NEW YORK — Sentiment is growing within financial circles that the retail recovery that eluded stores in the second half of 2002 might stage an encore no-show in the new year.

Having just digested what many are calling the worst holiday season in 30 years, retailers are now faced with the daunting task of luring customers who are coping with either the reality or possibility of higher taxes, fuel prices and debt, along with less job security and wage growth. The prospects of a war with Iraq, a showdown with North Korea and continued political instability in Venezuela loom large, as well.

Fitch Ratings, a credit ratings agency, said in a retail report last month: "Looking ahead, there is considerable uncertainty as to the timing of an eventual industry recovery. We believe signs of a recovery will not be apparent until later in 2003, and then they will be dim at best."

According to Fitch, the problems that diminished retail sales in late 2002 — a weak stock market, ongoing corporate layoffs and Middle East tension — have carried into 2003 with the ferocity of a bad New Year’s hangover.

Another barometer, consumer confidence, plunged in December. The Conference Board said on Dec. 31 that its monthly index sank to 80.3 from a revised 84.9 in November. Economists had expected the index to rise slightly to 85.3. The latest figure, however, is just barely above October’s nine-year low of 79.6.

Lynn Franco, head of the Conference Board’s consumer research center, cited the rising unemployment rate and discouraging job outlook as factors dampening the moods of consumers.

At UBS Warburg, retail analyst Linda Kristiansen issued a note on Dec. 31 forecasting that broadline retailers should continue to expect weak sales through the first half of the year.

The UBS Retail Sales Predictor, updated through November, "indicated industry sales weakness through the summer of 2003 based on its nine-month lead time to retail sales." As a result, broadline retail stocks are expected to "modestly underperform the market over the next several months," she wrote.

The downward drift of wage growth also has contributed to the pessimistic retail outlook. "Real average hourly earnings momentum, a key indicator, has been consistently negative this year," the UBS analyst wrote. "At the beginning of 2002, real average hourly earnings were up 2.7 percent on a year-to-year basis. By November, the rate of increase had dwindled to 0.6 percent, a function of both a slowing in nominal wages and a pickup in the inflation rate."Even many of those with a strong sense of job security are facing higher utility and gas bills and tax hikes at the local and state levels, and the continuing troubles in Venezuela and potential war with Iraq don’t suggest relief in the cost of energy any time soon.

Shari Schwartzman Eberts, equity analyst at J.P. Morgan Securities Inc., in a research report issued last month noted a "strong negative correlation between same-store sales results and retail gasoline prices, particularly for the discount stores, where gas costs make up a greater portion of the consumer’s disposable income."

With gasoline prices 20 to 30 percent higher than year-ago levels during the holiday season, Eberts had predicted that comps were likely to remain under pressure.

She advised a cautious approach to retail stocks "as underlying sales trends and economic indicators continue to deteriorate. We would lighten exposure to the group ahead of further sales and earnings disappointments in [the fourth quarter] and 2003," wrote the analyst, whose retail coverage includes department stores, discounters and warehouse clubs.

For Fitch, the ratings outlook for the retail sector "continues to skew negative, despite a significant number of downgrades recorded during 2002." The report noted that the ratings agency recorded 12 downgrades and no upgrades within its retail universe in 2002. The report also said that Fitch "expects there will continue to be a number of downgrades and few if any upgrades among the retailers in 2003. A persistently difficult retail environment will keep pressure on the weaker retailers — particularly the department stores and apparel retailers."

The margin-enhancing discipline exercised by retailers in 2002 may prove to be a hard act to follow, as well.

According to Fitch, tight management of inventories and expenses in 2002 allowed stores to expand or at least maintain operating margins in 2002 despite soft sales.

"However, we expect margins will begin to stabilize in 2003, and that further margin improvement will depend on restoring top-line momentum and gaining some operating leverage," the report concluded.

As competition intensifies, Fitch expects that retailers will continue to devise promotional strategies that appeal to their most loyal customers. Deflation also will put a cap on apparel pricing for all retailers as discounters become more adept at mimicking department store fashions.With market conditions soft, retailers will continue to demand and receive more favorable payment terms from their vendors, pressuring manufacturers’ results.

If there is a silver lining in the generally cloudy outlook, it’s that the difficult conclusion of 2002 will have stores facing sales comparisons that are relatively easy to beat. In its annual retail forecast, Ernst & Young said that yearend sales could grow 2 to 4 percent even as consumers cope with rising unemployment and high debt burdens.

"However, price reductions in many merchandise categories will keep consumers spending enough to drive a small increase in retail sales," said Ernst & Young retail analysts, Jay McIntosh and Pam Stubing, in a statement.

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