NEW YORK — Are we headed for a tough fall? Prospects for a fourth-quarter retail recovery dimmed considerably Tuesday as consumer confidence fell for the third month in a row and Merrill Lynch downgraded several broadline retailers.

Consumer confidence declined to its lowest level since November 2001, indicating business conditions are still challenging and suggesting consumers are unlikely to increase spending in the near future.

The New York-based Conference Board’s index of consumer confidence, which is based on a representative sample of 5,000 U.S. households, fell a worse-than-expected 3.9 points this month to 93.5 from a upwardly revised 97.4 in July, falling below economists’ expectations. The August reading is less than 10 points above the 84.9 mark, a 12-month low, registered last November in the wake of the the Sept. 11 terrorist attacks.

Consumers rated both current circumstances and future prospects less favorably in August, further dashing economists’ and investors’ hopes of a second-half resurgence. The Present Situation Index, the evaluation of ongoing conditions that constitutes half of the overall index, fell 7.4 points to 92 in August from 99.4 last month. The Expectations Index, the outlook for the next six months that constitutes the other half, dropped less drastically, falling 1.6 points to 94.5 from 96.1

"The month-to-month decline in the Present Situation Index is a strong signal that business conditions have yet to turn around," Lynn Franco, director of the Conference Board’s Consumer Research Center, said in a statement. "It also suggests that consumer spending is not likely to gain momentum any time soon."

Still, Franco said while consumer expectations are also down, they remain at levels that historically point to a continued, but slow, economic expansion.

Affecting both discounters and luxury retailers, Merrill Lynch analyst Daniel Barry, in a research note, suggested investors approach the broadline retail sector with a "defensive posture, deemphasizing economically sensitive retailers with the greatest chance of profit disappointment."

Since April 1, Merrill has been what it described as "aggressively neutral" on the sector.

Accordingly, Barry reduced his rating on "stocks that appear vulnerable to slowing sales," including Target Corp., to "neutral," as well as Nordstrom Inc. and ShopKo Stores Inc. to "sell." Earnings estimates on these firms’ stocks were also revised downward. Two weeks ago, the analyst lowered Neiman Marcus Group and Saks Inc. to "neutral."All of these stocks had their intermediate rating reduced by one notch.

Enduring stock declines to accompany their downgrades, shares of ShopKo tanked $1.73, or 10.5 percent, to $14.83, while Nordstrom dropped 96 cents, or 4.8 percent, to $19.17 and Target slid 79 cents, or 2.2 percent, to $35.

Overall, retail stocks underperformed the broader market with the Standard & Poor’s retail index dropping 5.5 points, or 1.8 percent, to 294.96 while the S&P 500 faded a milder 13.13, or 1.4 percent, to 934.82. The Dow Jones Industrial Average slid 94.6 points, or 1.1 percent, to end the day at 8,824.41.

Moody’s Investors Service economist John Lonski wasn’t especially alarmed by the drop in consumer confidence, which remained 6 percent higher than the final quarter of 2001 and above its post-Sept. 11 lows. However, Lonski said it is down 15 percent from its 12-month high, reached in May, of 110.3.

He attributed the drop in part to consumer worries about the soft labor market and the significant downturn in the equity market.

The possibility of war with Iraq also had an effect. "It is difficult for the stock market to enter into a lasting upturn until the uncertainty regarding a possible conflict with Iraq has been significantly diminished."

Not all of Tuesday’s economic news was bad. July’s steeper-than-expected 8.7 percent monthly surge in durable goods orders augured well for the second half.

In evaluating present circumstances, 16.6 percent rated August’s business conditions as "good," down from 20.2 percent in July. Those rating conditions as "bad" was virtually unchanged at 22.3 percent versus 22.1 percent in July. Consumers reporting jobs were plentiful declined to 17.2 percent from 18.8 percent, but those claiming jobs are hard to get remained unchanged at 23.9 percent.

Consumers’ expectations for the next six months were mixed. While a greater percentage expected an improvement in business conditions in the coming months, 22.1 percent in August from 20.8 percent in July, a greater proportion also held the opposite view.

The employment outlook was also less favorable. A greater percentage of consumers — 18.1 percent from 17 percent in July — expect lower job availability, but the percentage expecting more job openings rose slightly to 17.5 percent from 17.3 percent last month.As for income prospects, 21.5 percent of consumers anticipate an increase, up from 20.1 percent last month.

Because consumer spending generates two-thirds of gross domestic product, the combination of reduced confidence and Merrill’s downgrades cast a shadow on an already sober market.

Department stores digesting drops in their shares included Neiman Marcus, down $1.05, or 3.5 percent, to $29; Kohl’s, $2.12, or 3 percent, to $69.27; Sears, $1.36, or 2.9 percent, to $45.85 and Dillard’s, 29 cents, or 1.1 percent, to $26.83. Bucking the trend was Saks with a 17 cent, or 1.6 percent, uptick in its shares, which closed at $11.

Harder hit were the specialty stores. Among those seeing steep declines were Ann Taylor, down $2.19, or 7.6 percent, to $26.50; Chico’s, $1.19, or 7.3 percent, to $15.08; Wilsons Leather, 66 cents, or 7.1 percent, to $8.69; American Eagle Outfitters, $1, or 6.3 percent, to $15; Charlotte Russe, 83 cents, or 6.4 percent, to $12.22; Abercrombie & Fitch, $1.35, or 5.7 percent, to $22.15; Limited Brands, 92 cents, or 5.5 percent, to $15.95, and Talbots, $1.69, or 5 percent, to $32.06.

"The easy way to tell which retailers are most immune to a sales shortfall is to observe which retailers had the most consistent sales pattern last year during the recession," Barry noted. Among these retailers, which he said also have the lowest chance of missing earnings estimates, were J.C. Penney Co. and Kohl’s— both rated "strong buy" for the intermediate term — and Wal-Mart Stores, rated "buy" for the intermediate term by Merrill.

Barry asserted that while retailers’ share of the consumer’s dollar rose after Sept. 11 last year, a return to more normalized spending on travel, eating out and other non-retailing expenditures has pinched retail sales as of late.

Also expected to impede fall sales will be the unseasonably warm weather that is predicted through early September, six fewer shopping days in the Christmas season this year versus last as well as memorial services and a somber mood surrounding the anniversary of the terrorist attacks.

Retail stocks, which historically underperform during the last four months of the year, could also be hurt this fall by weaker earnings relative to the overall market. "Relative earnings have been in a strong uptrend over the past two years, providing the underpinning for the strong relative bull market in retail stocks," said Barry."Retail stocks have entered a new phase that has no historical parallel," he said.

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