With the final quarter of the year underway, all eyes are turned toward the performance of retailers as the October–November period embraces the key holiday season. As loads of sales-boosting events – Halloween, Thanksgiving, Cyber Monday, Black Friday and Christmas – fall in this quartile, the sector generally sees a sales boost.

Having said this, we would like to note that the quarter did not start on a joyful note this year especially after the soft jobs report for September. This, along with muted inflation and the global market crisis, restrained the Fed from a lift-off in September. The situation is so jumpy that most investors have shifted the timeline of the first rate hike in the U.S. to early 2016.

The retail sales also give cues of a slowing economy and lack energy to date. Though sales made a comeback in July having grown 0.7%, the pace once again slowed in August as sales nudged up 0.2% in the month. The data was also shy of the market estimate for August.

As per FTI Consulting, holiday retail sales are likely to expand 3.9% year over year this year, down from the 5.2% pace noticed last year. Whatever the case, no one can simply ignore the sector in the all-important Q4. As per FTI Consulting, consumer confidence is still quite high, but way below the eight-year peak attained at the start of the year. For September, the overall consumer sentiment index was the lowest in 11 months and painted a relatively dull outlook for the space.

Sill we highlight a few reasons why the space deserves close attention in this Q4.

Seasonal Tailwind: A Deutsche Bank report recently indicated that over the past five fourth quarters, the S&P Retail Index outdid the S&P 500 in return. While the retail index rose 7.7% on average the S&P 500 jumped 6.9%. According to the Equity Clock, “the period of seasonal strength for the consumer discretionary sector ranges from October 17^th through April 12^th,” yet again confirming the sector’s cyclical strength (read: 4 Sector ETFs for Q4).
 
Solid Earnings Estimates: Investors should also note that we are also just a few days away from properly stepping into the third quarter retail earnings season which would also leave some impact on Q4 trading activities.
 
Per the Zacks Industry Trend, the sector is expected to post earnings growth of negative 0.1% and 5.7% in Q3 and Q4 of this year, respectively, both better than the broader consumer discretionary sectors. Its sales expectation is also steady at 3.4% for Q3 and 7.1% for Q4, again better than consumer discretionary. The retail space was a super-performer too in Q2 as well with 4.3% earnings and 5.5% revenue growth.
 
Favorable Operating Environment: Plus, the Fed is still being dovish (and chances of tightening this year is less likely post a somber September job report) and oil prices are low enough to fatten consumers’ wallets. As per JPMorgan Chase Institute analysis, nearly 20% of the energy savings are being shelled out on restaurants and 10% on extra groceries by the consumers.
 
Also, the greenback has been range-bound lately which in turn should give a boost to the offshore earnings of the big-box U.S. retailers. All these point to a risk-on trade sentiment in the market and some interesting trends are already starting to develop.
 
Recovering Consumer Sentiment: Bloomberg's consumer comfort index rose to 44.8 for the week ending October 4 from 43.0 recorded in the week earlier. The pointer advanced 4.6 points over the last three weeks representing the ‘biggest gain for any comparable period since May 2009’.
 
Moreover, the Bloomberg buying-climate index, which gauges consumers’ opinion about if the right time to buy stuff, improved to 39.6 from 38.4. The data came in at the highest since May, per the source.
 
Reasonable Valuation: The sector also sports a decent valuation. Like most other products in the broader consumer discretionary space, the biggest retail ETF XRT  has a below-50 relative strength index at present. This indicates that the products are yet to enter the overbought territory.
 
Still, investors wary of the recent lull in retail stocks trading can consider the ETF or basket approach. This is because the ETF route helps investors to mitigate one company’s average performance with the other companies’ stellar results. Below we highlight three Strong Buy-rated rated ETFs which are expected to outperform in the months to come and could be excellent picks to tap the space (read: all the Top Ranked ETFs).
 
Market Vectors Retail ETF (RTH)
 
This fund tracks the Market Vectors US Listed Retail 25 Index and holds about 26 stocks in its basket. It is a large cap centric fund and is heavily concentrated on the top 10 holdings with 64.2% of assets – the largest allocations going to Amazon.com, Home Depot and Wal-Mart. Several constituents of the top-10 holdings hail from the top-rated sectors (see: all the Consumer discretionary ETFs here). 
Sector wise, consumer discretionary accounts for 56.4% of the basket followed by 33.8% weight attributed to consumer staples. The fund has amassed $211.2 million in its asset base. Expense ratio comes in at 0.35%. The product has a Zacks ETF Rank of 1 with a Medium risk outlook and added 1.3% over the past one month (as of October 7, 2015).
Vanguard Consumer Discretionary ETF (VCR)
Like RTH, this one also takes a slightly diversified approach into consideration and taps the broader consumer discretionary sector. This ETF follows the MSCI U.S. Investable Market Consumer Discretionary 25/50 Index, holding a basket of 385 stocks. The product has managed to accumulate $2 billion in its asset base so far, charging investors just 12 bps in annual fees (read: 3 Excellent ETFs for a Low Cost Diversified Portfolio).

Amazon, Walt Disney and Home Depot are its top-three holdings. The fund invests about 37.5% of assets in its top-10 holdings. VCR was up 1.8% in the last one month.

DWA Consumer Cyclical Momentum ETF (PEZ)

This fund follows the DWA Consumer Cyclicals Technical Leaders Index and provides exposure to 38 consumer stocks having positive relative strength (momentum) characteristics. No stock accounts for more than 5.2% of the portfolio, thus resulting in low concentration risk (see: 2 ETFs Rising to Rank #1 This Earnings Season).
 
PEZ is less popular with AUM of $180 million. The fund charges 60 bps in fees. The product was up 0.4% in the last one month.

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