Unfinished business: Financials, REITs, small-caps.

These three categories have only begun to really break down in this plunge. Let’s look at some charts. In a crash like this, you want to see deep new lows in all the vulnerable sectors before you can consider things complete.

Here are financials. These stocks are just revisiting July’s lows, yet to make a solid break to lower levels. XLF is our proxy:

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Next, REITs are finally breaking down, but they have a long ways to go, considering that an honest accounting of real estate prices would probably reveal that many of them have negative equity. IYR is a REIT-laden real estate ETF:

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For small-caps, we’ll switch to a 10-year shot of the Russell 2000 to show the magnitude of the bubble in crappy stocks since 2003. The Russell is making new 3-year lows, but like REITs, it has defied gravity since last year so there is a lot of air underneath these levels. (PEs on the Russell are infinite, by the way, just like the Dow.)

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May as well throw in an update on Wal-Mart for good measure. I shorted them a few weeks ago, not because they were horribly overvalued (they are, but less so than most junk out there), but because they have been boosted by a nifty-fifty “defensive stock” mania, and therefore the puts were dirt cheap. 2-year view:

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The fact that these laggards are just now breaking down, along with the lack of a meaningful bounce today, suggests to me that this plunge is not out of steam.

It’s a beautiful day for shorting. My picks: Wal-Mart & Costco

I wouldn’t be surprised if the market ends down on the week (maybe even the day). This morning’s little bailout* blip just offers shorts another chance to set up some trades we may have missed in the bounce since July. (*For a dissection of the bailout, here’s Mish).

Why short leading discount big-box retailers? Although they sell stuff cheaply, they have come to rely on Americans buying lots of cheap stuff. American’s have a habit of viewing low prices as an opportunity** to buy more of something, not to buy the same amount and save the difference. The aisles of these stores are packed with discretionary goods: a myriad of toys, cosmetics, housewares, sporting equipment, and all kinds of footwear and clothing. People’s homes are overflowing with decades worth of junk: enough clothing for a couple of generations, and used toys, tools and appliances galore.

These stocks are priced for perfection, as if the consumer binge will continue in perpetuity and the companies will continue to open new stores in new exurbs. Unfortunately, many of those new developments will be ghost-towns before long, and the stores will be big, empty cleanup liabilities.

Let’s take a look at the numbers:

Wal-Mart: Price: $61; P/E: 18; Dividend yield: 1.6%; Earnings growth, 2005-2007: 6.5%

Costco: Price: $70; P/E: 24; Dividend yield: 0.9%; Earnings growth, 2005-2007: 0.94%

By any Graham and Dodd style evaluation, these two are massively overpriced, Costco more so than Wal-Mart. However, I like the short odds on Wal-Mart just as much because it is so overbought and near a 52-week high in a sort of nifty-fifty bubble (hence, I picked up some puts this morning — I’ve had long-term puts on COST for a while).

Yes, same store sales may be up, but that is largely on account of groceries and gas. The profits are in discretionary items. Over the next 12 months, watch for sales to go flat and margins to shrink, before sales drop outright.

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**People don’t apply this logic to investment purchases, hence the securities and real estate markets are inefficient.