Take a look at the level of institutional ownership in the shares of specialty retailers, and one is shocked at the level by which professional money dominates the category.
Roughly 95% of the float of
is in the hands of institutions like mutual funds, pensions and hedge funds.
level of institutional ownership is roughly 88% and many other names are in the same neighborhood.
Why the smart-money love-in? Blame it on a virtuous circle. First and foremost, the sector has been on fire, with many of the companies enjoying their best growth ever. Double-digit sales gains have become the norm as flush consumers blow money on inexpensive luxuries.
This scorching performance, which kicked in at the beginning of 2003, sent the research community into fits of praise -- praise that was sold for the most part to institutions.
Professional money also viewed the category as an early economic cyclical, poised to outperform in the early stages of recovery. With so many funds working off the same playbook, the prophecies snowballed and the shares soared. Hot Topic rose 93% in 2003, Urban Outfitters surged 214%, Chico's rose 95%, PacSun jumped 79% and Ann Taylor was up 91%.
Don't look for a rerun. Analysts warn that the first sign of weakness in the group could be occasion for a mass migration out by institutional investors, some of which own as much as 4% of a company's total shares.
The group's early cyclical designation shows up in its price action: The S&P Retail Index is up about 52% from March 11, 2002, a period during which the
rose about 38%. Additionally, many individual stock prices have stopped reacting with the same gusto to blowout news. Chico's predicted a monster December on the day after Christmas but is only about 70 cents higher today than when the news hit. Hot Topic has been stuck around $28 to $29 since late October.
"We remain in a bubble," said Richard Hastings, chief economist and retail sector analyst at Bernard Sands, a credit rating firm. "The 100% gains are not going to be replicated
in 2004. The prices have no room left to grow."
One thing that might have aided margin expansion failed to materialize: a blowout holiday shopping season. According to Redbook Research, overall sales growth in December was trending toward 3.2%, below the firm's 3.8% target and well short of the 5%-plus growth some analysts were hoping for at the end of November.
Most of the big holiday gains in the sector occurred online, where shoppers flocked during the season's generally bad weather. Overall, the season fell somewhere in the middle of boom and bust, when boom was what valuations had priced in. Consider a warning published by Merrill Lynch Chief North American Economist David Rosenberg in November:
"It will still take a heroic jump in consumer spending this month and next -- we're talking double-digit gains -- just to get consumer spending growth to a 2% annual rate in the fourth quarter."
There are several explanations for the concentration of institutional money in specialty retail stocks.
George V. Reis, president of George V. Reis Investment Group and an owner of Chico's shares, notes that because many of the companies start off small, small-cap mutual funds can afford to take big positions and add to them.
Jeff Van Sinderen, an analyst at B. Riley, noted that these companies are also leveraged to recovery. "It might be that large mutual funds have higher concentrations
in specialty retail stocks just because they believe consumer confidence is improving."
Sinderen says that cycle isn't perpetual: "That theory is very well played out at this point." He expects stock prices to drop, noting that the companies' dependence on fashion increases their volatility. Eventually, portfolio managers will have to reconsider their holdings.
"It's a momentum thing. They have to sit down at the end of the quarter and see how much they are up," he said.
There are a number of stocks in the specialty retail sector that have a momentum following, Sinderen said, mainly those trading at forward price-to-earnings multiples in the high 20s.
Institutions also might be fixated on specialty retail stocks thanks to the amount of media and analyst attention they have received of late, Hastings noted. There aren't many specialty retail companies that don't have 30 analysts following them, Sinderen noted.
Hastings predicts retail's run to come to a close in mid-2004, which he believes will create a "strategic shifting" within the institutional realm. "Next year is a different ballgame," he said. "It will be a new paradigm in or about May or June 2004."
When confronted with this change, institutional portfolio managers will "get back to basics," which means returning to investing in more stable, dividend-bearing stocks like
, he said.
"The stock market is governed by some very anticipatory, smart people," Hastings concluded. "They know the game is changing."