Here’s A Potential Short Candidate For You
The S&P 500 Equal
Weighted, S&P 600 and the Russell 2000 all broke uptrend channel lines
yesterday signaling 1) a further consolidation or 2) a larger correction lie
ahead.  Either way, traders should remain cautious until the markets become
more oversold or until the indexes can re-capture these broken levels. We’ll
know by the end of the week if this is just a “bear trap” caused by options
expiration but until then, I’m operating under the guideline that a breakdown in
August often leads to weakness in September. Â
Yesterday, the S&P 500 broke down from a triangle
at 1226 and a sideways consolidation at 1223. Â
Even more worrisome is that the the S&P 500 Equal
Weighted Index (SPXEW) broke down from a strong up channel.  I often use the
S&P Equal Weight rather than the S&P 500 to gauge the market’s health because it
more accurately reflects what the average stock is doing. That index looks like
it wants to test the support range from which it broke out last month.Â
  Â
The S&P 600 (SML) broke down from a rising
channel as well and shows a high probability of trading down to recent support
levels between 330 and 337. The Russell 2000 (RUT – not shown) broke a similar
rising channel and is currently sitting on the upper end of the support range. Â
Last week, Gary Kaltbaum mentioned that retailers
were undergoing distribution. That was a prescient call since the stocks have
now followed through on last week’s initial drop. Â
One retailer to put on your screen as a potential
short candidate is Dick’s Sporting Goods (DKS). The company has been a
darling specialty retailer since it came public in 2002 at a spilt adjusted $6
per share. But yesterday, the company reduced its earnings guidance from
$1.82-$1.87 to $1.70-$1.75 because of problems with a recent acquisition. While
this in itself is not a horrendous shortfall, the stock was priced for
perfection and therefore gapped down from the high $30s to the low $30s. Â
From a fundamental perspective, problems with a
poor acquisition are hardly ever just “one quarter events,” in my experience.Â
Management’s time and attention are often diverted for several quarters as they
go about fixing the problems, leaving the rest of the business to run on
auto-pilot. This distraction often leads to additional problems in future
quarters.    Â
From an investment perspective, the stock now
finds itself in “no-man’s land” – it cannot be classified as a growth or a
value stock. At $32, the stock is still trading at over 18x revised 2005
earnings guidance, which is relatively expensive for a retailer that only grew
combined revenues at 4% and reported comparable store sales of 0.5% this past
quarter.  Institutional growth stock managers could continue to sell the stock
and value investors probably won’t find the stock attractive until it trades
below 15x earnings, or under $27. Â
I expect any rallies in the stock will present an
opportunity to go short for a trade. DKS is a weak stock in a weakening sector.Â
The weekly chart shows the stock has fallen back into the triangle consolidation
from which it broke out. In addition, the first significant support doesn’t
come into play until the stock tests the $26 – $30 range.Â
Thomas Neuhaus
Thomas Neuhaus is a principle of Investment
Management of Virginia, a registered investment advisory firm for which he
co-manages. Mr. Neuhaus’ career has encompassed all aspects of the investment
business from investment banking to sell-side research to buy-side portfolio
manager.