Brick-and-mortar retailers surged to higher ground last week, with many components breaking out of basing patterns or posting new 2018 highs. This buying wave should continue into the third quarter, with speculators betting on a surge in U.S. consumer spending, driven by tax cuts and receding trade tensions. Even so, it's best to stick with the strongest sector players because many components continue to lose market share to online juggernauts.

Major department stores finally bottomed out in the fourth quarter of 2017 after a two-year bear market dropped many components to five- and six-year lows. Department store stocks lifted well off multi-year lows into January and turned lower with the broad averages, dropping into the second quarter. Renewed buying interest in the past week may signal the end of that correction, allowing many issues to reach new 2018 highs. (See also: The Four R's of Investing in Retail.)

 

The SPDR S&P Retail ETF (XRT) offers the most popular way to play the broad retail sector as it tracks a broad-based, equal-weighted index of 84 stocks in the sector. The exchange-traded fund draws retail stocks from the broad S&P Total Market Index, not the large-cap-oriented S&P 500. It topped out in in the lower $50s in 2015 and dropped into a 15-point trading range that's still in force more than three years later. It spent nearly two years carving support at the 200-day exponential moving average (EMA) in the $30s, finally turning higher in November 2017, and has now posted a higher low at the 50-day EMA. This bullish action sets the stage for testing at major resistance between $49 and $52.

Rallies failed at the bottom of that resistance zone in 2015, 2016 and January 2018, so bears are likely to force another reversal, using weakness near the round number $50 and the 2015 high at $51.25 to reload positions. However, strong support in the mid-$40s could short-circuit their efforts, triggering a breakout that hits a bull market and all-time high. That would mark a major accomplishment, given the state of the traditional retail industry in recent years. (For more, see: Top ETFs to Trade the Retail Revolution.)

 

Kohl's Corporation (KSS) stock has lifted into mall anchor leadership, with lowly J. C. Penney Company, Inc. (JCP) and Sears Holding Corporation (SHLD) stuck at the other end of the performance spectrum. Kohl's shares returned to resistance at the 2002 and 2007 highs in the mid-$70s in March 2015 and rolled over, entering a downtrend that found support at a seven-year low in the mid-$30s. It completed a double bottom reversal in July 2017, while the subsequent uptrend stalled in January 2018 at the .786 Fibonacci selloff retracement level. 

The stock turned lower into early May, carving a descending triangle that's hugging the 50-day EMA. Last week's rally reached a six-week high within a point of triangle resistance, raising the odds for a downturn because this pattern has a well-deserved bearish reputation. However, it can generate dramatic squeezes when armchair short sellers get trapped, which may happen if buyers can pierce the lower highs trendline at $66.

[Learn to recognize chart patterns and plan your trading strategy in Chapter 5 of the Technical Analysis course on the Investopedia Academy]

 

Costco Wholesale Corporation (COST) stock entered a shallow rising channel in the first quarter of 2015 and is still trading within that pattern more than three years later. It posted a new high at $199.88 in January 2018 and turned lower, settling around the 50-day EMA in the mid-$180s. The stock turned sharply higher in April, returning to the prior high and dropping into a rounded pattern that has completed a small-scale cup and handle pattern.

A breakout forecasts a rally to $225, well above channel resistance at $205. In turn, that may generate a rock and a hard place setup, in which committed buyers and sellers get trapped within a small price zone, like an equity cage match, with one side exiting victorious. Sellers hold a small edge right now because on-balance volume (OBV) has failed to reach the 2017 high, generating a bearish divergence that needs a series of high-volume buying days to overcome. (See also: Costco May Plunge 11% as Growth Slows.)

The Bottom Line

Retailers are attracting strong buying interest, setting the stage for a mid-year rally that could lift many components to multi-year highs. (For additional reading, check out: Analyzing Retail Stocks.)

<Disclosure: The author held no positions in aforementioned securities at the time of publication.> 

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