IDEX Online Research: Jewelry Stocks Slump in Second Quarter

Jewelry stocks have historically been more volatile than the overall stock market, and they continued that tradition in the second calendar quarter of 2006. While the total market was down just under 2 percent, as measured by the broad market S&P 500, the IDEX Online Portfolio of Jewelry Stocks was down nearly 11 percent. The IDEX Online Portfolio consists of 13 global jewelry industry stocks, including internet merchants, retailers, and suppliers. The index is based on buying an equal number of shares of each company.

Every category of jewelry stocks – internet merchants, retailers, and suppliers – suffered from the market’s downdraft. The graph below summarizes stock market performance as well as jewelry stock performance for the second quarter.

Source: Stock Markets

Investor Uncertainty Hurt

While tangible signs of economic growth remained strong, investor uncertainty topped the list of reasons that stocks posted poor performance in the second quarter. On the positive side of the ledger, both the U.S. economy and the global economy continued to grow at an unprecedented pace. Businesses and consumers are still managing their finances successfully in the face of higher oil prices.

But investors often worry about what is around the next corner or just over the hill, especially when the economy appears to be peaking, and that was the case in the second quarter. Investors are worried that global economic growth may start to slow early in 2007. Investors are worried about the current inflationary pressures. Investors are worried about geopolitical issues. In traditional fashion, this wall of worry caused investors to over-react and sent stocks plummeting in the quarter.

Among jewelry stocks, investors continue to be worried about the consumer’s ability to fund discretionary purchases such as jewelry, especially as higher gasoline prices eat into shoppers’ budgets. We have already seen some fall-off in spending for dining outside of the home, beer, and some other discretionary categories. Jewelry sales had been strong in the first quarter, but showed signs of slumping as the second quarter rolled around.

Year-to-Date Stock Performance Disappointing

Both the market and jewelry stocks in the IDEX Online Portfolio posted advances in the first quarter of the year. In the second quarter, they gave back all of those gains and more. For the six months year-to-date, U.S. stocks as measured by the broad market indicator S&P 500 were up marginally. However, the IDEX Online Portfolio was down 12 percent. Year-to-date, Internet stocks took the brunt of the hit, falling by over 20 percent. Stocks of retailers fell by 8 percent and jewelry supplier equities were down 12 percent. 

The graph below summarizes stock performance from the broad market as well as jewelry stocks for the six months ended June 30, 2006.

Source: Stock Markets

Bold = Included in index

Internet Stocks Plummeted in First Six Months

Of the three internet jewelry stocks; only two – Blue Nile and Odimo – are in the IDEX Online Stock Portfolio. We generally remove a stock when it drops below $1.00 per share, and Abazias remains well below $1.00 per share. Odimo is flirting with the $1.00 threshold; this stock was as high as $9.40 in early 2005. If Odimo shares fall below $1 and remain there, the stock will be eliminated from the IDEX Online Portfolio.

 

Blue Nile showed the most dramatic decline in the quarter as investors continue to worry about the company’s slowing growth rate. Further, management has not shown that its new marketing strategy will be successful. Odimo sold off its crown jewel – the diamond.com domain name and related operations. What will be left? That’s the question investors are asking. Abazias continues to struggle, despite putting on a happy face for investors. This is a company that should not be a public company in the current regulatory and investing environment, in our opinion.

Bold = Included in index

Jewelry Retail Stocks Weak

Of the six retail stocks included in the IDEX Online Portfolio – Birks/Mayors, Finlay, Signet, Tiffany, and Zale – only two have risen in price from the beginning of the year: Birks/Mayors and DGSE. The others – all well-established names in the industry – are down.

 

In the case of DGSE, investors may be seeking a “gold play.” Gold bullion sales have surged to 40 percent of DGSE’s total revenues, up from about 20 percent three years ago. As DGSE sells low-priced gold from its inventory, its profits should be quite strong. In fact, profits from bullion sales in the first quarter were up six-fold from the prior year. Birks/Mayors is still somewhat of a mystery to investors. As financial disclosures from this merged operation unfold, investors will have a better understanding of the company. In the meantime, investors are probably betting that efficiencies of scale should boost overall profits.

 

The four established retail jewelers in the IDEX Online Portfolio all suffered the same fate: their stock price has fallen for the year-to-date. Besides investor worries about consumer discretionary spending, each company appears to have its own problems. Finlay continues to lose leased departments. Signet’s U.K. operations are disappointing. Zale’s management woes continue. Tiffany’s U.S. sales have been weaker than expected. Until these issues are resolved, these stocks could remain mired at the current low price levels.

 

Bold = Included in index

Supplier Stock Prices Slump

Stocks of jewelry suppliers also took a hit as investors fled them over the past six months. Charles & Colvard was by far the biggest casualty as sales gains have evaporated – a trend that could continue near term. Investors did not like the sales erosion in the first quarter – down nearly 30 percent from the prior year. As a result, they have fled CTHR shares, pushing the price down to about $10. At their peak in 2005, CTHR shares were selling for over $26 per share.

 

The performance of the balance of the jewelry supplier stocks were a mixed bag: some were up and some were down. Movado seems to be doing everything right: each of its brands has a solid strategy (though sales of its luxury Concord brand are weak), and it continues to grow its family of brands. As a result, MOV shares have risen by nearly 25 percent so far in 2006. LJ International struggles to get recognition in the U.S.; its sales have risen by nearly 9 percent so far this year. Lazare Kaplan shares continue to plod along in a trading range.

 

Aber Diamond continues to report good news, but competitive worries have ensnared investors. Man Sang shares are sitting in a trading range. House of Taylor is another company that should not be public in the current regulatory and investing environment, in our opinion.

 

Global Luxury Stocks Flat

As a comparison, IDEX Online maintains an index of ten global luxury stocks, including Burberry, Coach, LVMH, and others. For the first six months of 2006, this group of stocks posted essentially flat performance, as the graph below illustrates.

 

Source: Stock Markets

Outlook for Jewelers: Uncertain

Not only are investors uncertain, but jewelers and diamantaires are uncertain. The recent JCK Las Vegas market generated “mixed” results for most suppliers. This means that they were disappointed with their orders. Holiday jewelry orders are usually placed (or indicated) at this key show. Therefore, it appears that the prevailing opinion among jewelry merchants is that the 2006 holiday selling season could be slow. If they are wrong, it won’t make any difference: they won’t have enough product to meet customer needs. In other words, the lack of orders from retailers could be a self-fulfilling prophesy.

 

It is important to remember the old adage that Wall Street often points to: “the stock market has predicted twelve of the past six recessions.” In short, the stock market is a very poor forecaster of economic recessions; you can get the same odds by flipping a coin. However, we note that it is a relatively good predictor of economic upswings.

 

Unless it is clear that both the U.S. economy and the global economy are going to post solid growth for the foreseeable future, jewelry stocks are likely to remain under pressure. There is one bright note: if oil prices retreat (an unlikely event, but possible), jewelry stocks would likely soar.