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The Penney Drops as Clearance Stockpiles

NEW YORK (TheStreet) -- There are reasons why we do or don't do certain things. I am constantly trying to think about how my actions will be perceived outside of my small, loyal inner circle. Such meticulous thought led me to be very quiet as soon as J.C. Penney's (JCP - Get Report) same-store sales results were released on Tuesday evening.

I saw an array of cheerleading by really mean, nasty individuals on Twitter, which I giggled at, because that's not the way a financial services professional should carry himself or herself. "Talking your book" could be done in a more respectful manner to a social community. Your reputation is the only thing you have in this business.

I received a few hate-Tweets (rare for me, because as soon as I get hate, I hit block, no questions asked) as J.C. Penney's shares popped after hours, for being so vocally against the stock's bounce from the 52-week lows on suspect financials. Once again, I giggled, directing strategy to clients behind the scenes, knowing full well, or pretty well, that J.C. Penney shares would slide at the open on the following day.

How was I so sure that by Friday, J.C. Penney's stock would be down 14% inside of two sessions, with the latest blow being Kyle Bass cutting bait? It's called obsessing over a company's story (give it a try sometime), having the determination to amass enough information and probabilities to swiftly dig beneath the news as it arises, and outperform rivals.

Today I published a brief assessment on J.C. Penney for clients, reiterating a sell recombination and no price target. Here is what you should know about J.C. Penney, as communicated by a kind soul who has zero ulterior motives other than winning.

  1. Clearance racks are increasing throughout the chain. J.C. Penney needs to sell at its planned promotions in order to wipe clean any and all liquidity concerns. The new clearance racks are not solely dedicated to Ron Johnson's old product lines (for example, Haggar is a J.C. Penney stalwart), it's merchandise ordered by the existing management team. Read: The economy is creating competitive forces that require J.C. Penney to do more to regain its once-loyal customers. The retailer must enact its visually compelling 50%-off discounts, and then transact them at that promotion, not just invite them in to graze and return when there is a fresh clearance rack to be navigated.
  2. J.C. Penney's home department constitutes about 12% of its sales. I estimate that furniture, including living room essentials and mattresses, accounts for about 5% of its home-related sales. Unfortunately, the market is not allowing J.C. Penney to clear these goods at 50% off (and in some cases, we have noticed J.C. Penney trying to sell floor models), and the space is becoming stale (I have noticed same floorsets for at least six months in furniture). J.C. Penney may have to devise a sort of fire-sale promotion to reset the floors with merchandise that better caters to the economic realities of its core customer. This hypothetical fire-sale (think promotions north of 70%), and in the meanwhile, dust-collecting inventory, (why not move it to the parking lot?) would hinder the progress on gross margins that the market has now factored into the stock price.

Market Stalking

The S&P 500 trades at 16.1x forward earnings, 300 basis points greater than at the beginning of 2013, even as earnings look to be on track to be fueled by share repos rather than margin expansion in 2014. A correction of 10%-20% has not occurred in over two years. Specialty retailers' profit margins are being destroyed this holiday season, triggering dire earnings warnings. There is fear creeping into the start of a year that will contend with fiscal and monetary challenges right out of the gate. I talk with folks who are ready to unload 2013 winners, go to cash, do homework on laggards, and then return fresh for 2014.

This basically summarizes the rougher waters the market has had to deal with this past week. As I said on Monday, my first inclination is to lock in gains instead of listening to blowhard bulls who offer an array of wacky S&P 500 2014 year-end targets. Protect your turf!

--By Brian Sozzi in New York

At the time of publication, Sozzi held no position in the stocks mentioned.

Brian Sozzi is the CEO and Chief Equities Strategist of Belus Capital Advisors. He is responsible for developing and managing an equities portfolio of mid- and large-cap positions, in addition to leading the firm's digital content initiatives. He is also a personal finance columnist for Men's Health magazine.

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