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Watching the Retail Sector

Bernie Schaeffer
Bernie Schaeffer
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Last week, my colleague Richard Sparks commented on the differing construction of the Retail HOLDRs Trust (RTH) and the PHLX SIG Specialty Retailer Index (RSQ). Richard concluded that sentiment played a large role in this disparity, noting that "It's clear that more pessimism exists as a whole on RSQ components as compared, overall, to RTH components. That, coupled with the fundamental differences in the underlying securities, shows why RSQ has been the technically superior performer."

Adding to this, I think that the biggest albatross plaguing RTH is Wal-Mart Stores (WMT), which is quite a drag on the trust as its second-heaviest-weighted component. As I've mentioned before on, WMT is one of a select group ofoverloved, underperforming blue chips that remains a drag on the entire market, not just its sector index.

But don't count RTH out just yet. Even faced with the underperformance Richard referenced and the drag of certain dead weight, the sector could still present some profitable opportunities over the near term. Looking at the charts, RTH is edging higher after a successful test of support from its 80-day moving average. This trendline has been technically significant for months, serving as resistance in early September and support during the first week of December.

The trust also stands to benefit, for the next few sessions anyway, from heavy out-of-the-money put support at the 95 level. This strike is the site of heaviest open interest in the January series, home to nearly 16,000 open contracts. Should these positions be rolled forward into another month's expiration series, the structural support could remain a factor. Note how the trust's early-January 2006 lows were around this key strike price.

And finally, from a sentiment standpoint, here's a quick look at the action in the Rydex Retailing Sector Fund. Shares in the fund (that's assets adjusted for changes in the net asset value) appear to be coming off a short-term bottom, similar to that reached in October of last year. Unlike the October bottom, the price action in the fund did not warrant such steep outflows during the waning weeks of the year. As such, this fund could be considered oversold and ripe for an uptrend.

But while the retailing group could be poised to move higher, RTH's ultimate gains might be somewhat hindered by its large-cap components. The best way to play this sector currently is by assuming a long position in retail-group members that look most appealing from an Expectational Analysis® (EA) perspective. According to our sentiment indicators, these include (AMZN), AnnTaylor Stores (ANN), Abercrombie & Fitch (ANF), Jos. A. Bank Clothiers (JOSB), and Christopher & Banks (CBK). All of these issues have respectable price action and a decent degree of short interest at their backs, signifying the presence of sidelined funds.

To protect your portfolio, you can hedge by shorting stock or buying puts on names that are weak EA candidates. In addition to WMT, other unimpressive names include Walgreen Co (WAG), Kohl's (KSS), and CVS Corp. (CVS).

Bernie Schaeffer will be available to take your questions until Monday, February 6. Please use the form below to submit your questions.

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