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Retail Rollover\?

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I've watched the S&P Retail Index (RLX.X) trace two consecutive lower relative highs since peaking at 835 on October 17. For obvious reasons, the retail business is dependent on the consumer. And it's been the consumer who's kept the economy adrift during the current slowdown.

With this week comes several high profile economic reports, some of which will reveal a lot about the U.S. consumer. Perhaps the biggest release of the week is Friday's employment report. Other economic reports include Consumer Confidence Tuesday morning, Q3 Gross Domestic Product is set for release on Wednesday, and NAPM numbers will be released Friday, too. But I'd like to focus on the employment report Friday as it relates to the retail sector.

Friday's employment report will reveal more about the layoffs surrounding the September 11 attacks. For that reason, it should be a very negative report. Consensus estimates expect the Labor Department to reveal an unemployment rate of 5.2 percent, along with a loss in payrolls to the tune of nearly 300,000. While the employment report is a lagging indicator, it could offer more insight into the mind of the consumer.

The thinking is simple: If a consumer is worried about his/her job, he/she is less likely to spend, especially on discretionary items such as apparel, electronics, and footwear.

With components such as Best Buy (NYSE:BBY), Circuit City (NYSE:CC), Gap (NYSE:GAP), Home Depot (NYSE:HD), and The Limited (NYSE:LTD), the RLX.X is obviously tied to discretionary spending. A further loss in jobs and subsequent decrease in consumer spending could send this index lower over the short-term. I don't have any insight into that trend, nor do I care to speculate if further job cuts lie ahead.

Instead, the best thing that I can do to predict the future trend of consumer spending is to monitor the nuances of the RLX.X. The recent patterns of relatively lower highs in the index may indicate a further weakening in the consumer. As the chart below reveals, the RLX.X hasn't been able to push past its relative highs during recent rallies.

(The chart that I've used includes a retracement bracket, which measures the RLX.X's recent rally from its September 11 lows. I used roughly 685 and 870 as anchor points, but you can't see those because of the shorter time period [60-min] that I used to gain a short-term view of the RLX.X.)

The 800 level (38.2% retracement) has been used as support in the recent past, but was broken last week, so I think it's a weaker support level now. What will be interesting is if the RLX.X traces a lower relative low in this most recent pullback by trading below last week's lows around 790. If the RLX.X does fall below roughly 790 over the short-term, then I think the argument for a further deterioration in consumer confidence grows stronger, which may create some bearish opportunities in the RLX.X over the short-term.

In search of more conviction, I'd like to see the RLX.X give up some more relative strength versus the S&P 500 (SPX.X). For its part, the RLX.X has traded exceptionally well relative to the broader market. A loss of relative strength would only add credence to the argument for a further loss in consumer confidence.

Finally, for risk management's sake, I'd prefer to enter any bearish plays on the RLX.X up around its descending resistance level, which is currently around the 820ish area as drawn on the above chart. The RLX.X looks as if it's put in a top of sorts, and in the current market environment, I feel more comfortable entering a bearish trade near resistance than on a breakdown below support. The chart above revealed how the RLX.X broke down below the 800 level last week, only to quickly rebound and trace its second relatively lower high. I would rather be in on the third relatively lower high if it comes, than pursuing weakness.

Eric Utley
Option Investor

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