Retail stocks (23 September 2006)

Amateur stock picking is generally a bad idea, and every straight-talking guide to personal finance will tell you to invest in low-fee mutual funds that track certain indexes -- take the guesswork out of it, since changes in stock prices are generally a random walk that no analyst or fund manager could predict. The theory is that whatever information an investor could act on is already priced in to a security by the time you get your order for it in.

But this doesn't stop financial publications and financial service providers from pimping stocks and urging stock tips on readers. In One Market Under God Thomas Frank describes some of the hoopla about personal investing during the 1990s bubble, and what he calls "market populism." The idea was that anyone could use the stock market to get rich and that purchasing power rendered political power insignificant and made giant gaps between rich and poor immaterial. Part of the hype of the time regarded wise amateurs who could follow their gut and invest in companies whose products they believed in, as though it were as simple as having a good experience in a Home Depot (I know, a far-fetched example) and then phoning your broker the next day for 100 shares of it. Frank notes that one financial guru advised going to the mall and writing down the names of your favorite stores as a way to generate stock-investment ideas. Then you can have a personal stake in the success of the brands you prefer; you can cheer them on like sports teams, but have a legitimate reason for it.

I'm prone to do the opposite. Not that I'm a big-time stock picker, but whenever I read about recommended securities from the retail sector, I'm skeptical, and it has everything to do with my personal bias against brand-name shopping. I rationalize by thinking that it's foolish to bank on the overtapped American consumer's propensity to continue on a discretionary spending binge forever, but really it is that I don't want to believe that American Eagle Outfitters (AEOS) or Abercrombie and Fitch (ANF) are simply going to continue to grow; that duping teens with sexed-up advertisements can constitute a business strategy that Wall Street respects. I don't even want to take them seriously as businesses; I prefer to think of them as dark cultural forces that will be thwarted once everyone eventually wakes up and realizes how pointless brand-name clothes are. Investing in a company like Chico's (CHS) or Coach (COH) would not only be hypocritical, it would be against my utopian vision of the world, against what I want to believe about universal common sense. (Maybe this is precisely why I should be buying retail stocks. Never a bad idea to bet against utopias.) Perhaps the behavioral finance theorists have a term for this kind of bias, but I'm fully aware that it is irrational. But rejecting retail stocks because of a reactionary personal philosophy seems no less coherent than picking them because of the weather. And it turns out the weather is one of the most significant economic factor for retail stocks, perhaps more than fashionability or personal belief in the brand or a good feeling about a marketing strategy. Justin Lahart's column in Friday's WSJ noted the tendency for September's weather to determine a retail stock's fortunes:

September temperatures tend to vary a lot. And September is a crucial month for retailers. That means the weather plays an outsize role in the month's sales and can trump other economic factors, says Paul Walsh, a meteorologist at weather-analysis firm Planalytics, which advises retailers. September is when retailers, especially in the apparel business, are stocked with fall fare. Cool temperatures early in the season make it easier to sell sweaters and furry boots at full price. Last year, warm weather lasted across much of the U.S. until October, leading retailers to cut prices deeply in an attempt to clear inventory. The jolt of Hurricane Katrina also hurt many, meaning comparisons to last year are especially easy this month.

Obviously, if we follow the money, retailers must be scheming along these lines. Control the weather, control your portfolio. But it's amazing to me to think of all the sophisticated mathematical tools and spreadsheets and models and algorithms, and the vast sums of money at stake, and the myriad of different brokers and analysts who work everyday to try to harness the market, and in the end the kind of logic that is seen retrospectively to have affected the market can run along the lines of "Retail is thriving because September was sort of cold and more shoppers bought sweaters."