Investors in the retail sector took some much-needed profits Monday after a Wall Street analyst delivered a distressing critique of the U.S. housing market and its effect on consumers.

Credit Suisse First Boston analyst Gary Balter downgraded shares of

Home Depot

(HD) - Get Report

to neutral from outperform, citing the threat that a slowing housing market could pose to the home improvement giant's business.

In his report, Balter refers to an earlier note from Credit Suisse's housing analyst Ivy Zelman titled "Data Masks Grim Reality." It argues that the housing market is worse than current data suggest and is in the early stages of a hard landing that could last several years.

While he maintains a positive view of Home Depot from an operational and competitive standpoint, Balter says the macroeconomic outlook doesn't bode well for the company's stock.

"The extreme weakness in many housing markets may lead to extreme weakness in housing-related consumer spending, and the worst of the housing weakness is likely still to come," Balter wrote.

Shares of Home Depot, which had rallied over 9% in September, closed down 1.7%. Other retail stocks also dropped, killing

last week's rally that was spurred by a drop in crude oil prices. High gas prices have been viewed as a major drag on consumer spending, but critics say its impact will pale in comparison with that of the housing market's slowdown.

Balter argues that while recent housing data appear to hold the promise of an orderly slowdown and a soft landing for the economy, conditions are "far worse than anybody could have imagined" in reality.

"We urge investors not to rely solely on the tame macro headline data, and instead pay heed to company specific reports and our channel checks, which clearly indicate that a housing recession is on the horizon in many markets," Balter wrote.

Along with Home Depot, shares of the No. 2 home improvement chain,

Lowe's

(LOW) - Get Report

slid 1.7%.

In order to stave off competition from the likes of Lowe's, Home Depot said Monday that it expects to hire more than 1,000 new employees nationwide and invest $350 million during the second half of 2006 to improve customer service in its stores. The retailer has been criticized recently for shoddy service as it kept a lid on labor costs to boost profitability.

Outside of the home improvement space, other retail stocks suffered in the session as well. Shares of

Tiffany

(TIF) - Get Report

closed down 3.4%,

Wal-Mart

(WMT) - Get Report

dropped 0.5%, and

Target

(TGT) - Get Report

fell 0.6%.

The S&P Retail Index declined by 0.8% in the session.