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Edwards: Take Care Shopping the Retail Sector

On the surface, March same store sales numbers look like one of the prettiest packages presented to investors in the retail sector for a mighty long time.

It almost feels like the good old days of 2006 and 2007, which were the consumer equivalent of Woodstock and Lalapalooza wrapped in a Tiffany blue box with a pretty bow. That was the era of the aspirational consumer, when the target consumers for a retailer like JC Penney were shopping at Nordstrom and Saks using credit cards with zero percent balance transfers and money cashed out from home equity loans.

It was the heyday of cashmere and affordable luxury and “I need to have one because everyone else has one, why not?” And after that wild party, 2008 and 2009 in the retail sector were like waking up after Woodstock and knowing that you were solely responsible for picking up all the trash and setting the place to rights.

It’s only natural that investors are longing for a return to that retail Woodstock high, and after retail’s resurrection from the dead last year it’s understandable that they believe it possible. I can even see how a casual glance at March’s same store sales numbers would easily reinforce that vision… but Thar Be Dragons in those waters. I’m not saying don’t go swimming, I’m just saying pick your lagoon carefully!

Before you drink the Kool-Aid and start buying retail stocks indiscriminately, let’s review a few facts. Easter and Passover were a week earlier than last year, pulling a lot of sales from April in March.

And same store sales last year were so pathetic that it redefines the concept of setting the bar low. I’ll even buy into the concept of ‘frugality fatigue’ combined with replacement shopping – the idea that after minding the budget for a very long time, consumers just wanted a little retail therapy and had pent-up demand…but the idea that we are going to return to the Stupid and Giddy consumerism of 2006/2007 is quite frankly inane. The consumer has already maxed out their credit cards and drained the equity from their homes, where exactly will they get the funding for another retail spendfest?

Unemployment remains high, unemployment benefits are expiring for many, home foreclosures are expected to have another spike, consumer credit keeps getting tighter, interest rates and gas prices are heading upward, and many tax refunds have already been spent.

We’re quickly going to start coming up against tougher sales comparisons and retailers are going to have to prove that they’re doing more than just riding calendar shifts and surviving — they’re going to have to be thriving. Bluntly put, pretty soon the market should finally start to once again reward the best operators. The trick now is to know which retailers truly offer all three of the essentials: the right product at the right value with the right shopping experience.

Just picking a sector within retail isn’t going to get you where you want to go. Case in point is the current popular trade of going long retailers catering to high end consumers. Sure, the higher end consumer is less likely to have been impacted by the mortgage crisis, actually has an investment portfolio that is enjoying the recent market rally, and will only be mildly affected by higher gas prices.

But if I’m making an investment based on economic outlook, I want to own the higher end retailers with the best systems, merchants, market position, growth prospects, and of course, valuation also plays a role.

In my book that is a small and exclusive club. J Crew Group has Mickey Drexler, the genius behind Gap during its heyday, with his hand on the helm and a reasonable valuation given their growth prospects. The Buckle is a boutique concept for 20-somethings that offers designer denim and unique tops and jackets (they only stock one of each item in each size per store), and with only a little over 400 stores nationwide, there is a lot of room for expansion.

Remember that those 20-somethings are less likely to be struggling under a barrage of credit card debt or a mortgage — greater disposable income is a good trait! And finally, Nordstrom — while their valuation at 16.7x forward earnings is pretty much right in line with the five year median Price / Earnings ratio, I’m expecting that their excellent customer experience and fabulous merchandise is going to lead to earnings estimate increases throughout the year.

At least one strategist has recently suggested that the smart trade is to buy the high end retailers and short those on the lower end of the income spectrum such as Wal-Mart and Family Dollar. All I can say is do so at your own peril.

Think of “The Consumer” as a woman who is wearing a belt over her dress: as the belt tightens, things need to move north or south to get out of the way. As the belts tighten for the consumer it is the middle that gets squeezed and the majority of the movement is a trade downward. That middle income consumer is the former aspirational shopper, and the economy is forcing them to migrate their shopping habits back toward what they should have been all along: a new sort of frugality is beginning to reign.

These new Frugalistas are trading down on clothing, food and household goods so they can still afford those higher priced items that are most important to them (most often consumer electronics). Yesterday Family Dollar reported same store sales that were much better than expected and raised earnings expectations well above analysts’ estimates. Trading at only 13.8x forward estimates, Wal-Mart appears undervalued and ripe to profit from the middle income consumer’s continued trade down, as does TJX Companies trading at 13.9x forward estimates.

I doubt it to be coincidence that large, waist-cinching belts have been a recent fashion statement. Fashion has merely been imitating the consumer’s life. And the economic landscape makes me doubt that this fashion trend is just a fad.

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Trader disclosure: On Apr 8, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s Fast Money were owned by the Fast Money traders; Jon Najarian Owns (AAPL) Call Spreads; Jon Najarian Owns (AMZN) Call Spreads; Jon Najarian Owns (AMR) Call Spreads; Jon Najarian Owns (BAC) Preferred; Jon Najarian Owns (C) Preferred; Jon Najarian Owns (F), Is Short (F) Calls; Jon Najarian Owns (GS), Is Short (GS) Calls; Jon Najarian Owns (HPQ), Is Short (HPQ) Calls; Jon Najarian Owns (IGT) Calls; Jon Najarian Owns (JPM) Preferred; Jon Najarian Owns (JCG), Is Short (JCG) Calls; Jon Najarian Owns (LVS), Is Short (LVS) Calls; Jon Najarian Owns (MCD), Is Short (MCD) Calls; Jon Najarian Owns (MS) Preferred; Jon Najarian Owns (RIMM), Is Short (RIMM) Calls; Jon Najarian Owns (WMT) Calls, Is Short (WMT); Jon Najarian Owns (WFC) Preferred; Jon Najarian Owns (WYNN), Is Short (WYNN) Calls; Jon Najarian Owns (YHOO) Call Spreads; Jon Najarian Owns (AMR) Call Spreads; Jon Najarian Owns (HOTT); Jon Najarian Owns (CSCO), Is Short (CSCO) Calls; Terranova Owns (AXP), (EOG), (SWN), (FCX), (GLD), (POT), (TER), (YHOO); Terranova Is Short (XLY), (LCC), (FDX); Grasso Owns (ASTM), Grasso Owns (ABK),Grasso Owns (AAPL), Grasso Owns (BAC), Grasso Owns (BGP), Grasso Owns (C), Grasso Owns (CVGI), Grasso Owns (COST), Grasso Owns (JPM), Grasso Owns (NEM), Grasso Owns (PRST), Grasso Owns (WMT), Grasso Owns (PFE), Grasso Owns (BA). Grasso Owns (T); Edwards Owns (TM); Edwards Owns (UUP); Stutland Owns (MSFT); Stutland Equities Is A Market Maker In VIX And SPX Options; Kelly Owns (FXE) Puts; Cortes Owns (IAI), (MS), (GS); Cortes Is Short S&P Futures; Seymour Owns (AAPL),(F), (INTC)

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