The Stock Sector That Will Continue to Surprise on the Upside

retail stocksEarly this morning, giant Target Corporation (NYSE/TGT) came out with its third-quarter profit, up 23% to 535 million dollars. More meaningful, the retailer said that it expects its current forth-quarter same-store sales to be the best in three years.

Yesterday, we had the world’s biggest retailer, Wal-Mart Stores, Inc. (NYSE/WMT) report a 9.3% increase in third-quarter profit to $3.44 billion. Wal-Mart increased its fourth-quarter profit estimate.

The Home Depot, Inc. (NYSE/HD), the largest American home-improvement retailer, said its net income increased 21% in the third quarter to 834 million dollars. Lowe’s Companies, Inc. (NYSE/LOW) reported earlier this week that its third-quarter profit jumped 17%.

The above companies alone reported in excess of $5.0 billion in third-quarter profit. And they are all expecting a good fourth quarter (which means another collective $5.0 billion or so added to the bottom line).

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My message here is simple: the market loves earnings above all else. And companies are delivering those earnings in groves. I predicted that this holiday season would be the best in years for retailers and it will be. The Dow Jones U.S. Retail Index sits this morning at the same level it did in the fall of 2007. While the easy profits have already been made in the auto stocks, I believe that the retail stocks still have life left in them.

You can read on the Internet or in the business papers how the stock market is getting whacked. And we read all kinds of reasons why: Ireland needs a bailout; long-term interest rates are rising instead of falling under QE2; the U.S. dollar is rising in value again as the euro comes under pressure; and more.

But I have yet to see anyone (but me) say that old-fashioned profit-taking is what is really going on here. The Dow Jones Industrial Average opens this morning up 71% from its low on March 9, 2009. The investors who rode this market higher have every right to take some chips off the table.

Back to the retail stocks…I still like them. Black Friday, which is the day following Thanksgiving Day in the United States, is the kick-off for the Christmas holiday season. Watch this Black Friday be the best for retailers since 2007.

Michael’s Personal Notes:

I’m afraid to say it, but it’s true. Housing prices in the U.S., despite the hold back on foreclosures, are still falling.

Monday, my wife and I went to see a relatively new condominium in North Miami Beach. The complex has all the amenities one could ask for. Built by a world-famous architect, the penthouse units have multiple balconies. You name it, this complex has it: on the intercoastal with dock slips and its own yacht homeowners can charter; gym; party room; tennis courts; yoga classes; spinning classes; spa; concierge; bellman; valet; security; theater room…on and on.

The three-bedroom units originally sold during the boom at $1.6 million. The unit we went to see, also a three-bedroom, was purchased by the owner for $650,000 (all-in) last year. Today, we can buy that unit for $550,000. Even buying at the low market of last year, the owner is losing $100,000 one year later.

But here is what concerns me: the developer—or bank as we couldn’t get the real story from the realtor—has another 50 units in the complex (which it didn’t previously sell) coming onto the market in the next couple of months.

I thought prices were bottoming out—they’re not. From what I saw in South Florida this weekend, we are 10% to 20% away from a price bottom in the U.S. housing market. Scary stuff.

Where the Market Stands, Where it’s Headed:

The Dow Jones Industrial Average took it on the chin yesterday, down 178 points. The Dow Jones is up 5.7% for 2010.

A combination of things is happening with the market. Ireland looks like the Greece of earlier this year. It’s unclear if the Fed’s QE2 program is working. What is clear though is that interest rates are rising with corporate profits.

To break below its current trading range, the Dow Jones would have to break below 9,750 on the downside. We are far from that. Hence, I’m sticking with my belief that the bear market rally that started in March of 2009 is alive and well.

What He Said:

“If the U.S. housing market continues to fall apart, like I predict it will, the stock prices of major American banks that lend money to consumers to buy homes will come under pressure—these are the bank stocks I wouldn’t own.” Michael Lombardi in PROFIT CONFIDENTIAL, May 2, 2007. From May 2007 to November 2008, the Dow Jones U.S. Bank Index of the world’s largest bank stocks was down 65%.