Preparing For Holiday Depression

Add ZLC and TM Puts

PLAY #1: Buy the ZLC January 20 Puts (ZLC ND) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

PLAY #2: Buy the TM January 65 Puts (TM MM) at market, good for the day. Place a protective stop limit at $3.10 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

“We don’t know how consumers are going to behave when they realize they don’t have access to credit. This holiday season could shock investors.”

- Omar Saad, Credit Suisse Analyst

Dear Bottarelli Research Member,

In last week’s alert, I told you that the economic troubles here in the U.S. would most certainly result in a disastrous holiday shopping season for retailers.

This past Wednesday, we received proof of this assessment.

You see, many of the top retail companies just reported their September sales, and the numbers were brutal. It’s quite clear that the global financial crisis has made shoppers more reluctant to spend than ever before, and it’ll only get worse. Consider this:

Wal-Mart (WMT – NYSE), which has been the top-performing stock on the entire Dow Jones Industrial average in 2008, said that their sales rose 2.4%. This figure missed the estimate of analysts surveyed by Thomson Reuters, which predicted an average gain of 2.5%. It would appear that this was only a very small sales “miss.” But remember, Wal-Mart is the top retailer in the world. If they’re showing signs of weakness, you better believe other companies are in a world of hurt. And if you look closely enough, that’s exactly what you’ll come to find.

For example…

• Sales at wholesale giant Costco rose a less-than-expected 7%. Sales at rival BJ’s Wholesale Club missed estimates as well.
• Sales at Target dropped 3%, which was worse than expected. As a result, Target executives lowered their Q4 earnings guidance.
• Department stores are weak as well. Upscale retailers, like Saks and Nordstrom, and lower-priced retailers, like Dillard’s and J.C. Penney, all reported worse-than-expected drops.

This latest round of sales figures paints a very ominous picture leading up to the holiday shopping season (where some retailers can make 30% to 40% of their yearly profits). That’s why I think the upcoming holiday shopping season will be the worst of the last two decades. To profit off this trend, today’s LEAPS alert will offer you a two-part attack on the retail sector.

Below are some retail plays that I feel will face serious troubles over the next three months. As you will see, most of these stocks have fallen very hard. But considering the weakness that’s ahead over the upcoming months, they could fall even further. But at the same time, we must also be careful not to buy puts at a near-term low.

Retail HOLDRs (RTH – AMEX): This is the most comprehensive way to play a down-turn in the retail sector. By owning RTH puts, you’re exposing yourself to a basket of retail plays that includes Amazon, Wal-Mart, Home Depot, and Best Buy. As you can see, the RTH has gotten clobbered lately, so I’d like to wait for a bounce before adding puts.

Urban Outfitters (URBN – NASDAQ): This trendy teen retailer is currently trading at a P/E ratio of 27. That valuation looks awfully high and unsustainable, especially when you consider that their competitors like Abercrombie & Fitch and Bebe Stores currently trade at respective P/E ratios of 7.49 and 12.92. But once again, a crushing stock chart makes me feel apprehensive about adding puts. I’d like to wait for a bounce.

Best Buy (BBY – NYSE): Personally, I hate shopping at this store. It’s loud, the sales staff can’t tell their back-side from a hole in the ground, and they constantly try to sell you some bogus “extended warranty” plan. But I won’t let my personal biases cloud my judgment. Let’s talk facts. Best Buy’s main competitor, Circuit City, just reported a record $239 million loss. They also warned that the holiday season could be even worse. Their only solution was a new marketing campaign. Sorry guys, that’s not going to work. Electronic companies are in for a world of hurt this holiday season, and that’s why I would expect to see continued weakness in shares of Best Buy. But yet again, shares of BBY have been hammered lately. Therefore, let’s once again wait for a bounce before adding puts.

Bed Bath & Beyond (BBBY – NASDAQ): Here’s another niche retailer that operates 890 stores selling bed linens, bath items, kitchen textiles, home furnishings, and basic house wares. I don’t know about you, but all of these items are quite discretionary. In other words, when it comes to cutting the family budget, these items are the first to go. Compared to the stock charts above, BBBY could have more room to fall before bouncing higher. Nevertheless, the smart tactical play here is to hold off for now.

Tiffany & Co. (TIF – NYSE), Blue Nile (NILE – NYSE), & Zale Corporation (ZLC – NYSE): In my view, jewelry is the single largest discretionary item in the retail sector. Therefore, you can argue that TIF, ZLC, and NILE are the three companies most exposed to a global retail slowdown. Tiffany operates 184 retail stores worldwide, and sells gemstone jewelry, diamond rings, wedding bands, gold & platinum jewelry, and sterling silver jewelry. Blue Nile is the online version of Tiffany, selling diamonds and fine jewelry in the United States, the United Kingdom, and Canada. Zales covers the low-end jewelry market, with 1,471 specialty retail jewelry stores and 793 kiosks in the United States, Canada, and Puerto Rico. You can argue that the high-end customer, who shops at Tiffany, might be able to survive the recession. But in my view, the low-end customer who shops at Zales is toast.

On that note, here’s the important item to consider…

Right now, TIF has a P/E ratio of 10.40. NILE has a P/E ratio of 40.43. And ZLC has a P/E ratio of 95.31. That sky-high valuation is completely unsustainable in this market environment. Pure and simple.

Best of all, ZLC’s stock chart has yet to fully experience the downside moves we’ve seen in the other retail stock charts above.

Based on this analysis, it’s clear that NILE and ZLC are the two jewelry companies most exposed to forthcoming weakness. NILE could realistically trade for $17.00 and still be over-valued. ZLC could easily trade below $10.00.

Comparing the options premiums on NILE and ZLC, it’s clear that ZLC offers you the biggest bang for your buck. Therefore, let’s add ZLC January puts now! Here’s the play…

PLAY: Buy the ZLC January 20 Puts (ZLC ND) at market, good for the day. Place a protective stop limit at $1.90 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

OTHER PUT POSSIBILITIES:

China Life Insurance (LFC – NYSE): Could the weakness in U.S.-based insurance stocks (like MetLife, Hartford Group, and AIG) extend into China? If so, then we could see some major selling pressure on China Life Insurance, the largest provider of life insurance, endowment insurance, and annuities in China. This could be a future LEAPS put play. More to follow.

SAP AG (SAP – NYSE): On October 7^th, this German software maker reported that the continuing financial crisis has severely reduced their expectations for third-quarter revenues. Despite the serious drop, we could see even more weakness ahead. Keep this one on your radar.

Toyota Motor (TM – NYSE): I hate to say it, but Toyota’s run is now officially over. After all, Ford is trading at levels we haven’t seen since 1985. General Motors is trading at 50-year lows. And now TM, the company that pioneered hybrid vehicles (such as the Prius), is beginning to feel the effects of a global recession alongside their Detroit-based peers. Therefore, as our second play, let’s extend our retail put exposure and add Toyota puts now!

PLAY #2: Buy the TM January 65 Puts (TM MM) at market, good for the day. Place a protective stop limit at $3.10 and implement our scaled-selling technique as your position achieves gains of 50% (and greater).

UPDATES

American Capital May 25 Calls (DQS EE): As a result of the financial turmoil, banks around the world have become increasingly reluctant to lend to each other. As I noted, this is bullish for ACAS, especially as credit markets continue to dry up. This is why I feel that ACAS will represent the new wave of lending and financing in this country going forward. I want us to own exposure to stocks like this, especially at these low prices. But in the process, we’re seeing some big-time downside volatility in every financial stock, ACAS included. At this point, investors do not care about the company’s business model. Everything is being sold off. Therefore, we have some large draw-downs to deal with. Since we have an extended expiration cycle, I’ll continue to maintain the position. Hold.

Excel Maritime March 15 Calls (EKN CC): The bottom is still being hammered out. Once it’s been set, we’ll be in for quite an upside ride. After all, the dry bulk shipping sector has the ability to make major price swings. Considering our March expiration date, I’m hoping that we’ll be positioned to profit once the next up-swing occurs. Hold.

Apex Silver Mines January 2010 2.5 Calls (YSB AZ): Gold and silver continued to receive major investor interest this week, as money is flowing into both metals as a “safe haven” play. Therefore, SIL continues to have explosive upside potential. Hold.

General Mills April 70 Calls (GIS DN): In addition to gold and silver, consumer staple companies like GIS continue to offer relatively safe investment plays. As you know, we already took half of our profits off the table at the 50% profit mark. But unfortunately, two days of price declines on Wednesday and Thursday triggered our stop loss prices on the remaining half of our position. Therefore, this play is now closed. Sold.

Wells Fargo January 2009 30 Puts (WFC MF): On a more positive note, the termination of the SEC short-selling ban allowed us to lock in profits on our WFC puts on Thursday. Therefore, this position is officially closed. Sold.

Southern Peru Copper January 2010 25 Calls (YPV AE), Barrick Gold January 2010 40 Calls (WRX AH), & United States Natural Gas Fund January 40 Calls (UNG AN): As I said last week, gold, copper, and natural gas are three powerful commodities that we must maintain exposure to. ABX is on the verge of breaking to new highs, so continue to maintain all three positions. Hold.

Valero Energy January 35 Calls (VLO AG): There will be a time when investors finally realize the powerful potential in oil refiners. Unfortunately, it’s just not happening quickly enough. After some promising up-moves, VLO just cannot extend upon any momentum. Therefore, let’s officially close off this position as well. Sell.

America Movil January 2009 70 Calls (AMX AN), Petroleo Brasileiro January 90 Calls (PMJ AR), & Entergy January 140 Calls (ODF AH): Still no signs of life for these three. Since they’re at such nominal values, we might as well hold for a miracle. Hold.

Sincerely,