Joe America is tapped out.
After WWII, the US began shifting towards a consumer economy. However, this process was sped up rapidly in 1971 when we re-opened formal trade with China. As multinational corporations began shifting their manufacturing centers East to cut costs, American incomes and quality of life began deteriorating more rapidly: using the government's numbers, real (inflation-adjusted) average weekly earnings have fallen 15% from their 1972 levels.
You can see this in the stock market as well. As the US shifted to a services economy (especially financial services), the financial sector exploded. From 1970 until 2003, the financial industry expanded from less than 5% to 22% of the total market capitalization of the S&P 500. Over the same period, the sector increased its earnings from 10% to 31% of the total earnings of the S&P 500. Put another way, in 2003, virtually one in three dollars made by publicly traded corporations was made by a financial services company.
However, because Joe America had access to credit cards, he didn’t feel the pinch for some time. In fact, the combination of credit cards and cheap manufactured goods from China made Americans feel rich, though in reality they were simply spending their savings, filling their house with discretionary items.
This all came to a screeching halt once the Financial Crisis of 2008-2009 wiped out $50 trillion in household wealth. Since then, the US consumer has begun a seismic shift. For the first time in years the average American household is increasing its monthly savings. And this means one thing:
Retail is TOAST.
The below chart tells the whole story:
With unemployment already at a 25-year high and more Americans losing their jobs by the week, I expect this drop off in retail sails to accelerate throughout 2009. In particular, I expect clothing retailers to take it on the chin. After all, who’s going to go shopping for a new set of clothes when they’ve got no money coming in? And finding a job in this market is like looking for a needle in a haystack.
It’s already begun: clothing shops showed a 10% decline from the year before for the month of April. And it’s only going to get worse from here.
Which is why Gap (GPS) is ripe for a fall.
GPS owns the Old Navy, Banana Republic, and Gap store franchises. In this regard, the company has exposure to low price (Old Navy) medium priced (Gap) and relatively expensive (Banana Republic) retail demographics.
However, all three franchises appeal to roughly the same income brackets - the middle of the road folks who are cutting back more and more on their expenses. And despite the range in prices - everything from $20 jeans to $200 blazers - all of GPS’s clothing lines share a common quality: they’re not luxury goods.
Simply put, these are not high quality goods. They’re precisely the franchises that will suffer the most as consumers tighten their spending habits. In fact, they already are. GPS’s same store sales for 1Q09 plunged -8%, following up a 14% plunge in 4Q08 and a 12% drop in 3Q08.
GPS actually has a fairly long history of failure. The company hasn’t posted an increase in same store sales since 1Q04. GPS insiders are dumping their stakes as fast as they can. All told they’ve dropped more $30 million worth of GPS stock in the last six months alone.
Like the drop in same-store sales, this is nothing new: corporate insiders have sold off nearly 5% of the company’s shares outstanding in the last two years. This is an extremely bearish amount of selling. Clearly, the company’s insiders don’t expect a rebound or rosy future for GPS.
Which is why it’s striking to see GPS shares trading only 28% off their 3-year high.
click to enlarge
Let’s be blunt here. The US is currently in the worst recession going back at least 30 years, possibly bordering on a full-blown depression. Moreover, the world economy is entering its first contraction since 1945. And yet, GPS, a mid-line clothing retailer, is only 28% off its bull market high. Even more strangely, GPS, and retail in general have actually outperformed the market dramatically in the last three months… during a time in which the underlying fundamentals have completely fallen off a cliff.
This has the making of a major short sale: unfounded bullishness from investors with worsening fundamentals and insiders selling the farm.
When the next round of the financial crisis hits, GPS should retest is March ’09 lows. So cover your shorts if GPS falls below $10 a share.