By and  on November 29, 2006

The Grinch is circling.

With the news Tuesday that consumer confidence fell unexpectedly in November, observers are growing more nervous about the outlook for the holiday season. Softening confidence, coupled with the decline in house prices and plunging durable goods orders, could mean consumers might be inclined to play the waiting game to see how low prices go before they rush out and do the rest of their holiday shopping.

The fears again hit shares of apparel retailers, which took another dip in trading on Tuesday following a 1.2 percent drop in the S&P Retail Index on Monday.

Outfitters fell $1.75, or 3.63 percent, closing at $46.40, and Abercombie & Fitch saw a 28 cent decline, closing at $68.52. Overall, the S&P Retail Index closed down $2.91 to $494.24.

Causing equal concern among analysts is retailers' post-holiday hangover. The depth of Black Friday price cutting at a few specialty chains, particularly those targeting teens, has raised questions about the health of gross margins for the still-important fourth quarter. And even those shopping the outlets this past weekend might have had an easier time than in prior years: There were parking spots available at midday at one popular outlet center.

To be sure, it seems consumers have yet to catch the proverbial cold. While they are becoming more cautious, in general they are still more optimistic now than they were in the summer when gasoline prices cut into discretionary spending.

According to The Conference Board on Tuesday, the Consumer Confidence Index, which declined in October, fell again this month to 102.9 from 105.1 in October, in part due to a tighter labor market. The consensus among economists was an expected increase to 106. The index reflected declines in its two components: the Present Situation Index, down to 123.6 from 125.1, and the Expectations Index, which fell to 89.2 from 91.9 last month.

"The Expectations Index, which correlates more closely with the rate of growth in consumer spending than the present situation or overall indices, now looks consistent with a trend in real consumption growth of around 3 percent at an annual rate," wrote Maury Harris, economist at UBS, in a research note Tuesday.In other economic data news on Tuesday, the durable goods report regarding the manufacturing of big-ticket items fell by 8.3 percent in October, the biggest decline in more than six years, while home sales recorded their largest year-over-year drop, falling 3.5 percent from a year ago.

So what might it all mean for the holiday shopping season?

"Perhaps the holiday bears might be correct," surmised Richard Bernstein, chief investment strategist at Merrill Lynch, in a report Tuesday.

Bernstein on Sunday toured the Woodbury Common Shopping Outlet, Woodbury, N.Y., which he refers to in his note as one of the epicenters of the U.S. consumer. "We have contended that the collapse in gasoline prices might make the holiday shopping season much stronger than many expected," said Bernstein. However, after one day at Woodbury Common, he grew concerned because "at midday, we were able to find a parking spot without pausing," he wrote in his Tuesday note.

More indicative, the investment strategist wrote, was that several of the stores had placed stanchions outside their doors to control the lines of shoppers. "Most were completely empty. Only Coach had a line outside," he observed.

Other Bernstein observations: Despite the queue at Coach, not many people were coming out of the store with bags; Neiman Marcus had few people and no checkout lines; Ferragamo had a reasonable flow of customers, but no one buying and the "sales people [looked] bored"; Nike was empty, with virtually no checkout lines, while Puma was the opposite. He referred to the Gap outlet as a "madhouse," with clothes thrown all over the floors and very long checkout lines, while Banana Republic had shorter lines.

"Although we probably shopped in more than 25 stores, one should keep in mind that these observations are based on one day in one place. Nonetheless, this experience certainly seemed to bolster the arguments of the consumer bears, and made us wonder whether our short-term expectations might be too optimistic," Bernstein concluded.

Earlier in the Thanksgiving holiday weekend of shopping, Black Friday doorbusters and enticing bargains brought shoppers to the malls in droves, but had some analysts fearing that heavy holiday promotions might have done more harm than good even as they raised the store's foot traffic.Deep discounts post-Thanksgiving, such as Aéropostale's 50 percent off the entire store, can put gross margin expansion in jeopardy, wrote Eric Beder, analyst at Brean Murray Carret & Co., in a research note. Beder downgraded the teen specialty retailer on Monday to "Sell" from "Hold."

Beder observed the retailer's key competitors, American Eagle and Abercrombie & Fitch, continue to drive materially stronger results despite a concerted campaign to reduce discounting.

While Beder doesn't expect apparel retailers to rely on heavy promotions to drive sales throughout the holiday season, unseasonably warm weather and Wal-Mart's drastic rollback on prices could increase competitive pressures. "The only real problem I see is consumers don't want to shop for sweaters in 65 degree weather," Beder said. "It's too soon to tell, but this could cause unplanned markdowns later in the season. That is one of the fears of Wall Street and one of the reasons apparel stocks are weak right now."

"Although we believe that retailers have become better players of the game of ‘retail chicken,' and that most of these promotions were planned well in advance of the weekend," said Elizabeth Pierce, analyst at Roth Capital Partners, "we believe consumers have also become even more skilled at the game, and thus we wonder if this weekend's discounting raises the bar of expectations about subsequent promotions."

Unlike some of the bigger electronic gifts that can be in short supply, such as the PlayStation 3 and Xbox 360, apparel merchandise has not been in high demand so far this holiday. Pierce noted, "Consumers can get the same sweater or one close to it even if they hold out for bigger sales."

Pierce wrote in her research note that, while a few deals lasted the weekend, many offers ended on Black Friday. Yet in light of "Wal-Mart's disappointing results and given the price pressure we have seen in the electronics area, we cannot rule out the possibility of steeper discounts over the course of the next several weeks," she cautioned.

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