For the last year, the mall was a one-trick pony. If you had five pockets and a zipper, you had a business. But yesterday’s bloodbath in specialty retail—headlined by American Eagle (AEO) cratering 14.7% and Gap (GAP) stumbling over its own feet—was the market finally admitting what your closet already knew: we’ve hit Peak Denim.
Trends Drive the Business, Managers Take the Credit
The jarring vibe shift in all things denim, and the margin drop that caused it, hit the stocks as hard as anything else. Last November, AEO was touting "150% demand" for newness and apologizing for out-of-stocks, while Gap CEO Richard Dickson was taking a victory lap, claiming their "Better in Denim" ads were "authoring" the very cultural trend everyone else was just trying to join.
AEO sold out of much-hyped Sydney Sweeney denim run in weeks and spent much of the fall trying to get in stock to meet demand, which was already peaking. Gap, created a whole new promotional division, convinced it was driving the zeitgeist rather than just catching a wave.
Fast forward to this week: that "demand" has mutated into a margin-killing monster. The "150% demand" for new fits didn't save AEO from having to fire-sale the old ones, and Gap’s "cultural relevance" couldn't stop an 80-basis-point margin slide. The industry went from "inviting the world to the party" to "paying the world to show up."
Both companies will be fine, but there’s a reason the long-term charts for GPS and AEO are full of sound and furious rallies, ultimately going nowhere. If you’re the 3rd and 4th biggest sellers of denim in the U.S., margins are going to ebb and flow with the culture. Management’s job is to a) not believe their own hype b) stay in front of the trends. Doesn’t make them bad people, or even bad execs; Aerie continues to be amazing for AEO.
March is the Cruelest Month
There’s a reason I’ve got my consumer-facing Portfolio at its highest cash level ever, after taking huge gains by selling AEO ahead of the number. Q1 is when retailers tend to be most cautious in the best of times. Only the biggest surprises are getting bought. Winners need to have a great narrative, solid execution, and better-than-expected results. Just being Great isn’t good enough, as we saw with Costco and Walmart yesterday.
It’s a rough tape. Some managers like to short these kinds of environments. Hats off to them but shorting isn’t just a matter of flipping your book from long to short. I do better just getting out of the way and looking for opportunities. That’s the whole reason the Macke Portfolio exists: to take profits while there’s still a good chunk left and get a little greedy on stories where no one else believes.
It took a long time to learn how to do this; I’m not giving it away for free. If you stepped out of AEO before yesterday and bought my Turnaround of the Year in December, you’ve had a pretty good week, despite a sea of misery in retail.
