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How to Play Retail Stocks in 2010

If you want to play an economic rebound in the U.S.: Many retailers were hit hard in 2009, even those that were highly successful before the recession began. Some of these beaten down but still high-quality names will likely see a turnaround in 2010.

Keep an eye on American Eagle Outfitters (AEO), Pacific Sunwear of California (PSUN) and Target (TGT).

For two years now, American Eagle's women's merchandise has been selling only so-so, but the holiday season marked the first sign of an improvement, Chen said.

The teen retailer has also significantly reduced its promotional activity, which should lead to margin recovery in the first half of 2010.

Pacific Sunwear's new management team may be just what the skate- and surf-inspired retailer needs to return to profitability, said Brian Sozzi, an analyst at Wall Street Strategies. In June, Pacific Sunwear hired Gary H. Schoenfeld, former head of VF Corp.'s (VFC) Vans, to replace CEO Sally Frame Kasaks.

Turnaround stories are also likely at CVS Caremark (CVS), Home Depot, J.C. Penney (JCP) and Macy's (M), all of which should see strong earnings growth as the economy improves and company-specific initiatives gain traction, according to Citigroup's Weinswig.

Target's revival will be aided by the rollout of its P-Fresh format. The addition of food and consumables to its stores is driving traffic to other, more discretionary departments, Weinswig said, and positive traffic trends may turn into market share gains in 2010.

Consolidation within department stores should benefit J.C. Penney, allowing it to gain market share. The growth of private label and exclusive brands, such as Liz Claiborne (LIZ)and MNG by Mango, is another potential driver of earnings for J.C. Penney, Weinswig wrote.

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