Despite the so-called death of retail playing so loudly these past few years, the industry did have one advantage going for it throughout Trump’s presidency. Retail, specifically apparel, has been immune to the raging trade war between the U.S. and China.
On September 1, that’s over.
President Trump’s new round of tariffs – his fourth since beginning this battle – includes the last $300 billion worth of exports from China. And that includes the country’s stranglehold on clothing.
With more and more emphasis on fast fashion and cheap knockoff apparel over the last decade, many designers and retailers have been forced to cut costs by going to China for manufacturing.
Still, this hasn’t helped the industry enough to stave off record store closings and even bankruptcies due to behemoths like Amazon undercutting sales and offering more convenience.
So, now that those clothes are going to start costing at least 10% more next month, the already slim margins at many companies like J.C. Penney and Nordstrom are set to be devastated again.
You can see what just the last week in the post-tariff-announcement trading has done to these retailers:
This is the SPDR S&P Retail ETF, which comprises the big names like Abercrombie & Fitch, Kohl’s and L Brands.
Others, with more of a direct interest in what these new tariffs will do to apparel, have had an even worse time of it.
Take Macy’s. The company is off by about 8% since Trump’s Twitter announcement. And this only adds to a terrible 12 months of trading:
But is this incredible selloff for retailers, and Macy’s specifically, justified?
Revenue and earnings are certainly falling… and have been since about 2015. But in truth, the company’s top line is only off by about 8% in that time. Yet since then, its share price has fallen 70%.
Earnings have certainly slipped, but not by 70%. In fact, going back to the summer of 2015, you’d find a trailing earnings per share of $4.02. Over the last 12 months, Macy’s has netted $3.55 per share. So, it is down, but not out.
Though, for Wall Street, even if the previous stock decline wasn’t truly justified, these tariffs retroactively make it so… right?
Well, maybe not. You see, the timing of this tariff might ease some of the pain. The two top periods for a company like Macy’s is back-to-school shopping and the holiday season. By the time these tariffs hit, the company will have already booked profits from the former and locked in many of the prices and much of inventory for the latter.
So, in truth, this is more of a 2020 issue for large-box retailers like Macy’s. That gives it time to continue adjusting its supply chains… which it most certainly has been doing even before these tariffs.
Meaning, the impact of these tariffs might be far less than investors and analysts are expecting. And that brings us to a trading opportunity.
Macy’s reports its second quarter earnings next week. During its call Wednesday morning, you can bet the top questions will be about these new tariffs.
If the company responds in the way this line of thinking goes – that the timing significantly reduces the impact of the tariffs – investors could take a second look at Macy’s share price. The recent mini-crash on top of the previous long-term collapse, might have been a step too far.
And it’s not just timing. Consider that while the brick and mortar retailers have been suffering – and will further due to these tariffs – the larger companies face ever-shrinking competition. These new tariffs could be the last straw for companies like J.C. Penney and Sears (and therefore Kmart). Meaning in terms of anchor stores, Kohl’s and Macy’s could actually benefit from this all.
Next week’s earnings will be the true telling of where things stand… specifically for Macy’s. Kohl’s reports the week after, which could be a second catalyst for share prices to bounce back.
Now, I’m not claiming Macy’s should trade where it did in 2015. But maybe it should recover to where it was just a few weeks ago. Fortunately, there’s a way to play it without gambling on Macy’s stock. Instead, savvy investors could use an alternative strategy.
A Strategy For a Short Term Bounce
A bull call spread is a type of options trade that involves buying one call option with a near-the-money strike price of a stock you believe will rise in the short term… and selling a second call option with a higher strike price to reduce your cost.
The income from the second call offsets some of the cost to buy the first. This ultimately reduces the amount of money at risk in the overall trade.
That does mean that the potential profit of the trade is capped. But unless you think Macy’s is set to double overnight, there’s not much risk of missing out on those gains.
You can see how this kind of trade works here:
Source: The Options Industry Council
Clearly, the reduced risk and capped maximum profit potential makes this a rather conservative options strategy. But for a company like Macy’s, with such an important earnings upcoming, that’s exactly how you should play it.
Let’s look at a specific example of a bull call on the company’s shares…
A Specific Trade on M
Right now, a trader can buy a September 20 $20 call on M for $1.44 per share and sell a September 20 $23 call for $0.39 per share for a cost of $1.05 per share. Since each option represents 100 shares of M, that’s a total net debit of $105.
That’s the most at play with this trade… $105. And the only way for the trader to lose that is if shares sink below $20 and stay there for the next six weeks. As noted, shares at the very least have already fallen too far. A bounce from here is much more likely as investors absorb Macy’s actual situation next week.
The profit potential for this trade is remarkable, especially with few bullish investors betting a Macy’s right now. To find that, take the difference in strike prices ($23 – $20 = $3), and subtract the cost ($3 – $1.05 = $1.95). In other words, if shares do climb back to just where they were last week at any point in the next six, the trader would be looking at an extra $195 in his pocket.
So, he’s looking at a 186% return on the amount at risk. For a company so beaten down, in such an emotional market as we have today, these tariffs have created a tremendous opportunity for smart traders.
Next week is the first catalyst for things to turn around. The following week, when competitor Kohl’s reports is another. Then, traders will have full month to wait for investors to digest the real impact of these tariffs.