Which Way Wednesday – For Retail Sales?

Remember this from last year?:

Price-slashing failed to rescue a bleak holiday season for beleaguered retailers, as sales plunged across most categories on shrinking consumer spending, according to new data released Thursday.  Despite a flurry of last-minute shoppers lured by the deep discounts, total retail sales, excluding automobiles, fell over the year-earlier period by 5.5% in November and 8% in December through Christmas Eve, according to MasterCard Inc.'s SpendingPulse unit.  "This will go down as the one of the worst holiday sales seasons on record," said Mary Delk, a director in the retail practice at consulting firm Deloitte LLP. "Retailers went from 'Ho-ho' to 'Uh-oh' to 'Oh-no.'"  The holiday retail-sales decline was much worse than the already-dire picture painted by industry forecasts, which had predicted sales ranging from a 1% drop to a more optimistic increase of 2.2%.

That was the December 26th headline in the WSJ (the chart is from last year too) which presaged poor Q4 earnings that sent the markets off a 27% cliff from Jan 1st through March 9th of this year.  The Dow was at 9,000 last January and managed to fall all the way to 6,500 on those retail results – the same retail results we are hoping to beat by 1% this year with the Dow at 10,500.  This will be interesting to say the least.  We remain skeptical of the rally but have put up a new, very bullish Watch List as we have identified many stocks we can buy into a technical rally if it holds up into the week after New Years as we begin to deploy some of our own sidelined cash.

We held our short-term bearish stance but our premise is wearing thin as even the 2.2% GDP (20% worse than expected) announcement yesterday was somehow taken as good news by the market.  Today the WSJ is touting strong interest in a $1.1Bn CRE auction held by the FDIC as another positive market sign – forgetting the fact that these commercial properties are being sold at 50-90% discounts and are just 3% of the over $30Bn of seized assets the FDIC is sitting on and must sell over the next 12 months (so $1.9Bn short of target this month already). 

The FDIC must raise more capital in order to seize more banks as their balance sheet hit negative $8.2Bn at the end of September.  They had been putting off the sales, hoping for a turnaround but 50 cents on the dollar is about as good as it's going to get as they prepare to flood the market with a record amount of property sales. 

This is not necessarily bad for REITS though.  The ones that are solvent will be able to buy properties at bargain prices and will probably be able to make a go of the properties from a cash-flow basis, even if the prices stay flat for many years.  Meanwhile, the FDIC is likely to have to maintain a stake in the properties auctioned off AND provide financing since the banks, who still have their own $5.3Tn of CRE loans marked at 100% despite market discounts of 50% and lower.  Of that $5.3Tn of Commercial Real Estate, $1.9Tn is in Retail Space and THIS is where we think the whole thing is most likely to fall apart in 2010.

We hear a lot of reports about how office buildings are holding up well despite massive unemployment but that's because office buildings are the most efficient use of commercial space, accounting for just 4Bn out of 29Bn square feet in the US so 10% unemployment there impacts perhaps 400M sq feet.  Industrial Space, on the other hand, accounts for 13Bn square feet and we are currently running 20% below capacity.  This hasn't impacted CRE yet because they tend to have long-term leases and relatively few have run out this year and the government has been bailing out the big boys (like auto companies) to keep them from going bankrupt and defaulting on loans which might, heaven forbid, impact Goldman Sach's earnings.

So we're not really worried about Industrial Space just yet and we're not too worried about 2.5Bn square feet of Hotel Space as they too have long leases and International footprints that helps avoid sudden failures.  Retail Space, on the other hand, is 9.5Bn square feet of CRE and those guys could start going bankrupt as early as Q1.  If we assume a faily even distribution of $5Tn over 29Bn square feet, we can assume that lenders have about $1.6Tn tied up in Retail Space and a minor 10% default rate and we have $160Bn at risk and, if all goes well, perhaps "only" $80Bn in additional losses if all goes well.

$80Bn can, of course, be swept under the rug but the real danger is that a major failure in CRE next year will cause a demand for a realistic accounting of bank assets.  While the government has been super about helping the banks prop up their balance sheets in 2009, it's going to be difficult to sweep a 50% write-down of $5.3Tn worth of property values under the rug in 2010 when there is unlikely to be another multi-Trillion dollar bail-out package and we've already made as much of a joke out of accounting regulations as we possibly can in what is now known as "Mark to Fantasy Accounting."

While our government may not be concerned about the long-term damage we are doing to our nation's future by refusing to make a realistic assessment of our financial system, China is seeking to avoid making the same mistake and the People’s Bank of China “will study establishing a macroprudential management system,” the bank said in a quarterly monetary statement in Beijing today. The aim would be to prevent risks and ensure the safety of the financial system, it said. “China’s aggressive injection of liquidity into the banking system leaves the country vulnerable to some of the same potential problems that hit western economies,” said David Cohen, an economist at Action Economics in Singapore. “They recognize that they’re not immune.”

While China’s banks mostly side-stepped the mortgage-linked assets that threatened the U.S. financial system, this year’s lending has brought its own risks. Chinese banks’ capital strength is probably more “strained” than it appears as lenders use off-balance sheet transactions to make room for lending growth, Fitch Ratings said Dec. 17.  Bank of China Ltd. said last month it’s studying “various options” to replenish capital.  The central bank said today that it would “manage money and loan growth, guide financial institutions to lend in a balanced manner and avoid excessive volatilities.”  Central bank adviser Fan Gang cautioned Nov. 18 that the nation needed to be on alert for bubbles in equities, real estate and commodities.

That may be why we're seeing such a manic pumping up of commodities, even against the dollar rally as market manipulators are willing to pull out all the stops to get the hell out of their ridiculous positions before people catch on that THE Party has declared the party over for speculators in China.  Take away Chinese speculation and all you are left with is Japan's deflation, Europe's teetering alliance with Greece, Spain, Ireland and Iceland still threatening any hopes of recovery and, of course, America, which will announce another 500,000 weekly lay-offs tomorrow.  Oil is hitting $75 in pre-market trading and, unless the 10:30 inventory draw is more than 2Mb – we'll be shorting them again today. 

China had a wild 250-point stick save into the close, giving them all of the 1.1% gains for the day in the last 90 minutes of trading as the Central Bank's statement was not as harsh as anticipated but really it was the mega-pump by Citic Securities, who said growth in China may surge 12% next year and that drove pre-holiday traders into a frenzy which, coincidentally, worked out well for Citic, who are China's largest broker and probably managed to make their quarter on the sudden boost in trading – what a fortunate turn of events for them, don't you think?

Citic was especially lucky that their report happened to come on the Emperor's birthday in Japan so trading in Asia was exceptionally slow and easy to boost.  The Shanghai Composite was down for most of the day but had a big finish to wind up 0.8%.  Also putting on the pom-poms for the market early this morning was BlackRock's Bob Doll, who said: "The path of least resistance will continue to be to the upside,” he said.  The economic recovery “means earnings should be somewhat better and liquidity should still be plentiful. That’s a recipe for equities moving higher.”  Bob has $3.2Tn invested in the market so you just can't get a more objective opinion than that can you?

EU stocks hit a 14-month high as the BOE voted unanimously to maintain their $320Bn bond-purchase plan as that country struggles against deflation and a still-shrinking GDP.  Growth in money supply has been “disappointing,” the minutes said. The panel said that the narrowing in the spread between gilt yields and corresponding swap rates, which they had previously seen as a positive sign of the bond plan’s success, has “partly reversed” in the past two months. The measure of M4 money supply that the bank uses to assess the effectiveness of quantitative easing fell 0.7 percent in October from the previous month and was down an annualized 5.3 percent in the three months through October 

Mining companies led the rally as copper miraculously jumped back from $3.11 in US trading yesterday all the way back to $3.17 this morning thanks to the tales of endless Chinese demand as well as a very positive outlook on US Consumer Spending for November.   Funny story there – it turns out our Personal Spending was a miss, up just 0.5% vs 0.7% expected and down from 0.7% in October.  Personal Income was also down to 0.4% from 0.5% expected while the PCE remained very low at 0.2% and 0% at the core – indicating that retailers and manufacturers are still not able to pass along price increases, which is kind of dangerous if incomes are moving up 0.4% on them. 

Another report indicates that retailers may lose almost $9 billion in holiday sales as banks rein in lending to cash-strapped consumers before a new credit-card law takes effect, according to Britt Beemer, chairman of consumer polling firm America’s Research Group.  Sales in November and December may fall 1.2 percent to from the same period in 2008, said Beemer in a Dec. 21 interview.  

Available credit to U.S. consumers through cards fell to $3.6 trillion this year from a peak of $4.7 trillion last year, according to a study released in July by TowerGroup, a Needham, Massachusetts-based financial research and advising firm.  “We’re scared to death of what this law is going to do,” said Edward Record, CFO at Stage Stores Inc., the Houston-based operator of 759 stores including the Bealls and Peebles chains. “It’s definitely going to hurt consumer spending.”

We shorted MA yesterday as they hit $255, switching horses from our already profitable puts on V so that's me talking our book I guess.  Our plan was to short into a rally that tests and fails to make new highs and we'll be keeping tabs on Dow 10,516, S&P 1,120, Nasdaq 2,250, NYSE 7,285 (below 7,200 is our biggest negative indicator) and Russell 625 so it's all about the NYSE breaking over 7,200 and then a confirmation by the S&P to get us to make a few bullish bets but I'm hoping we simply have an opportunity to press the bear side as 1999 Redux moves to it's very likely conclusion.

We remain mainly in cash and looking forward to a nice, relaxing holiday.  There's no point in taking these very low-volume moves seriously no matter what the outcome and we'll continue to play for a possible plunge until we see an upside surprise to retail numbers – at which point we'll wave the white flag and run with the bulls.