Round 3 of the Recession: Main Street

As I've been saying for a while, despite all the pain over the past few weeks, there is plenty more in store for the S&P 500. Despite the fact that stocks in the US are trading around 40% down from their highs this time last year, the indices are still plenty expensive from a P/E and dividend yield perspective. While financial sector Armageddon seems to have been averted this week, with new bailouts coming from Europe and a redirection of the TARP to provide equity injections, there are still more than enough shoes to drop. It looks like Round 2, severe systematic risk to financials, (Round 1 was housing), is somewhat coming to an end, although we are not completely out of the woods yet, round 3, the real recession is just starting. Next up, as seen by today's retail numbers, is Main Street.

For months and months, there has been speculation about how hard the financial crisis was going to hit Main Street. By now, it is becoming clear that we are about to enter a savage positive feedback loop that will ravage cyclical businesses. As retail sales continue to drop, companies will be forced to cut staff, putting more pressure on the retail sector. The first companies to get hit will be in consumer discretionary, the bigger expense items the hardest.

Stock position: None.

This isn't news to anyone, but Ford (F) and GM (GM) are likely going to be the first casualties of the crisis' transition to Main Street. Behind them will be any highly cyclical businesses with a high debt/EBITDA, low margins and a significant portion of debt maturing in the next 18 months or so. I am looking at retailers in the consumer discretionary sector primarily, who are likely to suffer a spate of store closings and write downs. Best Buy (BBY) is one of the prime candidates for suffering, due to its 2% net margin. Additionally, any vacation-oriented company will likely get pounded as people opt to stay close to home for their vacations, rather than take exotic vacations. Carnival (CCL) would be an example. Computer manufacturers and airlines may also take a strong hit, as well as their upstream suppliers.

Even though the selling induced by hedge fund redemptions will end in a month or two, the indices are just too expensive right now, and as the economy continues to deteriorate, it will only get worse. Probably the best investment right now is in put options in cyclical businesses, with low margins and high debt/EBITDA.

Comments

[nixtr:]

I agree that left alone, F and GM would have a tough go of it through the next 4 quarters, but will they be left to hang from the trees of Detroit? Or will we have more socialism ride in wearing a white hat?

2008 Oct 16 02:18 PM

[nixtr:]

Also, a quick check of BBY on the S & P stock list has it rated 5 stars and projected to hit 55 in 12 months. I guess they will derate it after it has sunk to 10 bucks or so. Let's hear it for adroit analyst timing.

But your projections make sense, however bleak they may be.

2008 Oct 16 02:25 PM