Will the consumer show discretion?

Happy New Year! This year the government made a resolution to take more out of your check and consequently you are now making less money per year.  I am sure you have noticed by now that your paycheck just got a little smaller courtesy of the increase of the social security tax. Now I am not saying that I agree or disagree with the tax increase, I am sure that our elected officials did what was best. All I am saying is that me, you and everyone else is now taking home less money per paycheck.

Given this information one question comes to my mind, why are analysts so bullish on the retail sector?  It seems everywhere you turn there is someone on CNBC talking about retail and how high the retail sector can go. Call me crazy, but in November weren’t we talking about how slow Black Friday was for brick and mortar stores, and how disappointing Cyber Monday was? Oh that’s right; we blamed that on the fiscal cliff and economic fears.

Just like every investor, I watch headlines, look at numbers, and hope for the best; and if you look at the retail numbers that were released today, the economy looks to be spending more and the retail sector looks to be poised for a breakout.

The Commerce Department reported retail sales increased 0.5 percent after an upwardly revised 0.4 percent rise in November. Sales in November were previously reported to have gained 0.3 percent.

Economists polled by Reuters had expected sales to rise only 0.2 percent. Sales were up 4.7 percent from December 2011 and rose 5.2 percent for the whole of 2012.

Allow me to make my bearish argument. Do not forget, these numbers were for 2012. In 2013 we are all now making less money. So does this mean the typical consumer will start spending less and showing more discretion? One argument that retail bulls make is that the growth of the economy will be enough to sustain any decrease in spending that occurs.  Call me crazy but I have not heard a single economist say that we will have greater than a 2 percent GDP growth this year. I also heard Ben Bernanke say that he will continue quantitative easing until the unemployment rate falls below 6.5 percent, and oh yea…..wait for it……. Wait for for it……. That should happen sometime around mid 2015.

Please don’t get me wrong. I love Big Ben!! Bring on the QE! But I interpret that as slow, but steady growth. So the question remains - will taking money out of a slow growing economy result in less spending? I would be curious to see if the consumer credit card balances report for December rises. November saw a rise of 7 percent. If December rises higher, then I would start to get concerned that balances are higher and income is lower, which could result in less spending. I think that it is really too early to answer the question of what impact it will have on spending, but as you will see by my trade below, I am neutral to slightly bearish on the retail sector and cautiously waiting until we see a few months of positive retail sales.

There are two fantastic consumer based ETFs that can be affordable to buy and they both offer options.

XLY – SPDR Sector Consumer Discretionary, average volume 5,940,698

The XLY is focused on consumer discretionary stocks but this encompasses a wide range of stocks. The industries that the XLY has holdings in retail, media, hotels, restaurants, household durables, apparel & luxury good, autos, and 6 others.

XRT – SPDR S&P Retail, average volume 4,166,971

The XRT tracks and performs to the Retail index which is an equal weighted market cap index.

The breakdown of holdings for the XRT is 75 percent consumer cyclical, 21 percent consumer defensive and 2 percent technology.  

As you can see from the charts below, both the XLY and the XRT have had awesome runs to date but there is one significant point to make. If you look at the RSI both ETFs are very close to reaching the overbought territory. The last time both crossed into overbought territory was last September, and well as you can see buy the charts it was good to sell.

After seeing the XRT run up today over a buck, I couldn’t resist the temptation to short it. I played the Feb 16 64/63 put spread for 42 cents. If the stock drops to levels prior to today then I profit.

Don't get a RIMM job

I can remember ten years ago when I got my first Blackberry. I loved it, thought that I couldn’t live without it. I loved all the awesome things that I could do on my new smart phone that I couldn’t do on my old flip phone.  And the stock, man was that stock hot ten years ago. In the year prior to the great recession RIMM was trading at a high of $144.56. In fact in the short time frame from August 17 2007 to Nov 2 2007 the stock ballooned from 24.47 to 126.95.  Wouldn’t it have been great to have had purchased a few August 25 calls in November?  Even after the almost complete financial collapse RIMM did surprisingly well.  RIMM held up to hit a low of 36.34 in 2009 during the great selloff period, which was still 12 dollars up from the 24 bucks before the big balloon.  And if you were to hold the stock till September of that year you would have seen the stock bounce back to 87 dollars.   

I can remember four years ago, when I upgraded to the latest model Blackberry. It was perfect, a little smaller and a lot lighter. Wow is this nice. I could hardly feel it in my belt clip holder. But wait a minute, I can’t do anything new. Is this a new phone? I mean it feels like a new phone, it has a new set of ring tones and I think the calendar is new.

Consequently that was the last time RIMM would ever see a share price of 87 dollars.

Look back to September 2011. That was when the world realized that RIMM has not innovated anything in years. The stock was trading at its 18 month high of 29.68. Since then the company has had several lackluster releases of their Blackberry phones, and a sad attempt at a tablet.

The fact of the matter is the following; RIMM can never be a large player in the mobile industry anymore for three simple reasons:

First - It’s too late. Quite frankly, they missed their chance. I mean I have a phone that takes pictures when someone smiles and a tablet that doesn’t lock because it knows I’m looking at it. Now – to be fair to RIMM, I do not even know what Blackberry 10 has to offer, and you want to know why, because I don’t care.  They have been out of the loop for so long they are no longer thought about.

Second - my first blackberry was purchased by my business. They gave me the phone and I learned to love it. I started hating it after they took it away and I was forced to get a new phone. The point being, RIMM used to have a large business customer base. And this of course is one of the reasons the stock has not fallen farther. But as I have witnessed in my own business, Blackberry is not the only choice of phones now. Businesses are starting to allow their employees to choose between Android or Blackberry.  I have heard from a few friends that their business allows them to use their own phone to access corporate networks.

Third - developers do not develop apps for blackberry. Plain and simple. Point blank. Put a period on it.  Let me repeat, developers do not focus their attention on blackberry.  You can tell this by the number of apps that are available in the app store.  And let’s face it we love our apps.

So now that I have proved, in my humble opinion, that RIMM is no longer relevant and will continue down this path, let me show you how to trade it. RIMM closed today (Jan 14^th) at 14.95.  That is almost four dollars up from where it was last Friday. There has been huge volume on this stock - both buying the stock and in the options market.  I think this stock is way overbought and stretched way too far. When the crap hits the fan next month with the spending sequester, this stock is one that will take a beating by short sellers and profit takers. Let’s not forget that last week RIMM lowered guidance.

For starters, if you currently own the stock watch it and the first sign of weakness sell it for a profit. In fact, I would put a trailing stop in so that I can lock in the gains. I am not saying that the stock won’t climb while this buying frenzy is going on, but I would definitely sell it before March 1. That is when the automatic spending cuts from the fiscal cliff are set to kick in.

There are two ways to play the downside. If you like options then I suggest playing the vertical spread listed below. I don’t recommend selling stock short. There is a lot of risk in doing so but I would be willing to sell 100 shares short when we get closer to the debt ceiling debate and spending cuts debate.

A good bet and the one that I prefer would is the March 16^th 13/12 vertical put spread for a debit of 34 cents each.  This approach caps your losses and at the same time can generate a return of close to 200 percent.

Capital Required	34.00
Max Profit	66.00
Return %	194.12%
Break Even	12.66
Max Risk	34.00