(By Kevin Donovan) We have been accused of being a perma-bull, and not without reason. After all, last year we recommended home-building stocks in anticipation of healing in the housing sector, and we also thought selected retailers would do well as consumers grew more confident that the economic expansion was secure.
In the aforementioned, we hit the sweet spot. Pulte Homes (PHM) is up 102% and D.R. Horton (DHI) has gained 29% since we recommended purchase in May (see here). A month later we added Lennar (LEN) to our list. Its shares are also up 29% since that call.
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Our retail calls were mixed. Macy's is our big winner, up 23% since we recommended purchase on July 5 (see here). But our calls on specialty clothiers haven't played out as well. Gap Stores is down 15% since we recommended the stock in August and Rue21 is flat. And our recent recommendation on Penney's (JCP) shows a 15% decline.
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However, our non-clothing retail pick, Barnes & Noble (BKS), is up 10% since our advice to buy in mid-December.
Believers as we are in the revolutionary investment theory of buy low-sell high, we would take profits on the home builders and hold on to the retailers. This is a bit counterintuitive, given our outlook that the sequester is a bigger deal than the market thinks.
Our reasoning runs like this:
- The sequester standoff will prove more harmful than the market is currently discounting. The Republican Party would lose whatever credibility it still has by caving to President Obama, who is counting on economic pain to twist arms. On this front, check out Richard W. Stevenson's astute analysis in this morning's New York Times.
- We would sell the home builders on any strength fueled by February jobs data to be released Friday. It's likely, in our view, that employers may have kept hiring last month on the expectation that Washington would avoid spending cuts. Employment will take a hit in the months to come from the sequester, we think, and with it new home sales.
- Though we expect the economy to slow down, the Fed will keep printing money and the expansion going. Fed Chairman Ben Bernanke's congressional testimony last week was explicit as Fedspeak gets in expressing commitment to keeping the economy afloat. We still like our retail picks, which are still too cheap, even in a slower recovery, in our view.
A quick look at valuation explains our trade. The homebuilders are all trading at hefty premiums to book value, with, D.R. Horton at 2.0 times, Pulte at 3.00 and Lennar at 2.18 times book. For our retail picks, we look at price-to-sales ratios. Despite the run-up in share price, Macy's trades at just a 0.58 multiple to sales. Gap is at 1.07, Rue 21 at 0.75, J.C. Penny at 0.30 and Barnes & Noble at just 0.13.
At first blush, given our tempered outlook for economic growth and employment, selling everything and turning to cash would seem to be in order. But remember, our call is based on two pivots: 1)that the market is too cavalier about sequester, and thus the housing sector, and; 2)that it's too stingy in valuing retailers even in a slower growth environment. We believe that if sales can at least tread water in a slower growth