During a year when the S&P-500 has gained 11%, luxury goods stocks have been left behind. Not only have they under-performed the market, some of them have posted a negative year to date return. Kate Spade (NYSE:KATE) and Burberry (OTCPK:BURBY) are two of the worst performers, while Coach (COH) and Michael Kors (NYSE:KORS) have seen single digit returns. While some investors are hoping that these stocks can play catch-up in 2017, I remain quite skeptical. Coach's turn-around story does have signs of life, with the company posting 13% growth in annual diluted EPS for 2016. Unfortunately, the company's shares are telling a different story, as they make new 3-month lows.
Coach's revenues hit their highest level in 2013, and since they have eroded by nearly 12%. Unfortunately this has translated to weakness in their bottom line, as earnings have fallen off a cliff from 2013 levels. The company reported annual diluted EPS of $3.61 in 2013, and only $1.65 in diluted EPS for 2016.
One of my favorite quotes in trading is by Mark Abraham of Quantitative Capital Management:
"While a fundamental analyst may be able to properly evaluate the economics underlying a stock, I do not believe they can predict how the masses will process this same information. Ultimately, it is the dollar-weighted collective opinion of all market participants that determines whether a stock goes up or down. This consensus is revealed by analyzing price".
Despite this being one of my favorite quotes, I do not completely ignore fundamentals. Instead, I believe that fundamentals should always take a back-seat to price. While I am quite bearish on Coach going forward, Raffi Balyozyan is extremely optimistic. His most recent article "Coach: Dino Rexy Will Push Share Price To New Highs" is a little sanguine in my view. While Raffi makes a strong case for a Coach turnaround, a 130% gain from here is a very bold call to make, especially for a stock in a bear market. I am certainly open to the possibility of a move to $40.00 on Coach, but I do not see a move to $80.00 in the cards.
My investing strategy is a trend-following approach, and my buy signals are generated when stocks make new 3-month highs while above their 200-day moving average. My criteria for short candidates is based on very similar methodology, but I am looking for the exact opposite. My short signals are generated when a stock makes new 3-month lows, underneath a declining 200-day moving average. The reason I place so much importance on the 200-day moving average is very simple. The 200-day moving average is my line in the sand to determine whether an asset is in a bull or bear market. If a stock is above a rising 200-day moving average and making new highs, there is no question in my mind it's in a bull market. If a stock is below a declining 200-day moving average and making new lows, the stock is in a bear market.
In addition to the above criteria for short candidates, there is one thing I am looking for. When looking for stocks to short, I want to scan for stocks that are in clear downtrends on their weekly chart. The last thing I want to do is short a stock that is breaking down within a longer term uptrend. This type of setup is a recipe for disaster, as there is a possibility you are shorting at support within the uptrend. Due to the recent breakdown in Coach, I have started a new short position in the stock at $34.87.
As we can see from a weekly chart of Coach, the stock has been locked in a downtrend for nearly 5 years. The stock topped at $79.70 in mid 2012, and has seen consecutively lower highs and lower lows since. The one silver lining I will give to the Coach bulls, is the possibility for a inverse head and shoulders pattern to be developing. If Coach is able to hold onto the $33.00 level, the potential for a weekly inverse head and shoulders pattern stays alive. This would be a very bullish setup, and could easily support a move above $50.00. Unfortunately it is very early to entertain this idea, but I am keeping an eye on this development.
Moving to a daily chart of Coach, I can go into further detail on my new short position. As we can see from the daily chart, Coach's 200-day moving average (yellow line) has acted as a ceiling for the stock. Despite the stock trending above its 200-day moving average for the majority of the year, the stock has been stuck beneath it since September. Any rallies to the 200-day moving average have seen stiff resistance, and the 200-day moving average is now sloping down. This is not a positive sign for bulls, as a down-sloping 200-day moving average is often a sign of a looming bear market. While Coach is already in a bear market, the sloping 200-day moving average tells me it is likely to continue.
Coach has been trading in a range between $35.00 and $38.50 since September, but made new lows below this range last week. This is not a positive development for longs, as support is now in jeopardy. Due to this technical breakdown, I have opened a short position in the stock at $34.87.
What if I am wrong on Coach?
If I am wrong on Coach, I also have a stop in place to protect me. My stop on this trade is at $39.00 on a closing basis. This means that if Coach closes above $39.00, I will exit my short trade for a loss. There are 3 reasons why I have chosen a close above $39.00 as my stop:
1) A close above the $39.00 would represent a close above the 200-day moving average. I have no interest in being short a stock that continues to close above its 200-day moving average. The 200-day moving average currently sits at $38.62, and is dropping at a pace of $0.02 each day.
2) A close above $39.00 would represent new 3-month highs for the stock, a setup that I do not want to be short. The stock has found resistance at $38.60 the past 4 months, so I do not want to see a breakout above this level.
3) A close above $39.00 would also represent a breakout from the current daily downtrend. The downtrend has been established by connecting the July high to the lower high in late November. If the stock breaks out above this downtrend, I expect it to run into a ceiling at $38.60. If Coach finds a way to close above $39.00 (through resistance and the 200-day moving average) I will have to exit this short position immediately.
Due to my conservative risk profile, I only risk 1.0% to 1.15% on any of one trade. Due to this risk profile, I have to size my positions accordingly. The difference between my stop and entry is $4.13, which gives me a position risk of 11.84% for this trade. Due to this position risk, my size for this trade cannot exceed 9% of my account. To better explain how I have calculated my position sizing, I have shown the above template. My position size for this trade is 120 shares, and roughly 8% of my portfolio. Coach currently has a 4% yield, therefore I will be responsible for a 4% carrying cost annually to hold this short position.
Despite many authors seeing a bright future for Coach, I do not share the same sentiment. I believe price to be the final arbiter, and Coach's chart is not one to inspire confidence. The stock is sitting beneath a declining 200-day moving average, and as of last week is making new lows. While the dividend is certainly a benefit to investors waiting for a turn-around, I don't know that it's enough to off-set the potential decline in the share price. The trend is not the bull's friend in Coach, and I plan to remain short unless the stock can close above $39.00.
Disclosure: I am/we are short COH.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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