It's a dog's life being an analyst sometimes. In a classic case of bad timing,

Merrill Lynch

Tuesday downgraded book-and-stationery retailer

WH Smith Group

, only to see its shares jump to a record high the very next day. The stock's surge followed WH Smith's announcement of an Internet venture with

British Telecom

(BTY)

and

Microsoft

(MSFT) - Get Report

. On closer inspection, however, some of Merrill's pessimism may be warranted.

Merrill, which has no underwriting relationship with WH Smith, moved its recommendation on the retailer to neutral from accumulate. What perhaps turned the faces at the investment bank a deeper shade of red were the words: "WH Smith is to launch an improved transactional Web site in spring 1999 ... but this is unlikely to set the stock market alight."

Unfortunately, that's exactly what it did. The shares rose 11.4% to close Wednesday at 657.5 pence and climbed a further 6.9% Thursday to end at 703 pence.

The analysts at Merrill responsible for the report declined to talk to

TSC

("we get paid to talk to our clients, not the press," they said), which is a shame because most of the report is a study in incoherence.

The report, titled "Up with Events," says the bank is moving its "recommendation to neutral as the shares look up with events." Huh?

A more comprehensible reason the bank gives for the downgrade is that although it believes there will be a turnaround at WH Smith, as with other retailers, it will take time.

The macro picture certainly supports this view. It was a miserable Christmas, with retail sales in December falling 0.9% from November and rising only 0.7% over the previous 12 months. After a bounce in January, which had more to do with New Year sales than any rise in consumer confidence, retail sales fell 0.3% in February compared with the previous month and rose a disappointing 1.3% over the prior 12 months.

The press release from WH Smith that sent the stock through the roof was very short on detail, leading some analysts to say that the mere mention of the name Microsoft may have caused the surge in the shares as much as any excitement over WH Smith's Internet strategy.

Together with

Microsoft Network

and BT, "WH Smith will provide a fully fledged 'portal' with free access to the Internet and a wide range of education and entertainment content," the release stated. Those interested in things like numbers will have to wait for the full details "later in the spring."

Not surprisingly, WH Smith's current Internet operations are making a loss. Its online book operations,

bookshop.co.uk

, which it acquired last year for $15 million, and

CD Paradise

showed a combined loss of $660,000 in 1997 on revenue of $3.6 million.

Henderson Crosthwaite

, a British brokerage, estimates this loss will deepen to $1.6 million in the year to August.

Yet Iain McDonald of the U.K. investment bank

Charterhouse

doesn't believe the rise in WH Smith's shares is overdone. He argues that WH Smith is trading at only 17.7 times forward earnings, compared with

Dixons Group

, an electronics retailer with a free Internet service, which is trading at 32.6 times forward earnings.

McDonald also believes WH Smith will turn a profit from its Internet operations sooner than the perennial lossmaker

Amazon.com

(AMZN) - Get Report

because their strategies are markedly different. He says WH Smith's free Internet service, together with a portal that offers high-quality content, will build customers and direct them to its online book site.

Charterhouse has a buy recommendation on WH Smith and has no investment banking relationship with the company.

There are also hopes for the economy. Admittedly, retail sales have been in the doldrums recently, but the

Confederation of British Industry's

latest distributive trades survey showed 37% of retailers reporting an improvement in sales volumes in February compared with the same period last year, while 35% said sales had declined in February. This is a sharp turnaround from the previous month, when many more retailers said they saw a fall in sales instead of a rise.

The market can be a cruel and unforgiving place, as Merrill found to its acute embarrassment this week. But while the investment bank may be guilty of bad timing, at least it adheres to the maxim of never judging a book by its cover.