Dear Reader,
CJ here.
It’s been a big week for the market. No, scratch that; it’s been a huge week for the market.
Investors are breathing a huge sigh of relief as they speculate that the most recent Consumer Price Index (CPI) data will lead to the end of the Fed’s interest rate hike cycle.
If you missed it, CPI came in at 0.0% for the month compared to expectations that ran from +0.1% to +0.3%. Digging deeper into the data, you and I still feel some inflationary pressure at the grocery stores and pharmacies.
Wednesday’s Producer Price Index (PPI) came in at -0.5% compared to expectations of +0.1%. The second “read” on inflation was also better than expected, giving Wall Street more confidence that we’ve seen the end of higher interest rates.
This is the data that the market has been holding its breath for, and it shows in the two-day rally that has boosted the S&P 500 by almost 2.5%.
More importantly, this rally is likely the catalyst for what should be a strong second half of November. That’s because the seasonality trade is now kicking into full force.
As a bonus, the market has built quite the “wall of worry” over the last few months.
Rising interest rates and less-bullish corporate outlooks started to rattle investors’ faith that we would see a seasonal swing trade. Now, that fear is unwinding as buyers move money from the sidelines (cash) back to stocks.
There’s one sector that should benefit handsomely over the next two weeks from that “sentiment swing”.
Over the next two weeks, companies like Lowe’s Companies, Inc. (LOW), Nordstrom, Inc. (JWN), and Nordstrom, Inc. (JWN) will release their earnings results. The same wall of worry in place for the market is even higher for these stocks, which is why I see some opportunities.
As a group, the retail sector is up 5% for the year. Compare that to the Nasdaq 100 (up more than 40%), and you have the potential for a real “slingshot trade.” Investors will be looking for relative values in the market, and this is a target-rich environment.
Want proof?
Look at shares of Target Corporation (TGT).
Target shares jumped by 18% on Wednesday after their earnings. The results were mixed with lighter-than-expected revenue and an EPS beat.
On a side note, I don’t think the stock is a “buy” today as we’re likely to see some profit-taking, but it’s an example that some retail stocks are ready to pop.
That said, I still think there are some potential “bull traps” in the sector, so let’s take a few minutes to look at three stocks I’ve got my eyes on over the next two weeks.
First, let’s talk about what I’m looking for in the way of trade drivers for these stocks.
Technicals
80% (68 stocks) of the retail sector stocks are trading above their respective 50-day moving averages. Of those, only 35 retail stocks are trading above their 200-day moving averages. I’m looking for stocks that are trading above both trendlines to qualify as bullish candidates.
In addition, I’m eyeing stocks with a bullish 50-day moving average trend. This means that their 50-day moving average has a positive slope. It’s a fancy way of saying that it is trending higher.
I prefer stocks that aren’t trading at one-year highs ahead of earnings, as this tends to put them in a position of having to prove their valuations. I call it “priced to perfection”.
Sentiment
Stocks love to climb a wall of worry, but they jump over it during earnings season.
Because of this, I’m looking for stocks the crowd is bearish on ahead of their earnings reports.
First up is BJ’s Wholesale Club Holdings, Inc. (BJ), reporting on Friday, November 17.
This stock heads into its earnings announcement on Friday with the potential to break out of its two-month consolidation.
Last quarter, BJ reported flat revenue, but the company beat analyst expectations on its bottom-line EPS. In addition, management provided guidance that was in line with expectations. Shares dropped 5% as a result.
Since then, the stock has rallied more than 8% compared to the S&P 500’s 3% move (mostly made this week. But there’s a technical kicker for this stock heading into their earnings.
BJ’s 50-day moving average has been in a bullish trend since August. The last five-day rally in the stock has positioned it above both its 50- and 200-day trendlines. The move has also broken above $71 for the first time since September.
That technical break higher positions shares for a potential short-covering rally.
Short interest has been on the rise for BJ shares as the bears have been posturing for lower prices. The latest short interest data shows a 15% increase in short positions ahead of this week’s earnings report.
The current short-interest ratio above 6 puts BJ shares on my list of potential short-squeeze stocks as the company heads into earnings.
My upside target for BJ shares sits at $75 (7% higher).
Now for a “bear trap” retail stock, Best Buy Co., Inc. (BBY).
Best Buy has been a Golden Goose for technical traders that have used the 50-day as their barometer. Since turning bearish in August, Best Buy shares have dropped 18%, and my indicators tell me that there’s more selling to come.
Historically, the retail sector has seen some end-of-year seasonal weakness. Let’s call it a “holiday hangover”, as the SPDR Retail ETF (XRT) has averaged returns of 0.0% over the last 20 years. Furthermore, the same retail ETF has only closed higher 46% of the time in December over the same 20 years.
Over the same period, Best Buy averages a return of -2.4% for December and has only closed higher for the month 26% of the time (chart below).
This year’s forecasts for holiday spending are down sharply as consumers have indicated that they are budgeting for the holidays with inflation in mind. I know we just got a better-than-expected inflation reading from the CPI, but we’re still dealing with prices that have been significantly higher over the last few years.
The technicals on BBY shares are poor, at best.
Shares are trading 11% lower for the year, and that is AFTER the 8% rally that they’ve seen over the last two trading days. My trading intuition – which is good – tells me that the reason behind the rally was short sellers covering their positions, not the bulls coming in on a value play. Note the volume spike in the chart below.
Speaking of that volume spike, the last buying spike we saw was in the wake of last quarter’s earnings as the stock tested its 200-day moving average. This time, the stock is touching its 50-day moving average, which I expect to act as short-term resistance.
Looking at the sentiment picture, the bulls have been adding to their call positions of late. Call open interest and volume have been focused on the $75 and $77.50 strikes.
I’m not buying the hype. This sign of optimism suggests that the stock is pricing in a great earnings report, which often represents a “buy the rumor, sell the news” situation.
I expect the stock to see some pressure at its 50-day and will aggressively position for a break lower if we see a price above $72 ahead of the November 21 earnings date.
This looks like a bear trap; proceed with caution.
What’s my bottom line on the retailers?
The best approach to the retail sector is to stick with what has been working.
Walmart Inc. (WMT), American Eagle Outfitters, Inc. (AEO), and Costco Wholesale Corporation (COST), represent the leadership and momentum plays.
Names like Best Buy and Walgreen’s Boot Alliance, Inc. (WBA) remain tepid at best and should remain on your bearish list.
To your best trading success,
Chris Johnson
Quantitative Specialist
