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Why Retailers Wreak


The sector is surging but strategists warn against it.

The latest read on consumer confidence might be signaling an American shopper down in the dumps, but the stock market is telegraphing a very different message to investors.

Let's start with how we're all feeling right now. The answer: not so great, according to the most recent Consumer Confidence report released on Tuesday.

The Consumer Confidence Index (CCI) fell from a 16-month high of 56.5 in January to an 11-month low of 46.0 in February, at the bottom of its volatile flat trend, says Dr. Ed Yardeni of Yardeni Research.

The investment strategist also points out that the Washington Post/ABC Consumer Comfort Index slipped a point for the second straight week during the week ending February 21. The index is based on three core questions: Respondents rate the condition of the national economy, the state of their personal finances, and whether now is a good time to buy things.

The most recent reading is within four points of its all-time low hit in January 2009.

In brief, you and your neighbors, struggling with a lousy labor market and declining home values, are melancholy, which has retailers feeling understandably kind of nervous.

The Wall Street Journal puts it this way: "Americans show little sign of regaining the confidence that once made them world-champion shoppers, and that caution has retailers leery about the prospects for the economy in 2010."

The Wall Street Journal goes on to note that several top store chains this week reported stronger results and lingering doubts, with Target (TGT), Home Depot (HD), and Macy's (M) warning that sales gains will continue to be slow, especially in the year's first half.

More generally, the shift we're now experiencing -- from 25 years of go-go borrowing and spending to a new appreciation for thrift and frugality -- could be an enduring feature of the post-recession economy.

So says management consulting firm Booz & Co. In a survey released this week, the firm found that just 18% of consumers planned to spend on apparel, clothing, and shoes at pre-recession levels in the next year.

Moreover, two-thirds of respondents say they'll shop at a different store with lower prices even if it's less convenient for them.

But for all this new prudence of consumers and the skittishness of retailers, investors have been making their own decisions: They're committing capital to those consumer-focused companies.

The SPDR S&P Retail (XRT), an ETF with holdings including Foot Locker (FL), Sears (SHLD), and CarMax (KMX), is up 82% in the past 12 months. Year-to-date, it's up 2.7%. The S&P is down 2.3%.

In fact, Bespoke Investment Group notes that the S&P 500 Retail sector actually made a new bull market high yesterday.

"While the Consumer Confidence report is indicating a weak consumer, the market still seems to be predicting strength from the consumer," Bespoke analysts say. "If it weren't for groups like retail, the overall market would be doing worse."

How to explain the rocking retailers right now?

Jon Markman of Markman Capital Insight offers a theory: He points out that tax refunds are going out this month and next month, and they're larger than expected due to the delayed effect of tax cuts implemented last year in the $750 billion fiscal stimulus package.

"When families have extra money in difficult times, studies show they tend to pay down some debt and then spend the rest quickly at discount stores," Markman wrote clients in his morning missive today.

He says this accounts for the surprising strength in retailers ranging from Home Depot to Family Dollar (FDO), 99 Cents Only Stores (NDN), Ross Stores (ROST) and Costco (COST), all of which are at or near one-year highs.

However, Peter Boockvar, equity strategist at Miller Tabak, sees it a bit differently.

Investors have moved into the retailers, Boockvar argues, for the same reason they've regained optimism in many sectors of the market: They see that American businesses, in response to the economic downturn, engaged in some hard and fast cost-cutting.

Now, if these leaner and meaner businesses can just generate some decent sales growth in the months ahead, so investors figure, their bottom lines will receive meaningful, much-appreciated boosts.

Of course, as the year progresses, if sales don't materialize then even the leanest cost structure isn't going to drive EPS growth, Boockvar says, which is what he actually foresees and why he remains, in his words, "very bearish" on the retailers.

"I don't have the same optimism that revenue growth will meet expectations," he says. "Sales will disappoint and their cautious optimism will not be met as the year goes on."

So, for his part, Boockvar plans on steering wide and clear of the American consumer.

"I want to be less reliant on the US consumer, not more reliant," he says, adding, "You want your money where it is best treated and where it has the best growth prospects. To me, that's overseas markets, non-dollar assets, or big multinationals that do a good chunk of their business outside the US."
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