Preholiday Retail Pageant

This column was originally published on RealMoney on Aug. 21 at 1:00 p.m. EDT. It's being republished as a bonus for TheStreet.com readers.

The retail sector has perked up nicely in recent weeks. And unlike tech stocks, the group didn't start its recovery from severely depressed price levels. This relative strength lowers the influence of oversold technicals in the current bounce and increases the odds that higher prices will be sustained as we head into the fourth quarter.

Why have shareholders rekindled their buying interest in America's storefronts? Is it the improved inflation outlook, or are less obvious forces at work? I believe the rally has more to do with the calendar than with economic policy. We're just a few months away from our annual holiday-buying bash.

Traditionally, retail stocks find good sponsorship in early summer as speculators place their first bets on the quality of fourth-quarter sales. This seasonal phenomenon was suppressed this year by broad selling pressure infecting the markets. Now that things are perking up, buyers appear more willing to take aggressive positions in shopping-mall favorites.

Additionally, the flow of recent sales data has been quite encouraging. It seems that consumers are still opening their wallets these days, despite $3-a-gallon gasoline and higher borrowing costs. Add this to the heavy weighting of retail sales in the fourth quarter, and we have the makings of a legitimate recovery.

But don't overstay your welcome, because timing is everything in this sector. The end-of-year sales outlook for most companies will be fully drawn by Nov. 1, when holiday ads begin to spam the airwaves. By that time, fresh sales data will trigger instant profit-taking and quick shifts in capital between the season's apparent winners and losers.

Here are my top four retail picks for the 2006 holiday season: Casual Male Retail Group(CMRG Quote), American Eagle Outfitters(AEOS Quote), Federated Department Stores(FD Quote) and Men's Wearhouse(MW Quote). I examined my fifth choice, J.C. Penney(JCP Quote), last week in 360 Degrees of J.C. Penney, a RealMoney feature that highlights contributors' various takes on a stock.

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Casual Male Retail Group rallied to its 2004 high at $10.90 in May, moved sideways for three months, and broke out early last week. Price is now sitting at an all-time high, so there's no overhead resistance at all. This nascent rally isn't showing strong upside momentum yet, but that could soon change.

The stock sold off Friday, following a downgrade. The current pullback should offer a buying opportunity as it approaches $11.20. The lack of strong volume on the breakout predicts the stock will move sideways near the high for a while, in order to attract better sponsorship, but it should head toward $15 quickly once that goal is accomplished.

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Avoid American Eagle Outfitters if you don't have a strong appetite for risk. The retailer's volatile swings can shake out the most logical stops and turn profitable positions into instant losers. But there's little doubt this issue will be moving higher in the weeks ahead. Just pick your entry widely to avoid all the nasty whipsaws.

The stock has just broken out of a year-old sideways pattern, with key resistance at $34. The most bullish scenario would be if the rally stalls out here and drops into a narrow trading range near the highs through Labor Day. This consolidation would lower the emotional fires and set up good conditions for a rally up and through $40.

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Federated Department Stores shows weaker performance than department-store leaders Kohl's(KSS Quote) and Dillard's(DDS Quote), but it could play catch-up in coming months. The stock is grinding through a sideways pattern, with major resistance above $40. The next rally to that price level will complete the formation and set the stage for a multiyear breakout.

It looks like the stock is pulling back here to consolidate recent gains. A low-volume decline to support below $36 should offer a good buying opportunity for a run-up to the old high. Traders can take profits there and wait for the larger-scale breakout pattern to set up properly. That might happen a few weeks after the stock reaches key resistance.

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Men's Wearhouse rallied to major resistance at $37 on Thursday, in a vertical move that lifted price nearly 23% in seven sessions. This slingshot move completed a long-term cup-and-handle breakout pattern. But the hot stock needs to cool down first, so look for a low-volume pullback that fills in the recent rally.

That decline could reach $34.50 and still offer a good buying opportunity for an eventual breakout. The rally off the July lows shows an Elliott Wave structure that predicts a burst up to $41.50 before the move finally runs out of steam. So the broad pattern has excellent upside, especially if positions are taken well below last Friday's close.

Please note that due to factors including low market capitalization and/or insufficient public float, we consider Casual Male Retail Group to be a small-cap stock. You should be aware that such stocks are subject to more risk than stocks of larger companies, including greater volatility, lower liquidity and less publicly available information, and that postings such as this one can have an effect on their stock prices.