Consider Debt When Bottom-Fishing Retail

By any account, the retail sales report on Friday was awful. It was the largest drop in sales since the aftermath of 9/11. Auto sales were down the most, but spending was down in just about every category. It was the fourth month in a row that consumers spent less in the nation's malls and stores. Retailers are beginning to show some concern and have cut back inventories for the first time in over a year, resulting in the largest drop in business inventories in over three years.

Since retail activity is responsible for two-thirds of GDP, it looks like we will have a second quarter of negative growth. After the report, I saw a lot of discussion about this being the worst possible timing.

Since many retailers earn the bulk of their annual profits during the holiday season, I suspect it is far too early to bottom-fish the group. It is tempting, as many of the stocks look cheap, but the risks remain high. Sales are much worse than I ever expected, and I think they will be even worse in the fourth quarter than anyone foresees. It will be a bleak Christmas, I suspect.

When I look at the retail sector, I see stocks that I think are incredibly cheap. It is hard not to add stocks like Charlotte Ruse (CHIC - commentary - Cramer's Take) at these prices. There are some names that I think will do very well when the consumer returns, but until then, it could get quite ugly.

Earlier this year I took at shot at some names in the group, and although they held up better than many, I ended up selling at a loss. Charlotte Ruse is the only one I still have, and the proposed takeover would allow me to break even on the stock.

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At the time of publication, Melvin was long Charlotte Ruse, although positions may change at any time.

Tim Melvin is a writer from Stevensville, Maryland, who spent 20 years a stockbroker, the last 15 as a Vice President of Investments with a regional firm in the Mid Atlantic area. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Melvin appreciates your feedback; click here to send him an email.