How to Play This Economy: Short the Bottom, Go Long the Top

 |  Includes: COH, DG, RL
by: Michael Shulman

It all seems like that great scene from the movie Casablanca: At the request of the Nazis the hopelessly corrupt local top cop shuts down’s Rick’s, claiming “I am shocked, there is gambling on the premises.” As he finishes this statement the manager of the illegal casino comes out and hands him his winnings for the evening.

Now imagine Wall Street as that cop. They are shocked, shocked at a rise in jobless claims. They have abandoned all common sense, or perhaps they are visiting malls and restaurants and construction sites and state and local budget meetings these first days of January. Historically, people do not file the last couple of weeks of the year, they postpone filing. And they are doing it now in the face of a dead economy.

And the Street is happy underneath it all, for the jobless claims number is the equivalent of the casino manager handing them cash. But instead of an actor it is Ben Bernanke, the man who has pledged umpteen times to do whatever it takes in the face of a dead economy. So the market will stay buoyant -- up even, perhaps a little but really down; floating on a sea of liquidity in the face of a weak and eventually deteriorating economy.

The data itself? Seasonally adjusted initial jobless claims rose 35,000 to 445,000 for the week ending January 8. Actual claims rose 33% or 192,000 to 770,000. That is a lot of claims.

In one way the Street does not emulate that corrupt cop – who turns out to be a good guy. That's something that will not likely happen on the Street. Also, the Street actually believes the U.S. economy is going to turn around this year. That too is not going to happen, for the following reasons:

  • The engines of the economy – employment, credit and accumulated wealth – are all broken. Employment continues to suffer through its sharpest contraction in the work force since the end of World War II. Credit continues to contract and now banks are proposing a standard of 30% down for a house if they plan to securitize the note. Wealth is off 35% or so between home prices and the stock market.

  • The engine for employment is housing and it is broken and will be for at least four more years. Just look at the current late payment/default/foreclosure rates and do the math. Then juxtapose this against inventory. No boom in housing, And remember, if single family starts double and then almost double again we will then be back where we were four years ago.

  • The U.S. consumer is now deep into what I call the New Frugal. They will buy pounds of high quality products – Apple (NASDAQ:AAPL) iPads, Ralph Lauren, Coach – and forego other items. This will end up contracting the number of transactions, the number of retailers, the number of retail jobs and the number of malls. Check it out yourself: Credit card revenues are up, transactions flat to down. Fewer items, each more expensive on average.

The bottom line is simple: It is all about housing. No housing rebound, we slide into a double dip. Any one of thoe pundits on CNBC who states "animal spirits" and "organic growth" is going to make a dent in the unemployment and underemployment is talking their own book or dating a producer. Maybe both.

What to do? Short the bottom of consumer spending -- take a look at Dollar General (NYSE:DG), extremely welll-managed and extremely overvalued. Go long the top of consumer spending -- the aforementioned Ralph Lauren (NYSE:RL) and Coach (NYSE:COH). And if you buy the home builders, well, there is a bridge to Brooklyn for sale that I can get you a deal on. My great grandmother walked across that bridge the day it opened in 1883 and probably sold part of it right then. Ironically, when she reached her destination, she cleaned offices on Wall Street.

Disclosure: None