MARKETS SPECTATOR: Ripening retail
Investors are starting to believe that retail may have finally turned a corner. Consequently, several stocks stuck in basing patterns look primed to break-out.
The sector, when compared to the broader market, has really struggled over the last few years as retailers did battle with serious headwinds including weak consumer sentiment, the growth of online shopping and the strength of the Australian dollar, to name a few.
Many of these conditions still exist yet stocks have begun to move higher. As I’ve mentioned many times, the market never waits for the absolute bottom in the business cycle before stock prices begin to move higher. Instead, it pre-empts them and looks ahead by between six to 12 months.
In this case, it looks like the investment community has started to look across the valley and is realising it's probably seen the worst of the cycle and that some of these headwinds are starting to ease. It’s a classic case of ‘climbing the wall of worry’.
As you can see in the above chart, the S&P/ASX 200 Retail Index slumped 56.3 per cent versus a fall of only 21.7 per cent in the S&P/ASX 200 benchmark index. In fact, the retail index was only 8 per cent above its GFC lows.
Within the sector, there are a number of stocks that are really moving, as you can see in the chart below, and some which have just started to move. While some are probably too late to look at, there are three in particular that represent great risk/reward opportunities.
When looking for trading ideas I like to look at sectors of the market that are moving and then drill down from there. An added positive is when a sector has been beaten up for a long time and is breaking out of what technical analysts call ‘basing’ or ‘consolidation’ zones.
While the overall S&P/ASX 200 Retail Sector has already broken out to the upside, there are a couple of stocks which are on the verge or just have broken out.
The above chart of Harvey Norman (HVN) is picture perfect to the technical analyst. The green box represents the basing pattern which has played out over the best part of 18 months. During this phase, we basically have a situation where the amount of selling equals the amount of buying, hence the fact that prices basically move sideways.
The ‘basing’ or ‘consolidation’ pattern, at the bottom of an extended downtrend is an area where the smart money looks to get invested before the upturn eventually takes hold. A lot of big fund managers use this period to buy stock as it provides a lot of liquidity.
In the case of HVN above, it has recently broken out of the basing pattern and now looks to beginning a new uptrend. From a risk/reward perspective, this is the opportune time to get set into such stocks as you quickly know if you have got it wrong and the bulk of the investing community are yet to believe in the recovery.
For example, the broking community is still very bearish on this stock. Of 15 recommendations, 11 of them have sell recommendations with an average target price of $1.93, which is already more than 20 per cent below the current market price.
On top of this, there is a large short position in the stock, roughly to the tune of 10 per cent of shares on issue. Over recent months this has been decreasing, which probably explains a large chunk of the recent gains with traders short buying back their positions. Mind you, based on an average day’s volume it would still take 24 trading days for those positions to be completely unwound.
So the combination of shorters buying back stock and brokers upgrading their recommendations means there is huge upside potential. In short, as sentiment improves, more and more participants jump on board driving the price higher.
Having said all that, HVN has had a very strong run over recent weeks so I would probably recommend waiting for a pullback or pause before jumping on board.
As you can see in the two charts above, the other two stocks that look very interesting are David Jones (DJS) and Pacific Brands Group (PBG). Unlike HVN, where we have already seen a break-out to the upside, these two names are still within their basing pattern, albeit close to the top of them.
As money continues to flow towards the sector, I don’t think it will be long before upside break-outs occur and the stocks start to push higher. Nonetheless, my experience tells me it is always best to wait for the break-out and then buy the first pullback thereafter.