industries over the last year were the commodity and transportation sectors. The long inflation trade feels extremely overdone. Inflation will likely stay elevated relative to prior years. That said, the risk versus reward on the long side is horrific. Our preferred trade is identifying major retailers that are overly sensitive to global supply chain shortages. A lot of the large retailers are trading at all-time /multi-year highs.
Last year we saw a huge spike in retail sales post-pandemic. Most economists agree the trend is short-lived. The retail sales data has already normalized, yet the companies continue to trade at steep valuations. The industry as a whole looks cheap when you compare it to the other industries. For the most part, these companies are priced based on the deterioration of fundamentals. It’s no secret that E-Commerce players like Amazon make it difficult for middleman retailers to survive. Revenue growth rates have slowed dramatically. Additionally, margins have suffered as a result of the increasing competition.
Major retailers are citing supply chain issues as the biggest concern for the upcoming quarter. Q4 is typically the best quarter across the industry. However, this year we are seeing shortages in things like Christmas trees, sweaters, cardboard, food, clothing, semiconductors, oil, and natural gas. Supply chain analysts anticipate this will extend far beyond the holiday season. Labor shortages are at the heart of this and they are going to take time to resolve.
Goldman Sachs is one of the various investment banks that recently lowered their year-end GDP forecasts. The explosive post-pandemic growth is not sustainable. GDP is likely to normalize toward the second quarter of 2022. U.S. retail sales are projected to drop by 2%, which would make it one of the worst years in over a decade. Inflation, labor shortages, and supply chain issues are starting to catch up with us. Our team is moderately optimistic about U.S. economic growth. However, the stocks in the retail industry are priced to perfection.
The previous year’s consumer spending and retail sales figures were exceptional. Quarter-over-quarter growth was beyond anything we’ve seen in years. Retail stocks made a prodigious comeback during the pandemic, but the excitement has led to a wide discrepancy in stock prices from core fundamentals. Investors were avoiding these companies pre-pandemic for a reason. They have been struggling to operate in a world dominated by Amazon. Online E-commerce has made it really difficult for middleman retailers to survive. A major part of Amazon’s competitive advantage is faster shipment delivery times, and cheaper products. Competition from Amazon has compressed margins across the entire industry. Various retailers have been forced into bankruptcy. We argue that these fundamentals still trump the short-term excitement related to the previous year’s retail sales recovery.
Our team has identified a handful of retailers we believe to be overvalued. Over the past week, we started to get exposure across the industry. Our preferred vehicle is a combination of put options and short-call spreads. One of the most important aspects of any trade is timing. It’s important to recognize that this is not a one-week or one-month trade. I estimate that this idea will take at least three to four months to play out. The ideal structure is to sell a call spread or buy long-term puts that extend past January.
Major retailers are warning us of an upcoming global shipping crisis during the holiday season. Despite the fundamentals, investors are likely to continue to overvalue this industry until holiday season earnings come out. The size of our positions collectively will make up less than 5% of the portfolio. Although we are confident in our analysis, I’m not convinced that others will so easily change their opinions. The following companies are some of our upcoming/currently ongoing plays:
Let's explore why position sizing is the key factor to consider in trading and investing.
Let's explore why position sizing is the key factor to consider in trading and investing.
Let's explore why position sizing is the key factor to consider in trading and investing.
Let's explore why position sizing is the key factor to consider in trading and investing.
Let's explore why position sizing is the key factor to consider in trading and investing.