An Economic Surprise May Spark a Rally in This Sector

As a former economist for the government, I'm quite familiar with the data models that often put the markets on edge. I spent years developing economic projections of the labor market and predicting what growth meant for the economy. 

Since all of these models are limited to prior data, they ultimately miss forecasting actual economic activity by a long shot. But knowing the factors involved, as well as the less quantifiable dynamics at play, it was often possible to predict whether the actual results would surprise to the upside or disappoint. 

Of course, I couldn't trade on the information at the time. But now I can take that background and apply economic projections to my investments.

One projection could come in surprisingly high in coming months -- and make savvy investors a pretty penny as a result.
 
While it's taken a backseat to fears of a slowing Chinese economy and higher U.S. interest rates, forecasts for a weakening U.S. economy have played a role in the market's recent volatility. The Atlanta Fed GDPNow estimate puts third-quarter growth at just 1.4% on an annualized basis, less than half the growth booked in the second quarter.

GDPNow Chart

I think these forecasts are wrong. Several factors are pointing to an upside surprise for economic growth in the third and fourth quarters, which could elevate stocks into year end. 

The resulting sentiment should be especially beneficial for retail stocks heading into the holiday shopping season. Today's trade will allow traders to capitalize on this and earn a potential 40% profit before we ring in the new year.

Strong Economy Could Mean Holiday Shopping Cheer

Late last month, second-quarter GDP growth blew past estimates when it was revised up to a 3.7% annual pace compared to an initial estimate of 2.3%. The surprise was based on stronger-than-expected consumer sales, as well as a slight inventory build in manufacturing.

That inventory build, along with recent stock market weakness, have led to weak forecasts for third-quarter GDP growth. But consumers could be the wild card again. They shrugged off stock market weakness during the back-to-school season, pushing August retail sales higher by 0.2% -- nothing spectacular, but also nothing to sneeze at.
 
Strength in consumer spending is being partially driven by lower prices at the pump. The national average for gasoline now sits at $2.29 a gallon, nearly 32% lower than the $3.34 average this time last year. U.S. drivers average 1,123 miles each month. If their vehicle gets 20 miles to the gallon, drivers are tallying savings of $60 a month compared to last year.

An extra $60 in disposable income each month might not send retail sales into the stratosphere, but the effect on consumer sentiment has been tangible. The Michigan Survey of Consumer Sentiment hit an average of 94.9 in the first half of the year, its highest since 2004.

Finally, it looks like wages might actually be catching up to economic growth and could provide another tailwind for retail sales this holiday season. Average hourly earnings increased $0.08 in August, the largest gain since January, following a stronger-than-expected increase of $0.06 in July. 

Research firm Deloitte is forecasting a 4% increase in holiday sales this year, and the fact that most analysts are forecasting retail sales growth below last year's 5.2% increase leads me to believe there is room for a surprise to the upside.

SPDR S&P Retail ETF (NYSE: XRT) could be the best way to play this. Stronger economic activity and early estimates for holiday sales could push the ETF back up to $48, where it traded in mid-August and 5% above recent prices.

Amplify 5% Upside Into a 40% Potential Return

Call options offer an opportunity to turn XRT's potential upside into a 40% profit. 

I especially like buying options on ETFs because volatility is generally lower and option premiums cheaper than with individual stocks. In other words, there is the potential for outstanding profits with even less risk. 

Just check out these returns:

ETF Returns

(Besides the amazing returns, these trades have one other thing in common. Click here to find out what it is.)

With XRT trading at $45.58 at the time of this writing, we can buy XRT Dec 44.50 Calls for $2.50 each. That is a call option with a $44.50 strike price that expires on Dec. 18. Each contract controls 100 shares, costing you $250 per contract -- a fraction of what it would cost to purchase the shares outright.

The trade breaks even at $47 ($44.50 strike price plus $2.50 options premium), just 3% above the current price. 

If XRT hits my $48 target, then the call options will be worth at least $3.50 a share ($48 ETF price minus $44.50 strike price) for a 40% return in just 85 days. I recommend placing a good 'til cancelled (GTC) order to sell your calls at $3.50 and lock in the return.

The first estimate for third-quarter GDP will be released in late October, while Black Friday sales numbers will be released right after Thanksgiving. Both are potential catalysts to send XRT higher.

The options expire during the week of the FOMC meeting in December, during which it's expected the Federal Reserve will begin to raise interest rates. This could increase stock market volatility, and therefore option premiums, which could also help push these calls to the GTC price.

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