NEW YORK — The free ride may be over for retail stocks.

Having outperformed the equity markets as a whole, they’re now coming down to earth as a hoped-for turnaround in consumer spending, as well as employment and confidence rebounds, have failed to materialize.

Mindful of economic cycles as well as the laws of Newtonian physics, analysts and other observers of the equity markets aren’t sure of what the next few months will hold for retail issues, but they’re reasonably unanimous in their belief that the earlier dot-com collapse and recent corporate scandals had made retailers’ shares seem like a reasonably sound investment by comparison. Some sectors of retailing, particularly discounters selling life’s staples, are managing to retain that status.

Last year, retailing and much of the nation ground to a halt after the terrorist attacks of Sept. 11, providing for easier comparisons and a tough call for stock watchers this fall.

However, disappointing results and words of caution even from retailing’s superstars created a sense of caution. Merrill Lynch, in a recent research note, pointed out that retail stocks are coming off a highly bullish market. For the 19 months leading up to April this year, they have outperformed the S&P 500 by 46 percent, making the second-strongest relative outperformance in the 38 years for which the firm has data.

During the four months from May through August, the S&P Retail index slid 14.2 percent, slightly milder than the S&P 500’s 14.9 percent decrease. Marquee names like Wal-Mart Stores and Kohl’s Corp. dropped a much milder 4.1 percent and 5.4 percent, respectively. Target Corp. fared worse with a 21.4 percent drop.

Tuesday started September off with a bang. It was another tough day on Wall Street with the S&P 500 plummeting 38.05 points, or 4.2 percent, to close at 878.02. The retail index was off a milder 9.88 points, or 3.4 percent, at 284.41. (See related story, this page.)

Is the stage now set for more?

Eric Beder, an analyst with Ladenburg, Thalmann & Co., said the approaching anniversary of Sept. 11 makes any guess about consumer behavior even more difficult than usual.Uncertainty always means volatility in the equity markets. Over the coming months, Beder expects a continuation of July and August, which saw investors "taking relatively unimportant data points and using them to justify significant moves in stock prices."

Traditionally, the retail shares have lagged in autumn and early winter. Merrill Lynch analyst Daniel Barry, who last week pulled down his ratings on a handful of broadline retailers, some to "sell," observed that during the last four months of the year, retailing has underperformed the market by an average of 1.5 percent over the past 39 years.

He speculated this was driven by skittishness on the part of investors about the holiday season, which accounts for about 30 to 40 percent of annual profits for retailers. If back-to-school is a signpost, the holiday season could be in trouble.

A Wal-Mart Stores spokeswoman, commenting on recent back-to-school turnover, said, "Sales in fashion apparel are strong, but apparel overall is below plan for the period due to unseasonably warm weather."

If Wal-Mart Stores, the world’s largest company with a concept that caters to budget-conscious consumers, is hitting some b-t-s potholes, what’s happening in the rest of the retailing world? August comparable-store sales, which will be reported by most retailers Thursday, will say so definitively, but early indicators suggest sales have remained slow through the end of the month and are expected to continue at their recent snail’s pace.

Bond rating agencies are taking the conservative approach to the back half.

Fitch Ratings, in a recent report, said a meaningful recovery in the retail sector won’t occur until 2003. "Recent corporate scandals and accounting irregularities have added to capital market volatility, leading to more questions about the direction of the economy," noted Philip Zahn, director. "The bankruptcy filing by Kmart Corp. in January, along with the pending liquidation of Ames Department Stores Inc., underscores the stress that the difficult environment has placed on the industry’s weaker players."

Standard & Poor’s Gerald Hirschberg added, "We’re not looking for an awful lot. August may be a harbinger of things to come. It will be better than last year. The shape of the improvement will not be as good as we thought. It doesn’t look like up, up and away. It looks better, but consumers are not at this point buying the way a lot of retailers might have anticipated."Deborah Weinswig, an equity analyst with Salomon Smith Barney noted, "We still haven’t had a cold snap" in the weather. Lackluster sales of autumn-oriented b-t-s apparel have frequently been attributed to unseasonably warm weather. "Things are going to be sluggish until mid-September," she warned. The analyst also took a more tempered approach to the third quarter and a hopeful one for the fourth, the latter having even easier comparisons and a shorter holiday selling season that should create more full-price selling.

Questions over consumer spending have analysts groping for direction this fall. Lower taxes, interest rates and energy costs should keep consumer spending from falling dramatically this fall, said Weinswig.

Simeon Hyman, senior vice president with Stern Stewart & Co., a consultancy, added, "Consumer spending hasn’t been quite as decimated as you might expect in this environment. The refinancing boom has really been a tremendous cushion for what otherwise would have been a much lower last 18 months for retailers, but we’re running out of steam on that."

Various measures of consumer sentiment have failed to find evidence of a lightening of the economic mood in the immediate future.

As reported, The Conference Board last week said that consumer confidence, as seen through its widely used index, in August fell for the third month in a row to its lowest level since November 2001. The measure slid a higher-than-expected 3.9 points in August to 93.5 — fewer than 10 points above the 12-month low of 84.9, registered last November. The Expectations Index, which constitutes half of the overall index and measures outlook for the next six months, slid a lesser 1.6 points to 94.5.

Although they move the markets, David Lamer, equity analyst at Ferris, Baker Watts, doesn’t consider either consumer confidence or comparable-store sales reliable barometers. "The unfortunate truth is that, probably the number-one factor that affects the stock price will be same-store sales and number two will be consumer confidence reports. Both of these barometers are very weak. If there’s anything more simplified than same-store sales, it’s the consumer confidence report."

Voicing reservations that others chose to echo privately, Lamer likened consumer confidence reports to "using last week’s average temperature for the entire country to decide to take a picnic in Cleveland, Ohio tomorrow." That said, there are others who swear by the measure.Whatever consumers’ comfort level may be this fall, unemployment, which plateaued over the summer, will affect shopping patterns and ultimately retailers’ and manufacturers’ stock prices.

In July, the unemployment rate stood unchanged for the third month in a row at 5.9 percent, according to the Bureau of Labor Statistics of the U.S. Department of Labor. This means that 8.3 million Americans were unemployed.

With top-line growth stunted, often all retailers can do to adjust to economic downturns is to carefully manage expenses and inventories. Adjusting inventories downward limits markdown exposure and allows for optimal profits on limited sales. Department stores, hard-pressed to generate sales increase on either an overall or comp basis, especially found religion in this area.

A.G. Edwards & Sons’ survey of inventories-to-sales ratio, which tracks 33 retailers, declined 2 percent in the second quarter, the third-largest improvement for the more than 10 years the firm’s tabulated the measure. Analyst Robert Buchanan noted, "Impressive and unrelenting improvements in the inventories-to-sales ratio are occurring as retailer after retailer ‘steps it up’ in the matter of automated merchandise control systems and related business processes — not wanting to be left in the dust of the juggernaut named Wal-Mart."

Steven Skinner, a partner in the retail industry group at Accenture, a management consulting firm, noted, "Operating margins are improving, but typically, Wall Street won’t give a stock price a push for operating margins. They want to see you grow the top line." Just margin improvement will have a neutral effect on stocks, while rising margin and sales will be golden in the eyes of investors, he said.

"At the macro level, anything that Wall Street perceives to improve the pocketbook of the consumer will move stock prices," said Skinner.

Prices of retail shares run in cycles, tied in part to interest rates. A slowing economy produces lower interest rates that often benefit retailers with an uptick in consumer spending.

The Federal Reserve slashed the short-term interest rate 11 times last year, pulling it down to 1.75 percent in December, its lowest level in 40 years. Economists and analysts alike expect rates to stay steady or possibly drop to 1.5 by the end of the year. If a change is in the immediate future, it would likely spring from the Federal Open Market Committee meeting on Sept. 24.Retail stocks generally peak early in an economic upturn then start to drop, partially in anticipation of higher interest rates. Rising rates mean the consumer’s outlay on interest payments is rising and taking away from their purchasing power.

Offering a wide view of the economy in the not-so-distant future, Ken Goldstein, an economist with The Conference Board, noted, "We’ve had this — not recession, but hardly rip-roaring recovery — and to some level, the bad news is that we’re going to get more of the same into and possibly through the second half of the year." The economic climate should improve, though not dramatically, for the holiday season, he said.

To some extent apparel retailing since the mid-Nineties has been swayed by a set of circumstances that don’t necessarily apply to the U.S. economy as a whole. "If you’re not selling clothes, it’s not too bad," said Goldstein.

His comments are understandable in light of apparel price deflation. While prices have fallen since 1989, due in part to foreign sourcing, improved technology and the rise of the discounter, consumer income is a third higher, Goldstein noted. "You can’t get a better bargain than clothing right now and it’s just sitting on the shelves," he said.

Razor-thin profit margins will also continue to take their toll. "There very likely is going to be another Kmart-type story this holiday season," he said of the bankrupt discounter. "There’s got to be somebody out there whose been limping along, hoping against hope that the tide’s going to turn and if they only hang on long enough it will all pay off."

J.P. Morgan Chase economist James Glassman took a rosier view. "We’re broadly in a recovery. It’s more moderate, not as great as we all thought at the beginning of the year. We’re coming into the third quarter with consumer spending taking off again."

Corporate profits, he said, will be the most important driver of the stock market this fall. "We’re going to get a lot of guidance from companies this month," he noted. "People have been so pessimistic about profits, they’re going to be impressed by what unfolds."Accenture’s Skinner added, "It is very clear that the value players will continue to have strong performance. It is less clear how the other segments of the marketplace will perform. There is clarity because consumers still need to go buy stuff and they are not completely confident in the health of their pocketbook and therefore they’re trying to spend as little as possible."

Weinswig, with Salomon Smith Barney, noted that the larger value-oriented stores such as Wal-Mart and Target, along with the stronger department store players with strong balance sheets, have become a safe haven of sorts for investors, especially given the strength of the consumer through the last recession. Food and drug retailing — an area the large discounters have muscled their way into — had been the safe haven, she noted. Investors won’t feel the need for that haven forever, though.

"When tech does rally, you run out of retail because that’s when the outperformance really ends," she said.

Tech? Rally? Retailers could have a little bit of time left in the sun.

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