Floor Seen in Retail Options After Worst Start Since ’08

Options traders are betting the worst has passed for U.S. retailer shares, which posted the biggest decline to start a year since 2008.

The cost of using options to protect against losses in an exchange-traded fund tracking supermarket owners and clothing chains has fallen to the lowest level since September 2011, data compiled by Bloomberg show. That’s after six of the 10 worst-performing stocks in the Standard & Poor’s 500 Index this year were retailers, including Best Buy Co., Staples Inc. and Bed Bath & Beyond Inc., which fell more than 20 percent.

Investors are positioning to benefit from a rebound in the SPDR S&P Retail ETF as analysts forecast the fastest profit growth for the industry in four years. Better weather and an improving labor market should encourage American consumers to spend more, according to Jim Russell of U.S. Bank Wealth Management.

"The U.S. consumer’s on track," said Russell, who helps oversee $115 billion as a senior equity strategist at U.S. Bank in Cincinnati. "Low interest rates, the march ahead in the stock market and jobless claims moving in the right direction -- they all add up to a solid package for the consumer."

Retailers have posted the worst return this year of 24 industries in the S&P 500. Snow that blanketed much of the eastern half of the U.S. and kept people from visiting shops pushed the S&P 500 Retailing Index to a 4.9 percent decline from the end of 2013. That’s the industry measure’s worst performance since it lost 5.8 percent in 2008. The broader S&P 500 has gained 5.6 percent in 2014.

Future Volatility

The ratio between the retail ETF’s expected volatility in one month and its actual price swings fell to 0.75 on May 23, its lowest since September 2011, according to data compiled by Bloomberg. It climbed to 0.87 on June 6.

While gross domestic product contracted in the first quarter for the first time in three years, economists are forecasting that the U.S. economy will still expand 2.5 percent in 2014, data compiled by Bloomberg show. The labor market has shown signs of strengthening this year: the four-week average for jobless claims fell to 310,250 in the period ended May 31, the lowest since June 2007.

Although fewer people are claiming jobless benefits, Americans decreased their household spending in April. Consumer expenditure unexpectedly fell 0.1 percent, a Commerce Department report showed on May 30. A 1 percent increase in spending in March had indicated that demand was rebounding following the harsh winter.

U.S. Consumer

"I wouldn’t overreact to this number," Russell said. "The comparison to March was pretty difficult. This doesn’t mean there was a fall off or dramatic change in the U.S. consumer."

Analysts estimate that the combined profit of the S&P 500 Retailing Index’s members will jump 19 percent this year, the fastest rate since 2010 when net income surged 25 percent. Profit for the broader S&P 500 will rise 9.2 percent in 2014, according to data compiled by Bloomberg.

Veronika Pechlaner of Ashburton Ltd. said her firm has reduced its exposure to U.S. cyclical stocks -- the shares that are most tied to economic growth -- because their valuations have risen dramatically. Retailers rallied 311 percent from the start of the bull market on March 9, 2009, through the end of last year. They trade at 21.3 times estimated earnings, while the broader S&P 500 has a multiple of 16.5.

‘Be Selective’

"You have to be very selective on U.S. consumer names," said Pechlaner, who helps oversee $2.3 billion as an investment manager at Jersey, Channel Islands-based Ashburton. "The company needs either a niche or pricing power that’s not already reflected in valuations."

Best Buy, which surged 237 percent in 2013, has lost more than a quarter of its market value this year as declining holiday sales triggered concern about the chain’s turnaround. Staples has slumped 30 percent this year after two successive quarters of profit that fell short of analysts’ estimates.

The Chicago Board Options Exchange Volatility Index, the gauge of S&P 500 options prices known as the VIX, climbed 3.9 percent to 11.15 yesterday.

Some retail companies remain quality growth stocks, according to Louis de Fels of Raymond James Financial Inc.

"The U.S. economy contracted 1 percent in the first quarter, so of course that impacted consumption," said Paris-based de Fels, a fund manager at Raymond James, which oversees about $53 billion. "We are positive on the U.S. economy and retail stocks should come back."

(For an options column news alert: SALT OMA.)
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