Skip to main content

With oil prices down 17% over the last month, investors see a ray of sun shining through the clouds that hung over retail stocks all summer long.

The breakthrough came Tuesday, when crude oil futures extended their decline to seven days in a row, closing down $1.85 to $63.76 a barrel. And finally, retail came to life.

The S&P Retail Index rallied 3.1% Tuesday to reach its highest close since June 1, and the momentum spilled over into Wednesday's trading. The index recently was up 0.5%.

"Retail has been under a cloud for a long time on the assumption that consumers were going to run out of money or have less to spend buying goods," says Paul Mendelsohn, chief investment officer of Windham Financial Services. "That hasn't really materialized on a major scale. There's no concrete evidence yet that the economy is really going into a tailspin.

"The evidence so far is that we're coming down from a 4% to 5% growth rate maybe to a 3% growth rate," he adds. "That's very sustainable, and if that brings down commodity prices and inflation, that's good for the retailers."

Shares of


(WMT) - Get Walmart Inc. Report

, which have been trading sideways while management blamed slower sales on high gas prices, jumped 1.2% Tuesday.

Home Depot

(HD) - Get Home Depot Inc. (The) Report

, another retail titan that has posted consistent earnings gains while its shares stayed stuck in the mud, rallied 4.6%.

In specialty retailing,

Best Buy

(BBY) - Get Best Buy Co. Inc. Report

demonstrated that it's still firing on all cylinders as customers continue to

Scroll to Continue

TheStreet Recommends

stock up on flat-screen TVs. The leading consumer electronics chain posted a 22% increase in second-quarter earnings that topped Wall Street's estimates, and its shares ended the day up 9.1%. Its chief rival,

Circuit City

(CC) - Get Chemours Company (The) Report

, added 6.6%. Both retailers were adding to those gains Wednesday.

Even some laggards in the apparel space are attracting some newfound optimism.

Urban Outfitters

(URBN) - Get Urban Outfitters Inc. Report

was one of the top gainers on the


Tuesday after Goldman Sachs and Banc of America Securities both expressed optimism in its long-term outlook. Its shares surged 8.7%.


(GPS) - Get Gap Inc. (The) Report

attracted its own accolades on Wall Street Wednesday when Lehman Brothers upgraded the company's downtrodden shares to overweight from equal weight and raised its price target to $21 from $19. The specialty retail empire has promised investors a successful product makeover in the back-half of the year and a comeback for its iconic brand.

Meanwhile, AG Edwards on Wednesday reiterated its buy rating on teen clothier

American Eagle Outfitters

( AEOS).

Oil Enthusiasm Slippery

All the enthusiasm, largely based on the drop in oil, comes fraught with risk. After all, oil prices can easily reverse course, as they've demonstrated many times, based on geopolitical events, seasonal factors and a myriad of other concerns. Crude showed modest gains Wednesday amid a Nigerian oil strike.

And, of course, gas prices aren't the only headwind for consumer spending. The slowing housing market, high consumer debt levels and the negative savings rate are all threats that loom for economic growth.

The latest housing figures were anything but pretty. The National Association of Realtors reported late last month that existing homes sold the lowest level in 2 1/2 years, while the inventory of homes on the market reached a record high. The Census Bureau reported seasonally adjusted sales of new single-family homes in July fell roughly 22% from a year earlier.

Perhaps the most worrisome aspect of the housing reports was the jump in unsold inventories. The seasonally adjusted estimate of new houses for sale at the end of July rose to the highest-ever level of 568,000, up from 566,000 at the end of June. If inventories continue to build, prices will ultimately start falling. If consumers that have garnered most of their spending power from the increased value of their homes in recent years start to realize their assets are worth less than they thought, a profound change in spending habits could be in order.

According to Howard Davidowitz, chairman of a retail consulting and investment banking firm called Davidowitz & Associates, roughly 40% of home buyers in the last two years took out high-risk mortgages with no money down. Meanwhile, he estimates that $2.7 trillion worth of mortgages will be reset at higher prices in the next two years.

"Energy prices aren't meaningless, but compared to the numbers coming out of the housing market, this drop in oil prices is an absolute drop in the bucket," says Davidowitz.

He says the housing boom of recent years drove consumer spending and the economy, and investors have yet to fully come to terms with what its end will mean for the economy and the stock market. He predicts a soft holiday shopping season followed by a recession in the second quarter of 2007.

Woody Dorsey, president of research company Market Semiotics, says retail investors' latest exuberance looks like an overreaction.

"Oil prices have been due for a correction, and now we're getting a nice correction here that is obviously positive for stocks," says Dorsey. "But it probably makes sense not to read too much into it. It may be a bit of a breather for the consumer and the market, but this rally is more a reflection of a tactical trading kind of environment then any change in the macroeconomic outlook."

Richard Hastings, a retail analyst with Bernard Sands, agrees.

"It's very likely that later this year, oil prices will go back and the risk premium for retailers will remain in place," says Hastings. "That said, earnings still look great, and there are many retailers out there that will continue to perform even if consumer spending does slow in the months ahead."

He also agrees that the data coming out of the housing market are troublesome, but he says whatever correction is in store won't cause a major shock to the economy.

"It's very serious and dangerous, but it's not like a stock market collapse where everybody pushes the sell button at the same time," says Hastings. "Whatever happens, it's going to be slow and continuous and steady, and as far as the overall economy goes, that process could provide a soft landing."