Editor’s Note: ACCESS YIANNIS AND ELLIOTT’S PRELIMINARY RESEARCH. Elliott contributes regularly to Seeking Alpha, a free website that features analysis of stocks, markets and economic trends. He’s started publishing some of the initial research that he and Yiannis do for Cocktail Stocks on Seeking Alpha. Readers interested in a behind-the-scenes look at Yiannis and Elliott’s process should register with Seeking Alpha, follow Elliott’s feed and share their take on their investment ideas. Your input could help determine which investment idea becomes the stock of the month. Of course, the final pick is reserved only for loyal Cocktail Stocks subscribers. Yiannis and Elliott look forward to hearing from you.
The Trade: Best Buy (NYSE: BBY)–Sell Short > 23
Why Now: The stock market appears overbought, and the risk of a meaningful pullback will increase as the US presidential election approaches. Best Buy (NYSE: BBY) also continues to lose sales to online retailers and faces margin compression.
Yiannis calls Elliott to discuss where they’ll go to hash out the pick for the March issue of Cocktail Stocks.
Yiannis: Let’s grab dinner in DC tonight. I think the time is ripe for us to highlight a short play in Cocktail Stocks.
Elliott: I like eating downtown, but I’m sick of crossing the Potomac every month for our Cocktail Stocks meeting. How about La Bergerie in Alexandria?
Yiannis: That’s inconvenient for me, but the prospect of eating at the best restaurant in Alexandria could lure me to your neck of the woods.
Elliott: Not my fault you choose to live in the middle of nowhere.
Yiannis: McLean is hardly the middle of nowhere!
Elliott: Keep telling yourself that. Anyway, I want to ask Laurent when his second restaurant will open. It’s called the Del Ray Café and will serve breakfast, lunch and dinner.
Yiannis: All right, what time should I meet you at La Bergerie?
Elliott: I’ll book a reservation for 8:30 p.m.
When Yiannis arrives, he finds Elliott sipping a glass of wine at a table for four.
Yiannis: I grabbed the parking spot right in front of the restaurant–it’s perfect. That’s a good omen for this month’s pick.
Elliott: Glad to hear it. Laurent tells me the Del Ray Café will open in April. We should check it out and have a Cocktail Stocks meeting there.
Yiannis: If you’re buying, I’ll be there. What’s in your glass?
Elliott: Giving this Rhône a whirl. Here’s the wine list. Why don’t you pick a bottle for this month’s meeting? After all, you’re in my neighborhood.
Elliott slides the wine list to Yiannis, who orders a bottle of Pauillac.
Elliott: Let’s get down to business before we order. We have eight potential investment ideas for the March issue: four names that went public recently and four candidates for a short sale. Do we go short or long? What’s your outlook for the stock market?
Yiannis: The stock market has rallied significantly in the new year and appears overbought. Investors are too excited about equities these days. The market could be due for a correction.
Elliott: I agree. I wrote about the potential for the stock market to pull back in the March 2, 2011, issue of Personal Finance Weekly. With Brent crude oil trading at almost $130 per barrel, investors should be having déjà vu: A similar spike in oil prices in the first half of 2008 and early 2011 weakened the global economy and sent stocks spiraling lower. As higher oil prices take their toll, some US economic data will fall short of expectations, tempering investors’ enthusiasm. That’s not to suggest that the stock market will collapse, but the S&P 500 could pull back 5 percent to 10 percent.
The waiter arrives to take Elliott and Yiannis’ orders.
Elliott: I’d like to get the four-course meal with the duck and pan-seared foie gras, but I need to know if any of the dishes contain chocolate.
Waiter: I’ll ask the chef to prepare the foie gras with a port-wine reduction or another sauce.
Yiannis: I’ll take the three-course menu with the beef. Also, the chef can include as much chocolate as he wants in my dishes.
Elliott: I despise chocolate in all forms; I can’t even stand its smell.
Yiannis: On second thought, I’d like to have any chocolate stricken from my dishes.
The waiter leaves to deliver Yiannis and Elliott’s dinner orders to the kitchen.
Yiannis: We’re on the same page. Did you read the article I penned for Investing Daily, Asset Allocation for a New Demographic Destiny? In this piece, I argued that the US economy will grow at a rate that’s well below the 3.5 percent that it’s averaged historically.
The developed world has entered a prolonged period of slower growth. Although investors may get excited about the near-term improvement in the US economic data, reality eventually will set in once again.
Elliott: I agree. Investors tend to mistake short-term cyclical trends in economic data for long-term secular trends.
When US economic data weakened last summer, many pundits incorrectly called for a recession. But much of that weakness stemmed from temporary factors such as a spike in oil prices and manufacturing supply-chain disruptions related to the earthquake and tsunami that devastated Japan’s Tohoku region in March 2011. The debate over raising the US debt ceiling and the worsening EU sovereign credit mess didn’t help sentiment, either.
But as those temporary headwinds abated, the economy picked up steam and the stock market embarked on a furious rally.
Now, we face the opposite extreme. Investors are mistaking the recent improvement in economic data for a return to the good old days when gross domestic product grew by 3.5 percent to 4 percent.
In reality, the US economy has continued to grow slowly, with pockets of periodic strength and weakness.
Yiannis: I like the idea of shorting China’s Baidu.com (NSDQ: BIDU). Although I remain bullish on the company’s long-term prospects, any slowdown in the near term could send the shares lower. That being said, I can’t foresee a specific downside catalyst.
Elliott: I see plenty of reasons why the stock market could pull back: the recent spike in oil prices, a weaker-than-expected reading from the Manufacturing Purchasing Managers Index (PMI) and political uncertainty ahead of the US presidential election. I discussed these concerns in a recent article on Seeking Alpha. Of course, timing such a pullback is difficult.
I’d prefer to short a stock that faces long-term secular disadvantages and could continue to tumble even if the stock market continue to rally or just trades sideways. What do you think about Best Buy (NYSE: BBY)?
Yiannis: Retailers will struggle if we’re right about the US economy growing at a slower pace than in the past. What’s Best Buy’s story?
Elliott: I like to think of Best Buy as an unofficial showroom for Amazon.com (NSDQ: AMZN).
Yiannis: Ha! What do you mean by that?
Elliott: Best Buy is the leading electronics retailer in the US, with some 1,300 stores. These big-box stores are great fun to visit and have all the latest televisions, computers and smartphones. The one I go to is often quite busy and full of people.
Yiannis: That doesn’t sound bad.
Elliott: But the competition, especially Amazon.com, is eating Best Buy alive. Amazon.com sells all manner of consumer electronics online and prices these items aggressively. Members of Amazon Prime even receive free two-day shipping. Customers go to Best Buy to check out the technology in person and then go home to order the products from Amazon.com.
Yiannis: Makes sense.
Elliott: Best Buy’s problems are secular, not cyclical. Online retailers such as Amazon.com are part of the problem, but Target Corp (NYSE: TGT) and Wal-Mart Stores (NYSE: WMT) have also broadened their product offerings and priced these items aggressively to win business.
Competition intensified toward the end of 2011: Best Buy offered aggressive promotions in its stores, expanded its product selection on BestBuy.com and offered free shipping during the holiday season. The results: In the fiscal third quarter ended Nov. 26, 2011, same-store revenue (sales from stores open more than a year) ticked up 1 percent from year-ago levels, while online sales jumped 20 percent. Revenue from Black Friday sales increased 7 percent on a year-over-year basis.
These efforts have taken a toll Best Buy’s earnings, with third-quarter gross profit falling 3 percent from the prior year.
Yiannis: That is not a good sign for Best Buy.
Elliott: Consumers’ preference for Apple’s (NSDQ: AAPL) popular iPhone and iPad presents another challenge, as these products carry far lower profit margins for Best Buy than laptop PCs and digital cameras. Moreover, as the iPhone wins market share with each new release and the iPad continues to dominate the market for tablet computers, Best Buy’s margins will come under increasing pressure. In addition, customers are opting for value-priced televisions and computers, models that often have lower profit margins.
Yiannis: Do Apple’s retail locations pose a threat to Best Buy? I love spending time in the Apple store.
Elliott: Yeah, Best Buy can’t compete with Apple’s unique store layout and enhanced customer service. Many customers’ first inclination is to go straight to the source for Apple products. The outright collapse in sales of video games and consoles is another major challenge for Best Buy.
Yiannis: I know nothing about video games. You’ll have to explain this one to me.
Elliott: According to market research firm NPD Group, sales of video games plummeted 21 percent in December 2011. Many customers are waiting for the next generation of consoles to hit stores in 2012, instead of buying older systems. Game publishers have adopted a similar approach, holding off on new releases until the new consoles come out.
At the same time, games on Apple’s iPad and social media sites such as Facebook also occupy more of consumers’ time.
Yiannis: I’ll take your word for that one. I did enjoy playing Flick Fishing on your iPad last summer in Greece.
Elliott: RadioShack Corp’s (NYSE: RSH) fourth-quarter results may also provide a preview of Best Buy’s fiscal fourth quarter; despite their differences, the two firms face similar headwinds.
One challenge RadioShack faced in the fourth quarter: Sprint Nextel Corp (NYSE: S) updated its customer approval models, making it harder for consumers to qualify for service. The wireless provider also began charging customers a penalty if they opt to upgrade their handset before their service contract expires. These new policies should make it more difficult for customers to purchase new handsets, resulting in lower sales for RadioShack. Although Best Buy has less exposure to Sprint Nextel subscribers, this headwind won’t help the company’s fortunes.
Best Buy’s stock sold off after RadioShack reported disappointing results in late January, but the shares have recovered some of these losses–likely because of strength in the broader market. The stock recently tested resistance at its 200-day moving average and looks poised to dip lower before the company reports results for its fiscal fourth quarter on March 29, 2012. Sell Best Buy short above 23.
Updates on Open Positions
August 2010: Vale (NYSE: VALE)–Buy < 30
Although commodities prices will moderate if the global economy slows, blue-chip miners are the place to be for a potential turnaround. Vale’s long-term growth story remains intact, though iron ore prices will drive the stock in the near term.
September 2010: Teekay Tankers (NYSE: TNK)–Buy < 10
A 15 percent yield is Teekay Tankers’ only saving grace. We have been in this trade long enough that all the bad news has been priced into the stock–including lower day-rates on the spot market in 2012. The stock has surged 28 percent thus far in 2012 but has a way to go for us to break even.
February 2011: ProShares UltraShort 20+ Year Treasury (NYSE: TBT)–Buy < 30
Betting against US Treasury notes has been a losing proposition. This position could recover some lost ground when investors rotate funds from safe havens to equities, a process that has yielded a 6 percent since the new year began.
May 2011: TAL International (NYSE: TAL)–Hold
The stock has rallied significantly and should have more upside. Investors who are already in the trade should hold their positions.
June 2011: iShares MSCI Italy Index (NYSE: EWI)–Buy < 15
This play on Europe’s turnaround is less risky than our Greece-related bet. The Italians are progressing well under the leadership of their technocratic government. The exchange-traded fund is up about 14 percent thus far in 2012.
July 2011: TransGlobe Energy Corp (NSDQ: TGA)–Buy < 12
Shares of this small-cap oil producer have rallied 44 percent thus far in 2012. This speculative stock will outperform bull markets and underperform in bear markets.
July 2011: Market Vectors Gulf States Index (NYSE: MES)–Buy < 23.50
This exchange-traded fund has held its own since we featured it in the July issue. That said, this year it has not performed as well as we would like it to. We’re holding out for a powerful upsurge.
August 2011: National Bank of Greece (NYSE: NBG)–Buy < USD6
This stock is our most speculative play to date and is only appropriate for aggressive investors who can stomach a bet that’s based solely on a turnaround in Greece. Any orderly resolution to Greece’s sovereign-debt crisis could send the stock price higher.
September 2011: China Cord Blood Corp (NYSE: CO)–Buy < 4
Don’t let near-term volatility shake you out of this stock. Shares of China Cord Blood Corp have rallied more than 20 percent this year. Expect more upside as the industry’s fundamentals turn.
October 2011: Infosys (NSDQ: INFY)–Buy < 55
A slower mover than other technology stocks, shares of Infosys should keep pace with India’s stock market. Investors should adhere to our buy target and only add to their positions when the stock dips below 55.
November 2011: Melco Crown Entertainment (NSDQ: MPEL)–Buy < 12.75
This casino and hotel operator remains the best way to gain exposure to lucrative gaming market in Macau. The stock has surged 35 percent thus far in 2012. Don’t pay more than 12.75 per share.
December 2011: Symantec Corp (NSDQ: SYMC)–Buy < 17.50
Internet security is a major growth market, and Symantec should continue to benefit. Do not chase the stock above 17.50
February 2012: Greenbrier Companies (NYSE: GBX)–Buy < 27.50
The stock is down marginally, but the company’s underlying fundamentals remain intact.