Gaining an Edge with Retail Stocks

Retail stocks are surging as we enter a strong seasonal period. Here are two solid performers to buy on pullbacks and a lucrative play from last year that may pay off again.

As stocks continue to push higher and higher, those looking to increase their equity exposure are faced with a tough choice: Look to buy stocks in sectors or industry groups that have not yet participated in the stock market rally, or look for good entry points in the strongest areas?

For me, this decision is generally made easier by looking at two different factors. The first is how an industry group or sector is doing relative to a major average such as the S&P 500. It is the trend of this relative performance, or RS analysis, which is most important. Secondly, I look at the seasonal trends of certain industry groups or sectors.

On August 30, I pointed out that the retail sector was acting better than the S&P 500 and was entering a strong seasonal period.

This strong period generally lasts until late November, and some years, it can last very close to Christmas. Many of the retail stocks dramatically outperformed the market since the lows last week. For example, J.C. Penney Company, Inc. (JCP) is up 21% versus just a 12% gain in the Spyder Trust (SPY).

Though I have previously recommended several stocks in this sector, there are two department stores that will look attractive on a pullback and one star performer from last year’s seasonal trade.

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Chart Analysis: Dillards, Inc. (DDS) has been a strong performer for the past few years, rising from a 2009 low of $2.96 to a high of $61.08 in July. The weekly chart shows that the support in the $38-$40 area appears to have held.

• DDS may be able to close above its prior swing high at $49.50 this week, which will confirm a bottom
• There is next strong resistance in the $55-$57 area. Once above the July highs, there are Fibonacci retracement targets in the $67-68 area
• The RS analysis shows a multi-year uptrend and did make a new high in July. It has turned up this week
• The weekly on-balance volume (OBV) is very close to overcoming its weighted moving average (WMA). It has held well above its uptrend (line c) and did confirm the July highs
• There is first good support for DDS in the $45-$46 area

Sears Holding Corporation (SHLD) appears to have formed double bottom in the $51-$52 area, as it has rallied well above the intervening high, line e. The long-term downtrend on the daily chart, line d, has just been broken.

• There is next strong resistance in the $78-$80 area
• The downtrend in the daily RS has been broken, and the weekly RS (not shown) also shows a completed bottom formation
• Volume has picked up recently, and the daily OBV is above its weighted moving average. The OBV is still below the long-term downtrend, line g
• The weekly OBV (not shown) is also above its weighted moving average
• Using Wednesday’s spike high, the 38.2% retracement support is at $65.45 with strong chart support now in the $63.40-$63.70 area, line e

NEXT: Lucrative Seasonal Trade Setting up Again This Year

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One of my best speculative trades from the fourth quarter of 2010 in was Blue Nile (NILE). It ran from a low of around $42 to over $61 during the strong seasonal period.

• Last year, NILE had a very high short interest that likely helped power the stock higher. The short interest is also very high this year, as it will take 18 days of normal volume to cover outstanding short positions
• The 38.2% resistance level has been reached with the 50% retracement level at $47.20
• The RS has broken its eight-month downtrend, line c, and shows a short-term bottom formation
• The volume has not been impressive on the rally, as the OBV is just barely above its weighted moving average. The weekly OBV (not shown) may close above its WMA this week
• There is first support for NILE at $38.60-$39 with stronger support in the $36 area

What It Means: Even though the stock market is doing a good job of holding its gains, a decent setback is still very likely in the next week or so. This should be a good opportunity to buy some of these retail stocks, which I expect to continue to lead the market higher.

Last week, I recommended three retail apparel stocks, and for those, as well as the existing August recommendations it is now time to adjust the stops.

How to Profit: For Dillards, Inc. (DDS), go 50% long at $46.04 and 50% long at $45.10 with a stop at $41.32 (risk of approx. 9.3%).

For Sears Holding Corporaton (SHLD), go 50% long at $65.06 and 50% long at $63.76 with a stop at $59.48 (risk of approx. 7.6%).

For Blue Nile (NILE), go 50% long at $39.24 and 50% long at $37.86 with a stop at $35.68 (risk of approx. 7.4%).

Portfolio Update

• Previous buyers went long Under Armour Inc. (UA) on Oct. 5 at $67.10 and sold half the position on Thursday (Oct. 13) at $76.32. Raise the stop on the remaining position to $66.42.
• Previous buyers went long Polo Ralph Lauren Corporation (RL) on Oct. 5 at $128.78 and sold half the position at $140.52. Raise the stop on the remaining position to $132.42.
• The recommended buy level was not hit in Wolverine World Wide, Inc. (WWW). Cancel that order at this time.
• For Target Corporation (TGT), previous buyers should be long at $50.34, as the stop at $47.52 was just missed. Sell half the position at $54.36 and raise the stop on the remaining position to $49.82.