A Rising Market into Retail Earnings

The Strength of the Consumer Discretionary Sector

It wasn’t that long ago that Walmart (WMT) pre-announced negative earnings revisions (July 26th to be exact), and we saw WMT stock gap down 10% overnight on the news, and take all retail stocks with it. That pre-announcement that initially looked like it would put a grey cloud over the second half of earnings season, ended up being a discount buyers gift. In fact, with that move we saw a fall that came within dollars of Walmart hitting a new low on the year, only for buyers to bring the stock right back up to where it came from, within a time span of only five trading days.

Check out the pre-earnings view of Walmart in the Hot Zone below:

Walmart on 8.15.22 prior to reporting Q2 earnings.

It was around this time that I was noting to Mastery members that institutional short interest was incredibly high and most notably concentrated within consumer discretionary, retail, and housing stocks. This was after noting almost a month prior that the put/call ratio was at the highest level since March of 2020, which is typically a major sign of a reversal.

The irony of the stock market rallying despite the fact that companies are reporting job cuts, earnings revisions, cost-cutting measures, impacts of continually high inflation, and more is not lost on me, but this is a reality I noted to my Five Star Trader readers the week of FAANG earnings.

As I stated to readers on July 26th, 2020, along with a note of the incredibly high put/call ratio:

“The only other catalyst I see on the docket is the possibility that the put/call ratio gets so high and sentiment gets so weak, that we end up rallying simply because everyone is too short – but not because the economy or stock market are actually improving.”

Ultimately, this is how it played out. Despite so many negative headlines throughout the core of earnings season, it was the short-covering rally that ended up causing a FOMO-induced (fear of missing out) buying rally that has exceeded expectations.

The Short Covering Rally from Hell (if you were short…)

The reason why short covering can laugh and make you shake your head from time to time is that often times it doesn’t really make sense. You may see the trashiest stock and the most worthless looking chart suddenly gap up and rally 10-20%, or more. Fundamental analysts will look at each other and say, “No way! The value of the company didn’t change that much overnight!” But, it’s technical analysts and traders that know that when it comes to high short interest, a news-related catalyst, and a break of highs (the spot where short sellers cover) that can cause these massive moves.

And, crazy enough, with the amount of short interest out there, especially in the retail space, despite high inflation, consumers getting squeezed due to that inflation, consumers running down savings and charging on credit cards and more – retail stocks can and are rallying.

Check out the daily chart of the consumer discretionary sector (XLY) below:

Again, it’s a chart that a fundamental analyst may look at and say, “It doesn’t make sense!” But it does, in the context of short-covering. This space was the most heavily shorted space, and once the market started bottoming out and investors started to fear they missed the bottom, that buying pressure plus short-covering caused by moves higher has only meant upside in this market.

But, there is a difference between short-covering and actual, real buying that determines the difference between a bear market rally and ‘THE low.’

Right now, it still strikes me as short-covering. But, this week will tell us whether or not the bear lost this battle for good. Why?

Retail Earnings Week

This week, we see many heavy hitters reporting earnings. These companies are the core consumer discretionary names that are the largest weighted stocks in consumer discretionary, staples, and housing as well. Reports from the likes of Walmart (WMT), Home Depot (HD), Lowes (LOW), TJMaxx (TJX), John Deere (DE), and more will be absolutely critical to determining whether or not this rally is destined to die right here, or not.

The craziest part about this week is that I know for a fact there will be a fair amount of negative tidbits to glean when these various companies report earnings. Going into earnings season and throughout earnings season thus far I have stuck by my analysis that earnings would shed light on the bevy of economic issues that are entrenched in the current state of affairs. I do believe this has been the case (AMZN reporting two losing quarters in a row, MSFT missing numbers, WMT negative pre-announcement, SNAP destruction, ROKU obliteration, and more) however the moves that come after aren’t always going to make sense or align with the fundamental perspective. That’s why, no matter how bad the situation may seem, one always has to be wary of the short squeeze from hell…because it’s exactly when everything seems so impossibly bleak that it will come out to shine.

Lowes in Focus

While WMT will be critical, so will the response to Home Depot and Lowes. It’s not just the actual numbers, but what matters, even more, is how the market digests that news. As we have seen, the report could be downright terrible and the stock can still rally! So, what are we looking for? Well, let’s focus on our stats and check out the Hot Zone, but don’t forget that the post-earnings momentum is even more in focus this quarter than normal. Click here to learn more about my favorite earnings tool, the Earnings Hot Zone! 

Lowes (LOW) in the Hot Zone

LOW in the zone on 8.15.22 after market close

Now, first of all, let me start off by saying I’m bullish on Lowes overall long-term. I am an investor in the stock and I love opportunities to average in on the long side. But, I’m also bullish on earnings, with the slight caveat being that this ticker has rallied so hard going into earnings, the only way it can actually continue going higher from here is if shorts continue to run for their lives (which is entirely possible) and this continues to spark FOMO buying. It may not make sense, given these technical levels, but that is what I’m looking at. If LOW can report well, which, they normally do – beating EPS estimates the last 12 quarters in a row, I wouldn’t be surprised to see LOW trade to $220. At that juncture, there is a massively important resistance zone at the 200 SMA. If that zone breaks, even despite already having such a strong rally, it could still keep going. That is the crazy part.

Conclusion

Sometimes the market doesn’t make a lot of sense, but if you think about this current market as a function of purely emotional buying and selling based on news, then it makes a little more sense. It’s sure to be another volatile week, and the moves this week will also determine quite a bit of what is to come at the end of the month. If you want to join me as I walk through all of these reports and more, join me in my Stacked Profits Mastery program where you can join now for a special one-month trial for $47! While I can’t tell you for sure which way this thing will go, one thing is for sure…it shan’t be dull, but we’ll walk through it together!