NEW YORK, United States — Wall Street's bet against empty malls is getting too crowded, according to Citigroup Inc. analysts, who instead recommend wagering against individual retailers as the "next big short."

Investors should consider buying default protection through the derivatives market on a basket of bonds from retailers that include Target Corp., Gap Inc., Nordstrom Inc. and Macy's Inc., according to Citi's Anindya Basu and Calvin Vinitwatanakhun.

The strategy differs from the one pursued by a growing number of hedge funds, which have wagered against mall properties through CMBX derivatives indexes that tracks commercial mortgage-backed securities. The prevailing theory is that failing brick-and-mortar retailers will mean higher vacancies and bankruptcies for mall operators, with losses inflicted on CMBS holders.

But the trade has become so crowded in recent weeks that betting the index will drop even further is a longshot, Citigroup said in an April 5 report. Analysts at Credit Suisse Group AG have said that non-CMBS specialists piling into the trade have helped push down the benchmark.

“A more appropriate way to express a short view on the retail sector is to go directly to the source,” Citigroup’s analysts wrote, pointing out that deterioration in the sector will be reflected in the issuers’ credit quality, and investors won’t have to worry that mall operators will head off disaster by filling their space with new kinds of tenants.

Buying credit default swaps tied to individual retailers is more precise than shorting CMBX tranches, according to Citi’s analysts. They estimate CMBX indexes may only have 10 percent exposure to mall properties, with a greater proportion tied to non-retail properties such as office buildings. What’s more, buying CDS protection against individual merchants can be cheaper and maintained over a longer term -- an important point given that distressed retail stores could survive for years before they default.

Longer Horizon

"It is difficult to assign a timeline around when the retail sector begins to capitulate and defaults start to occur," Citigroup said. "We are more comfortable using the CDS market where maturities are longer — even go up to 10 years — versus the options market, where maturities are much shorter."

Retailers have been struggling for years as consumers defect to online merchants such as Amazon Inc. and shift spending to experiences such as dining and travel instead of merchandise. Mall operators are under pressure from anchor stores such as J.C. Penney Co. and Macy's, which have announced plans to shutter stores, and Sears Holdings Corp. has raised doubts about its survival. Payless Inc., the shoe retailer, yesterday joined a growing list of smaller chains that went bankrupt.

Major US retailers reported disappointing Christmas sales last year, but analysts have said the downturn may ease as more Americans receive delayed tax refunds. The payments from the Internal Revenue Service are running 10 percent lower in the first two months of 2017 than the same period a year earlier, according to IRS data compiled by Convergex.

"The most often cited reason for the slow start to the tax season was the IRS’s need to more fully vet returns that claimed the Earned Income Tax Credit, a measure commonly used by families with children to reduce their overall tax burden," said Convergex’s Nicholas Colas and Jessica Rabe. "Worth noting: families with children are an important customer base for many brick and mortar retailers."

By Tracy Alloway; editors: Nikolaj Gammeltoft, Rick Green and Dan Wilchins.