TomAspray's  Instablog

Restaurant stocks have held up surprisingly well during the correction and could lead the market’s next leg higher. Here are three technically strong stocks that may be worth a nibble.

While concerns over the economy are continuing to grow, there are few signs that they are impacting many of the restaurant stocks. From the May 2 high close on the S&P 500, it has since declined by 6.9% (through Thursday’s close) while the S&P Restaurant index was up 1.7%. That is a differential of 8.6% in just over six weeks.

Many of the individual restaurant stocks have done even better, and typically, those stocks that perform the best during a market correction will lead the market higher once it turns around.

On the other hand, the sectors for which the technical and relative performance analysis is negative have done even worse than the S&P 500.

The technical outlook for the materials sector and the Select Sector SPDR - Materials (XLB) was discussed on May 3 (see “Will the Materials Slump Continue?”), and since the May 2 close, it is down 9.1%, as is the Select Sector SPDR - Energy (XLE). This is 2.2% worse than the S&P 500’s performance over the same time period.

On the first oversold rally in the stock market, the materials and energy sectors may see more short covering, but once the market starts a sustainable new uptrend, groups like the restaurant stocks are likely to do the best.

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Chart Analysis: The S&P 500 Restaurant group bottomed in late January and broke through major resistance, line a, in early May while the S&P 500 was topping. The breakout level at 634 was tested this week.

• The 38.2% support is at 632 with the 50% retracement support at 620.80
• The relative performance, or RS analysis, bottomed in February and formed an uptrend, line c. The downtrend in the RS (line b) was overcome in May
• The on-balance volume (OBV) broke through resistance, line d, ahead of prices. The OBV has just tested its uptrend, line e
• There is initial resistance at 654.50 with the all-time highs at 665.27

McDonalds Corp. (MCD) has acted very well since the market peaked in May, as the stock is up 3.8% since the May 2 close. It has consolidated over the past three weeks but has held the support in the $80 area.

• There is first retracement support at $79 with much stronger chart support in the $77-$78 area
• The weekly RS bottomed early in the year and broke through year-long resistance (line h) in the latter part of May
• The weekly OBV moved back above its weighted moving average (WMA) in March and has made higher highs and higher lows since. It shows a clear uptrend, line i, but has not yet made new highs
• The daily OBV (not shown) also looks strong
• The weekly trend line resistance (line f) is now in the $86 area

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Ruth’s Hospitality Group, Inc. (RUTH) is a small, $190 million company that is best known for its Ruth’s Chris Steak House. The stock averages about 180,000 shares daily and has a whopping short ratio of 19.7. Therefore, with average volume, it would take over 19 days to cover the outstanding short positions.

• RUTH broke through weekly resistance at line a this week on the heaviest volume since February
• The completion of the trading range (lines a and b) has upside targets in the $6.40-$6.60 area
• RUTH hit a high of $18.63 in March 2006 and the 38.2% retracement resistance level is at $8.00
• The weekly RS has also broken out of its trading range (lines c and d)
• The weekly OBV moved above its weighted moving average a month ago and is now approaching its long-term downtrend
• Initial support is in the $5.20-$5.40 area with stronger support at $5.00

Starbucks Corp. (SBUX) is considered more of a ”specialty eatery” than a restaurant. It is now testing the lower boundaries of its three-month trading range in the $34.50-$35 area, line f.

• SBUX broke through resistance in the $34 area in March, so this now becomes strong support with the uptrend, line g, at $33.15
• The relative performance, or RS, also broke through resistance in March (line h) and now shows a short-term positive formation, lines i and j
• The daily OBV is below its weighted moving average and a move through the resistance at line k would be quite positive
• The weekly volume (not shown) has turned up but is below its WMA
• The completion of the trading range (lines e and f) has upside targets in the $40-$41 area. This corresponds to the 2006 highs

What It Means: The technical action of the restaurant group does suggest that it is likely to be a leading sector for the summer months. The three stocks covered have acted much stronger than the S&P 500 and have held up very well during the market’s decline.

Since it is my view that an intermediate top has not been completed, those underinvested in stocks should consider these three companies.

How to Profit: As recommended in mid-April, buyers should be 50% long McDonalds Corp. (MCD) at $76.46 with a stop now at $78.82. Those not currently long could still buy at $81.32 or better with a stop at $78.86 (risk of approx. 3%).

The risk is a bit higher for Ruth’s Hospitality Group, Inc. (RUTH). Buy at $5.36 with a stop at $4.89 (risk of approx. 8.7%), sell half the position at $6.35, and then raise the stop on the remaining position to $5.18.

For Starbucks Corp. (SBUX), buy at $35.08 with a stop at $33.28 (risk of approx. 5.1%). Sell half the position at $38.88 and raise the stop on the remaining position to $34.78.

To learn more about relative performance, or RS analysis, click here.