Why Does This Sector Keep Bludgeoning Investors?

by: Lou Basenese

Pick any tired cliché about a dramatic shift in a short period of time… Like nothing ever happened. What a difference a week makes.
They all apply. Two weeks ago, stocks were in the midst of a nasty pullback. Correction chatter dominated the headlines. Heck, individual bullish sentiment dive-bombed nearly 50% from year-end levels.

And now? The stock market has strung together six consecutive days of gains. The S&P 500 Index is back within striking distance of a new all-time high. And everyday investors are downright giddy again, as the American Association of Individual Investors (AAII) bullish sentiment reading jumped from 27.9% up to 40.15% last week.

Now, don't kill the messenger… But not every nook and cranny of the market is on the mend. In fact, there's one industry that could be setting up for a nasty fall. All I need is a single chart to prove it, too.

Retail Me Not

While everyone is fixated on the major market indices, few have noticed the terrible performance of the retail industry. The SPDR S&P Retail Fund (NYSEARCA:XRT) was down a staggering 11.4% in the beginning of February. That's the worst start to a year for the group in over a decade. Even after the recent rebound, the industry is still down 7% versus only a 1% decline for the S&P 500.

I know, I know. The weather is entirely at fault, right? For when the weather outside is frightful (which it's been for two months now), Americans stay indoors and don't do much shopping. Hogwash! While that's a convenient explanation, it's not an accurate one.

Consider: The latest data reveals that headline retail sales slumped 0.4% last month. However, on a category-by-category basis, non-store retail sales (i.e., online shopping) dropped by even more (0.56%). If being stuck indoors prevents shopaholics from hitting the malls, you'd expect them to get their fix online. But that didn't happen. In other words, weather has little to do with it. Americans simply aren't shopping as much as economists expected.

Why? Well, as I shared last week, the average consumer is getting pinched by rising fuel costs, soaring utility bills and stagnant wage growth. I'm sorry. But that's not the recipe for runaway shopping sprees. The problem is, retailers refuse to accept this cold reality. They keep hiring more employees in anticipation of increased shopping activity.

As Neil Dutta, Head of U.S. Economics at Renaissance Macro, says, "Something has to give… Either retailers stick with it and stay confident on the expectations that sales will improve, or they will be forced to cut employment dramatically." In other words, retailers are playing a nasty game of chicken. And I don't see it ending well for them, particularly ones that rely heavily on brick-and-mortar sales in mall locations. Here's why…

No More Mallrats

During the past holiday season, foot traffic fell nearly 15%, according to ShopperTrak. Meanwhile, at the most recent National Retail Federation convention, Rick Caruso, CEO of Caruso Affiliated, predicted that traditional malls are on the brink of extinction. To his point, a new indoor mall hasn't been built since 2006.

Heck, all we have to do is look at the performance of anchor tenants in many malls, like J.C. Penney Company, Inc. (NYSE:JCP) and Sears Holdings Corporation (SHLD). They've been sucking wind for years. And increasingly so, which explains the recent announcements that both companies are closing even more stores. Sears alone has shuttered about 300 stores since 2010.

Along with Radio Shack (NYSE:RSH), I'm convinced that it's only a matter of time before all three kick the bucket and file for bankruptcy. Given the current conditions, I wouldn't be surprised if it happened before the year is out.

Bottom line: Blaming poor retail sales on the weather ignores a deeper, more troubling situation. U.S. consumers aren't consuming as much as economists expected at this point in the recovery. Until we see definitive signs of a change in behavior, the only way I'd put money to work in the industry is by betting against the most troubled retailers by buying some cheap January 2015 put options.