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Dissecting the Sectors: Retail and Homebuilding

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Contrarian investors should continue to look for trade setups where outperforming retail stocks remain unnoticed by the crowd. Investors who are long housing should consider hedging to guard against possible short-term shocks.

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Here are a couple of sectors of note.

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) successfully tested support last week at its 40-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 $65.57 -- 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). 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 34% from its March peak.
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No positions in stocks mentioned.
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