Is the Retail Sector About to Rebound?

NEW YORK (TheStreet) -- The retail sector has been getting destroyed. Decimated. No body wants to have anything to do with it. In my recent article, Bricks and Mortar Died. Where Did it Go?, I detailed the major shift that has occurred in how consumers are shopping. But everything has a price, and at some point, it becomes too cheap to pass up on. 

Seasonally, the SPDR S&P Retail ETF (XRT) does well in the February through April time period. That time period has been positive for the ETF each of the past five years. 

Trivia question: Which year provided the worst performance during that period in the past five years?

Surprising to say, 2013 was actually the worst period, despite the ETF appreciating a whopping 40% in the year. Here's a look at the past five years: 

In fact, each year since 2009 the ETF has actually performed worse and worse. But who cares? 8.80% is the worst return for the fund in the three month stretch between February and April. On an annualized basis, that's a 35% return. Even if it only returned 4% to 5% in that period, that's still a solid return for three months of work. 

For all the other years, the ETF appreciated by a double digit percentage. Year-to-date, the ETF is off 9%, which increases the odds that it could rally higher in the coming months, especially as we approach the beginning of February. 

But there's a lot of doubt regarding an impending rally. Individual stocks -- like Best Buy (BBY), Coach (COH), Lululemon Athletica (LULU), Bed Bath & Beyond (BBBY), Sears Holdings (SHLD) -- have already reported or pre-announced less than acceptable results. 

And that's just to name a few. Such an easy seasonality trade may seem "too good to be true," which is why I'd exercise some caution. I don't particularly love the holdings in the ETF. The top holding is Groupon (GRPN), with only a 1.09% allocation. 

The other nine stocks, in order of allocation size, include: (OSTK), SuperValu (SVU), The Finish Line (FINL), Aeropostale (ARO), Brown Shoe Company (BWS), Expedia (EXPE), Cabela's (CAB), CST Brands (CST), and Sally Beauty Holdings (SBH). 

Instead of going with these names, I honestly think investors would be better off going with a retail ETF that they custom make. Of course you can't actually make an ETF, but investors can buy a basket of stocks that would mimic a retail ETF. 

When trying to figure out what to buy, I would definitely go for quality. Stocks like Nike (NKE), Costco Wholesale (COST), TJX Companies (TJX), Michael Kors (KORS), Macy's (M), VF Corp. (VFC) Amazon (AMZN) -- even a stock like Starbucks (SBUX) can be considered a retail name. 

I would rather own those eight stocks than the top ten holdings in the XRT. You could even add more stocks for further diversification if you so chose (and depending on the size of your portfolio). 

Of course, if you want to keep it simple, just stick with the XRT. I'm only making a suggestion towards higher quality stocks in that sector that I think will outperform the ETF in the event of a broad sector rally. 

My point is so simple and direct: Retail stocks seasonally outperform between Feb. 1 and April 30. But after the broadly-mixed XRT ran higher throughout 2013, it's quite possible it's time for a break. 

Seven of the eight stocks we mentioned -- Nike, TJX, Costrco, Kors, VF Corp., Starbucks and Amazon -- are down from the start of the year, with the exception of Macy's. 

I'm okay with that. Nike and Starbucks have reported good quarters, in my opinion. Great quarters? No. But definitely ones that should ease investors' worries that the entire retail sector is falling to pieces. 

So long as the rest of these companies report acceptable or decent quarters, I think the retail sector as a whole will likely bottom sometime in the near future. Perhaps by mid-February or so. 

Although the flip side would be that the sector continues to sink amid a broader market correction that weighs on U.S. equities in the first half of 2014. If that's the case, it's important to honor stop-losses and manage your risk appropriately. 

When everyone seems to hate a particular asset class, that's the time to start accumulating a position. When in doubt, always go with quality.

-- Written by Bret Kenwell in Petoskey, Mich. .

At the time of publication the author was long SBUX.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Bret Kenwell currently writes, blogs and also contributes to Robert Weinstein's Weekly Options Newsletter. Focuses on short-to-intermediate-term trading opportunities that can be exposed via options. He prefers to use debit trades on momentum setups and credit trades on support/resistance setups. He also focuses on building long-term wealth by searching for consistent, quality dividend paying companies and long-term growth companies. He considers himself the surfer, not the wave, in relation to the market and himself. He has no allegiance to either the bull side or the bear side.

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