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The Other Side: Trading the Middle Class Meltdown


Much can be made of the disappearing, the off-shoring, the aging and frankly the death of the middle class in the United States.


Note From Prof. Krueger: I wanted to share what may be on the other side of both a headline and a stock that you have no doubt read and heard of.

Before anyone disagrees with either crazy notion, let me be the first to join you.

This will be the origin of each "Other Side" column. I am simply sharing the result of work that began by attacking my own ideas (posing as the other side of each of my trades and structural positions and building a case against myself), especially if I can find a mis-priced trade resulting from over-bet assumptions including, at times, my own. Our biggest mistakes can be found in the mirror, not on the screen.

This image is of a painting thought to be an original Jackson Pollock, worth about $50 mln. It was purchased in a thrift shop a few years ago for $5, after a truck driver refused to pay $8. I am bullish on a lot of what sits on each end of those extreme price points and bearish the debates and consumers in the middle.

Much can be made of the disappearing, the off-shoring, the aging and frankly the death of the middle class in the United States. Much money, I believe. I don't view it as good, bad or sad – I see it as a trade.

I spend zero time forecasting the overall economy at my firm and do not care one bit about any tenth of a point in GDP. Economic numbers have an unblemished streak of predicting precisely what has already happened, and often later revising it. Instead, I turn to a 12-member jury who delivers a verdict to me each day at precisely 4 PM EST – my dozen screens.

I trust my research methodology and the designed traps I set every week, regardless of whether I intuitively agree with the outputs or not – that's the whole point of the process. But on the topic of the "Haves versus Have-Nots" – I can actually sit with the jury, which is quite rare and see exactly what it sees. The verdict on this case is one of the few that actually make complete sense to me. That instead of wondering about the rise in the Haves and worrying about the explosion in the Have Nots, each fueled by defecting members of the middle class, it makes more sense to me to go long each end of that barbell and sell or short the middle. I have had this secular trade on, with a variety of names, for several years now and yet I see it accelerating going forward.

The Have Less

A lot of attention is paid, and investments made, in a shopping basket of some of Middle-America's favorite choices for a variety of products. Had you invested five years ago before this great move in the stock market in the following: Walgreens (WAG), Safeway (SWY), Harley Davidson (HOG), Bed Bath Beyond (BBBY), Home Depot (HD), Dell (DELL), Anheuser Busch (BUD), Kohls (KSS), Ford (F), and General Motors (GM), you would have less money today than when you started, despite a 60% rally in the S&P 500.

I want nothing to do with my version of the "Mall of America" and hundreds of others just like them - growing in supply, dwindling in margins, and their customers keep doing a lot better or a lot worse financially than they are supposed to. In between the debate about the Haves versus the Have-Nots sits an awful lot of companies who may Have Less.

The Haves

Well we're movin on up.
To the east side.
To a deluxe apartment in the sky.
Were Movin on up.
To the east side.
We finally got a piece of the pie.
-The Jeffersons

Over that same five-year period just completed, had you filled a basket with the expensive stuff from places like: Nordstrom (JWN), Polo Ralph Lauren (RL), Coach (COH), and Apple (AAPL) you would be up an average of + 737% in five years. Niche products will always make sense, and have always appealed to the Haves and that group is growing in strength. Before you think these stocks only did well if you found them years ago, consider they are also up over the past 12 months an average of +50%, more than quadrupling the S&P 500's move.

This year alone has seen tremendous moves from stocks like Blue Nile (NILE), which I have written about often, Under Armour (UA) another name I Buzzed about and still causes me to cringe at what I pay for that stuff, Sotheby's (BID) that my friend Guy Adami would have to teach me the etiquette for, and Wynn Resorts (WYNN) where my favorite movin'-up-east-sider, Toddo, recently made a splash. These four expensive choices are up an average of more than +50% as a group year-to-date in a flat overall market.

NILE, which sells luxury jewelry at a nice price break, leads that charge up over +120% this year and offers a hint about tracking the Haves. One of the reasons I am long this stock came from a lesson I learned many years ago after finding out the most successful 99 Cents Only (NDN) store in their entire chain was in Beverly Hills, CA. Shh…the rich love a great deal. That's how they got rich.

The Have Nots

Temporary lay offs. Good Times.
Easy credit rip offs. Good Times.
Scratchin' and surviving. Good Times.
Hangin in a chow line. Good Times.
Ain't we lucky we got 'em. Good Times.
-Good Times

Since we all agree that a lot of people are going broke, I think the better question is – where do they go next? The consumers that I want to track couldn't qualify for a loan even before the latest credit crunch.

I'd be more worried about the traditional financial organizations that count on the middle class and can see its customers disappear, no differently than any other retail chain. The shares of Washington Mutual (WM) which has grown and bought several other banks to serve this group were worth $37 five years ago. Today they change hands at $37.

Over that same time there was a group of companies catering to the group of consumers most investors fear instead of trade with which is surprising given our almost universal agreement that they are skyrocketing in numbers. Ezcorp (EZPW), First Cash (FCFS) and Cash America (CSH) are up together, an average of more than +750% in five years. They are covered by an average number of Wall Street analysts that I wouldn't need all fingers on one hand to count. Strangely, most of those firms' own strategists consistently point to the trouble the consumer is having and all the places they can no longer afford to go.

I have always wondered why the analysts next door don't at least follow them to see where they are going – pawnshops, in many cases. Outcry continues over their usurious rates which are entirely miscast, but pretty darn profitable, and gladly paid by a group of customers swelling in numbers. A lot of their customers are behind on bills, we all agree, and most folks on Wall Street add it to the chart of impending doom and list of reasons not to own stocks. I have had a lot less success connecting those dots to predict overall boom or doom, and made a lot more money buying some of those late bills than pointing to them.

Die or Multiply?

Of course there is the other side of this story. The middle class may be disappearing in the U.S. and for us that gave birth to this secular trade as described above: Long Have's, Long Have Not's, avoiding or Short of the Have Less. But the trade that we have been spending far more time on over the past few years is tracking the emerging middle classes in other countries. U.S. investors spend an awful lot of time trying to game where we'll spend our next (or last?) discretionary dollar. I think that for the rest of our investing lives there will be more money to be made figuring out where much of the remaining 95% of the world is looking to spend their first.

At the end of the day, we would likely all agree - regardless of income – that our standard of living is pretty darn spectacular. Even the "poor" in this country have air conditioned apartments or homes, electricity and plumbing, a television, and often a car. With few exceptions they have a job and with zero exceptions an opportunity. The dramatic increases in standards of living will be in other countries and sadly those "gains" are often viewed as our "losses." As a trader, nothing is ever good or bad, although I have a hard time not viewing that as good, dare I say great, for a few billion people. Rather, things are simply and always – different. Different makes good debates and even better trades.

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Position in NILE, AAPL and UA
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