Here's Where to Find the Biggest Outperformers for the Rest of 2018

Here's a big prediction, straight from my Best in Breed screen: A huge portion of the profits you'll make for the next three months will be in just two sectors – retail and consumer discretionary.

Here's why I know...

See, instead of following overhyped slogans like "Sell in May and go away" - which would have cost you about 8% in returns based on the S&P 500 since May 1 - I prefer to actually look at what the data really says about seasonality. Crazy, right?

The data's telling me that the back-to-school, Halloween, and holiday shopping periods are three of the most fruitful selling seasons for this special group of stocks.

I'm going to let the numbers do the talking...

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The Charts Don't Lie

The table below shows that since 2000, during the Sept. 1 through Dec. 1 period, the SPDR S&P Retail ETF (NYSEArca: XRT) and the Consumer Discretionary Select Sector SPDR ETF (NYSEArca: XLY) are two of the top three performers, both in terms of absolute return and relative strength against the S&P 500.

Last year, for example, XRT and XLY gained 11% and 8% respectively during this period, while the S&P 500 managed a respectable 7% return.

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So why the outperformance?

Well, I see this as a "buy the rumor, sell the news" type of situation. Around the beginning of September, investors buy into the upcoming holiday shopping season, expecting these stocks to get a boost from sales results.

This bullish period ends around Dec. 1, when investors sell out of the trade to lock in profits as Black Friday results come pouring in.

In fact, the broader market tends to catch up with the retail and consumer discretionary sectors in December, as the "Santa Claus rally" often kicks in for the S&P 500. That's when seasonality usually shifts to favor banking and regional banking stocks.

While you might think the holdings of these two sectors overlap such that investing in one could cover both sectors, once again, a check of the facts says otherwise. While there is some duplication in lower-weighted holdings, not one stock can be found in either exchange-traded fund's (ETFs) 10 largest holdings. So I'd play both to maximize the clear seasonality strength.

Let's briefly look at each fund.

Here's a Peek Under the Hood of These Profit Machines

XRT is an equal-weighted ETF, as its top 10 holdings - which include SUPERVALU Inc. (NYSE: SVU), Rent-A-Center Inc. (Nasdaq: RCII), and Rite Aid Corp. (NYSE: RAD) - comprise less than 15% of total assets. Since the April 2 low, XRT has been a beast, driving 20% higher. In contrast, the S&P 500 is up 12% during the same period.

XRT is pulling back a bit from last week's all-time high just below the $53 level. But all pullbacks of the past several months have been well supported by the tandem efforts of the 20-day and 50-day moving averages.

What's more, XRT has a composite short-interest ratio of 7.4, the third highest of all the ETFs I track. My readers know I love high short interest, because it typically unwinds into buying pressure when the shorts are squeezed out of their positions by a strong uptrend (like we're seeing with XRT now).

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XRT Stock Chart

While XRT has fewer headline-grabbing names, XLY is on a completely different path. The top 10 stocks comprise more than 60% of the total assets, led by Inc. (Nasdaq: AMZN), which commands nearly 25% of the ETF. Other top-10 holdings include heavyweights Netflix Inc. (Nasdaq: NFLX), McDonald's Corp. (NYSE: MCD), and Walt Disney Co. (NYSE: DIS).

XLY's chart is similar to that of XRT, with a gain of just under 18% since April 2. Likewise, support from the 20-day and 50-day moving averages is in play, leading the ETF to another record high today. In fact, XRT hasn't closed a day below its 50-day since early May.

XLY Stock Chart

With Sept. 1 right around the corner, I'd jump aboard these sectors this week and ride the seasonality wave for the next three months. If you'd like to leverage the expected move with options, I suggest the XLY at-the-money $115 call that expires on Jan. 18, 2019.

Later this week, I'll follow up with two Best in Breed stocks from these juicy sectors. I'll see you then.

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About the Author

Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.

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