Investors had reason to celebrate after a key reading of consumer sentiment rose for the third straight month in December, surpassing economists' predictions.

Meanwhile, a check of holiday retail sales suggests the U.S. consumer hasn't gone into hibernation, at least not to the extent that was once feared. While some sectors are struggling, there's evidence that overall retail sales could post modest gains this Christmas, a much better performance than some had predicted at Thanksgiving.

"The improvement in consumer's confidence suggests that spending is going to keep pace and not going to fall off," said Jennifer Rossum, economist at Thomson Financial/IFR. "But without any growth in income, we're not going to see that pop in retail sales that we're looking for to pull the U.S. economy out of a recession, at least not in the first quarter."

Feeling Good

Consumer sentiment is an important gauge of consumption, which contributes about two-thirds of U.S. gross domestic product. The concern has been that consumers will beat a sharp retreat because of rising unemployment levels, weak capital markets and worries about terrorism.

But things are looking more hopeful since September, when the index fell sharply. The University of Michigan's consumer sentiment index rose to 88.8 in December from 83.9 in November. That beat consensus forecasts for a reading of 85.7 and blew past the index's recent low of 81.8 in September. The index, which is based on telephone interviews with about 500 Americans, is sharply off its peak of 112.0 in early 2000.

The current conditions index, which gauges consumers' attitudes about their present financial situation, climbed to 99.0 in December from 95.3 in November. The expectations index, which tracks consumer attitudes about the next 12 months, rose to 82.3 from 76.6 last month.

Short Purse Strings

Meanwhile, the Commerce Department's Bureau of Economic Analysis reported Friday that personal spending fell 0.7% in November, though the drop was not as bad as the consensus estimates of a 0.8% decline. Personal income prior to September hadn't declined since January 1994, Rossum noted.

Sales of durable goods, including autos, dropped 5.7% after October's 15% surge, which came from successful auto sales incentives.

Telling the recessionary story, personal income dipped 0.1% for the third consecutive month in November.

According to David Durrant, economist at Julius Baer Asset Management, the third monthly decline in personal income doesn't bode well for spending levels next year. Durrant expects the unemployment level to rise to about 6.5% next year. Subsequently, "consumption will continue to be constrained and we're not going to get an economic boost from the consumer sector," he said.

The short-term consumer outlook has been supported by a host of incentives, ranging from cheap auto financing to aggressive retail discounts. Even then, real consumer-demand growth is unlikely to exceed 2% in the fourth quarter of 2001, wrote Stephen Roach, global economist at Morgan Stanley on Friday.

"And as this aggressive price-cutting gets removed in early 2002, the payback effect could well push U.S. consumer demand further to the downside," Roach said.

Resilience in Retail

On Thursday, specialty-retailer

Nike

(NKE) - Get Report

pleased Wall Street when it forecast modest revenue and earnings per share growth for the year, despite the wobbly U.S. retail environment. Nike said U.S. revenue grew 3% to $1.2 billion, and said futures orders, scheduled for deliver between December and April, totaled $3.9 billion, or 8% higher than orders in the year-ago period.

Shares of the company gained $2.51 to finish at $56.30 Friday.

"The fact that

Nike's doing better than expected is somewhat encouraging as it suggests that people aren't just spending their money at

Target

but are buying their $150 sneakers," said Thomson's Rossum.

Other retail analysts cite encouraging data. Ira Silver, senior retail advisor to Telecheck, a check acceptance company, said his firm's retail index for the first 24 days of the shopping season indicate a 1.8% rise in same-store sales, in line with expectations for a 2% or more increase over the whole holiday shopping period. Last year, the season ended up 3.1%.

"The numbers are certainly better than what people feared just a couple of months back, and they're encouraging," said Silver. "They indicate, along with other indicators like the consumer sentiment and initial unemployment claims, that the economy is probably in a bottoming-out stage and will probably start growing sometime in the spring or early summer of next year."

National Retail Federation chief economist Rosalind Wells agreed. In a recent report, the NRF said holiday sales of general merchandise, and others, including apparel, furniture and electronics and appliances, rose a healthy 2.9% from a year ago. Holiday sales could increase an average of 2.5%, Wells estimated.

Signs of a "bottoming-out of the recession are becoming evident, which should lead to accelerated sales gains next year," Wells wrote.