Sometimes to go up, you must first go down. That statement may sound a bit like Yoda from Star Wars, but that doesn't make it any less true. Just two weeks ago, the Dow was holding just above 7000. I wondered if a brief plunge below 7000 would incite the bout of panic needed to put in a short term bottom in stocks. I use the words short-term as we will not know until months later if the March lows are indeed "the bottom". While the market has dropped steadily since the Inauguration, it was only in the first two weeks of March that we began to see a climb in fear accompanied by a "waterfall" like decline in the market. This is the type of behavior that usually leads to a “spring cleaning” of sellers. Investors who sell now will not be around to sell in a few weeks should the market move higher. In fact, to participate in any upside, today sellers would have to re-buy. This could add fuel to any potential rally.
I use the CBOE Options Volatility Index or VXO to indicate levels of fear in the marketplace. To recap, the VXO is a contrary indicator; a high level of fear may mean that the majority of selling is done and a rally may be at hand. Since last September, the VXO has traded in a range of 40 to 102. This is approximately double the VXO’s “usual” range.
Ironically, I have found another data point that shows just how high the market’s angst currently is: handgun sales. For November, 2008, Federal records show a 42% year over year increase in handgun sales. December sales slowed to only a 24% increase, but the dawning of 2009 showed a bump back to 29%. Finally, February slowed again to only a 23% sales jump. The overall trend shows November as the peak and while gun sales continue to grow, they are doing so at a slowing pace.
Those data points mimic much of the action in the VXO and the stock market as a whole. The VXO peaked at 102 in the early fall, fell off a bit in December and then staged a smaller spike in fear through January and February. Fear and unrest appear to be universal feelings that are manifested in any number of ways. At a time when otherwise sane people are forecasting the end of civilization, it may prove to be a buying opportunity.
The decline in the S&P 500 is following a timeline that is similar to the sequence the market undertook from 2000’s peak to the 2003 bottom. The size of the decline was 49% from the peak in 2000 to the bottom in 2003. Currently, the swing has seen a drop of 57% from the 2007 high to the March 2009 lows. So while the drop has been more severe, it is still similar in size and ferocity to what we saw seven years ago.
I bring this up to give us perspective on today’s events. Some of us have been in the industry for many years and we have "seen it all". The media appears to want us to believe that we have not. When one is confronted with an unfamiliar challenge, one tends to be more nervous than when faced with the same old problem. My message to you is that this is indeed the same old problem. We saw it in 1987, 1994, the fall of 1997, the fall of 1998 and of course in March of 2000. Stick to your “knitting,” rebalance your clients’ asset allocations to reflect today's opportunities and act slowly but decisively to take advantage. Eventually, we may look back and wonder why we were not more aggressive.
Why are the retailers having such a hard time in the last eighteen months? Yes, the credit crunch has something to do with it, but the answer could be much simpler: overbuilding. Since 1990, domestic spending on clothing grew at an 89% clip.
89% growth seems impressive until you look at the other side of the equation. During that same time frame, the number of clothing stores increased by 168%! Something had to give, and the housing- driven credit crunch provided the catalyst. However, we are beginning to see opportunities in several of the cash rich, debt free retailers.
Additionally, the S&P retail index (RLX) made its yearly low of 207 back in November of 2008. Recently, the Dow plunged to levels not seen since 1996. On March 6, the RLX put in a “higher” low of 223. This type of relative strength could portend positive action in the retailers over the next several years.
The crux of the plan is to own the debt-free retailers. With financing scarce, the absence of the need to restructure debt levels is critical. Being cash-rich can buy a company time to make the right decisions for the long term; without that flexibility, a heavily indebted retailer may not even make it to the long term. I hope many of you will be able to join us on our conference call in early April.
