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Dissecting the Sectors: Retail and Homebuilding

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Stocks that have enjoyed positive reactions to earnings and/or same-store sales numbers include Lululemon and Limited Brands. Preferred homebuilder names include KB Home and PulteGroup.

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Here are a couple of noteworthy sectors.

Sector: Leisure/Retail
Bullish


Outlook: Same-store sales for September rose 1.3% from the previous year, according to Briefing.com, and were helped by seasonal weather and the debut of fall merchandise. For the fifth month in a row, discretionary sales trumped staples, 2.6% versus 0.9%. This is an encouraging sign that consumers remain willing to spend.

On the charts, the SPDR S&P Retail ETF (NYSEARCA:XRT) recently tested support at its 50-day moving average, which is parked in the $62 area, site of the security's March/May highs. The next technical hurdle for the XRT -- beyond its annual high at $65.47 -- could come around $67.50. This is roughly 50% above the key $45 mark, which acted as a ceiling in June 2007 and April 2010, before providing support in August/October 2011.

On the options front, we are seeing huge put open interest in the front-month series for XRT, which suggests long players in the sector are hedged via the ETF, and could mean limited downside on pullbacks. As far as specific equities go, we prefer stocks that have enjoyed positive reactions to earnings and/or same-store sales numbers, such as Lululemon Athletica (NASDAQ:LULU), Limited Brands (NYSE:LTD), and Gap Inc. (NYSE:GPS).

Contrarian investors should continue to look for trade setups where outperforming retail stocks remain unnoticed by the crowd. Given recent indications of overexposure on the part of hedge funds, however, we would recommend avoiding any "popular" stocks in this group that have suffered poor price action. One example of this phenomenon is Sears (NASDAQ:SHLD), which is among the top-50 holdings at these prominent hedge funds, despite dropping roughly 30% from its March peak.

Sector: Homebuilding
Bullish


Outlook: We continue to see evidence that the housing sector is in recovery mode. Recent reports have shown housing starts at a 28-month peak, existing-home sales at a 27-month best, home prices at a new five-year high, and the average 30-year mortgage rate at just 3.36%. Plus, the Fed's plan to buy mortgage-backed securities as part of its QE3 endeavor is even more bullish for homebuilders, and the Fed's Beige Book indicated that economic activity "expanded modestly" in September, with residential real estate the bright spot.

Despite positive price action, some of the "sell"-side analysts are getting nervous. For example, since late September, Barclays, Susquehanna, and MKM Partners have downgraded the housing sector. This is in addition to the report earlier this month that hedge fund manager Whitney Tilson is betting against the group. This downbeat backdrop is encouraging for contrarian investors, as it sets the stage for positive momentum on any good news, and underscores our theory that the euphoria evident at tops isn't yet in place for this group. Meanwhile, the SPDR S&P Homebuilders ETF's (NYSEARCA:XHB) 50-day put/call volume ratio on the International Securities Exchange (ISE), Chicago Board Options Exchange (CBOE), and NASDAQ OMX PHLX (PHLX) stands at 2.23, as puts bought to open have more than doubled calls during this time frame. We saw a similar pop in this ratio in February, preceding a three-month rally in the ETF.

This latest uptick could be the result of hedge funds using these puts to protect the long stock positions they've been accumulating. As a result, individual investors who are long housing may also want to consider hedging with the broader puts to guard against possible short-term shocks. In addition to KB Home (NYSE:KBH), some of our preferred names in the group include PulteGroup (NYSE:PHM), D.R. Horton (NYSE:DHI), Toll Brothers (NYSE:TOL), Lennar (NYSE:LEN), and Meritage Homes (NYSE:MTH), due to a combination of solid price action and lingering skepticism from Wall Street.

This article by Schaeffer's Editorial Staff was originally published on Schaeffer's Investment Research.

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Twitter: @schaeffers
No positions in stocks mentioned.
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