Big Short on Big Lots

The consumer-discretionary group has been one of the weakest sectors in this market, right behind the financials. The weakest names in this group have acted very poorly and continue to grope for any kind of support.

Since the summer correction, the sector has weakened sharply, with traders abandoning the group on the long side, and the short-sellers continuing to lean on these names. The problems for this sector are skyrocketing crude oil and a weakening domestic economy.

Consumer Discretionary ETF

Click here for larger image.

The consumer-discretionary stocks are holding an inverse correlation to the price of oil. When oil prices rise, the sector weakens. It's really that simple. The idea is that as oil rises, consumers will have less discretionary income to spend at the retail level. This trade has been working for short-sellers, and they're going to ride it until the wheels fall off.

Oil prices will have to reverse and start trending lower for this sector to find a low. We believe oil will at least test the $100 level before any selling emerges in the commodity.

Traders on the short side also are betting that weak home prices and an ever-widening mortgage crisis will keep consumers defensive and out of the stores. We're sure that consumer spending will slow down to some degree, but the stocks are acting as if consumers will never set foot in another store.

Consumer Discretionary Breadth

Click here for larger image.

Breadth for the group has reached fresh lows, which shows that liquidity is moving away from the sector with conviction. In spite of all the bad news, our internal SARSI indicators show that the group is not yet oversold. There appears to be more room to move lower in the group.

Until oil prices start to break down and the financial crisis reaches some sort of resolution, the consumer-discretionary sector will remain under pressure. Traders on the long side should avoid the group and not be tempted to bottom-fish until deeply oversold readings are reached. The more productive trade may be to short selected names in the sector.

One name that is weakening in the group and looks like an attractive candidate on the short side is Big Lots (BIG - commentary - Cramer's Take).

Big Lots

Click here for larger image.

Big Lots is a discount retailer currently under pressure. The stock has broken important support at the $23.50 level, which suggests that the bears are reasserting control and taking the stock lower. The stock also has broken out of the long-term downtrend channel to the downside, which suggests a long-term bearish change in the stock.

We would put out short trades in BIG at this level and look for further downside to develop. Use tight stops over the broken support line to close out the trade in the event of a snapback rally. We're expecting the group to remain weak as long as oil is strong. Traders should view this trade as an inverse oil play.

---

At the time of publication, John Hughes and Scott Maragioglio had no positions in the stocks mentioned. Hughes and Maragioglio co-founded Epiphany Equity Research, which has developed and utilizes proprietary tools to identify and track liquidity changes in the market indices and sectors. Hughes advises numerous asset managers, hedge funds and institutions managing in excess of $30 billion. Maragioglio is a member of the market technicians association (MTA) as well as The American Association of Professional Technical Analysts (AAPTA) and holds a Chartered Market Technician (CMT) designation. Maragioglio has also served on the board of directors of the AAPTA.