A Retail-Led Rebound

Includes: XLK, XLY, XRT
by: Clif Droke


Retail stocks join tech in outperforming the S&P 500.

Relative strength in the retail sector bodes well for the interim outlook.

Investors should accordingly increase exposure to retail stocks.

The strong performance lately in retail stocks has largely escaped Wall Street's notice. While the financial press is quick to highlight whenever the retail sector shows weakness, retail strength is often ignored. In today's report we'll see why the recovery in the leading retail stocks is yet another sign in a growing list of reasons why this summer should be a bullish one for the broad market and for the U.S. economy.

Before we examine the retail sector, let's take a quick look at how the overall market has been performing. The S&P 500 Index (SPX) finished last week on a high note and closed the latest session at a 2 ½-month high. While the SPX remains below its technically significant 2,800 level - which marks the upper boundary of February-June trading range - it should soon succeed in overcoming this level and attack its Jan. 26 high of 2872 based on the leadership already shown in other areas of the market.

The stock market continued to show signs of improvement throughout the last week, led by gains in small caps and mid-caps. While the small cap Russell 2000 Index (RUT) has led the charge higher since May, the S&P 400 Mid Cap Index (MID) finally joined the Russell in making a new high last Friday. The MID is one of the six major indices which comprises my trend indicator, the others being the Dow, the SPX, the RUT, the NYSE Composite (NYA), and the Nasdaq 100 (NDX). The S&P 400 Mid Cap Index joined the Nasdaq Composite and the Russell 2000 in breaking free from the confines of a multi-month trading range on June 8. The closing high in the MID was the first new high for this index since January, which is significant. It's also another piece of the puzzle that points to higher prices ahead for the large cap stocks since the mid-caps also have historically led the S&P 500 index at important junctures.

S&P 400 Mid Cap Index

Source: BigCharts

Also supportive of the broad market outlook heading into summer is the internal health of both the Nasdaq and the NYSE. Shown here is the 4-week rate of change of the 52-week news highs and lows on the Nasdaq exchange. This indicator is a useful measure of the incremental demand for equities on a rate of change, or momentum, basis. The direction of this indicator suggests the market's near-term path of least resistance. As you can see here, the Nasdaq's short-term internal momentum remains in fine shape. As I've emphasized in recent commentaries, tech sector relative strength vis-à-vis the S&P 500 normally bodes well for the S&P's chances of catching up to the techs by making new highs in the coming weeks.

Source: WSJ

Another indicator which points to a new high for the SPX this summer is the opening hour indicator. The opening hour indicator reflects price momentum on a short-term basis, doing an admirable job of that for most of this year. The value of measuring the opening hour of trading on a cumulative basis is that it tends to show the market's main direction even better than the S&P 500 Index. A rising opening hour indicator, as shown here, is typically bullish for the near-term outlook.

Source: WSJ

Looking closer at the sectors which are most responsible for the market's recent performance, two sectors stand out most prominently: tech and retail. As delineated by the following graph of the Technology Select Sector SPDR ETF (XLK), tech continues to manifest strength and is leading the charge higher for other segments of the broad market.

Technologoy Select Sector SPDR ETF

Source: BigCharts

The tech sector isn't the only engine of the market's recent show of strength, however. Retail has shown major improvement since last month, with the SPDR S&P Retail ETF (XRT) recently making a new high for the year. More importantly, the retail ETF is showing powerful relative strength when compared with the S&P 500 (SPX). The following chart shows XRT's relative price strength versus the SPX in recent weeks. As you can see, the relative strength line has made a new high and is moving almost straight up. This is a testament to the increasing upside momentum among the major retail stocks. By extension, this is a powerful commentary on the increasing strength of the U.S. consumer economy and also bodes well for the near-term direction of stock prices due to the influence of retail stocks in the major large cap indices.

SPDR S&P Retail ETF vs. S&P 500

Source: StockCharts

Not just retail in general, but consumer discretionary stocks in particular are also doing well on relative basis. Shown below is the relative performance of the Consumer Discretionary Select Sector SPDR ETF (XLY) versus the S&P 500. XLY is one of a few industry-specific ETFs right now to conspicuously outperform the broad market.

Consumer Discretionary Select Sector ETF vs. S&P 500

Source: StockCharts

In view of the above mentioned considerations, investors should continue to lean bullish as we head closer to the summer months. This should be another strong summer for equities overall with tech and retail especially showing promise. Accordingly, investors should weight most of their intermediate-term portfolios more heavily toward retail-specific and tech-focused stocks and ETFs, including the ones mentioned here.

Disclosure: I am/we are long XLK, HACK, IYR.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.