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For Retail, Pain Is a Four-Letter Stock

The Nasdaq took major hits last week on chain-store weakness.
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Back in September, bullish investors viewed the collapse in consumer confidence as a temporary blip in response to the devastation wrought by Hurricane Katrina. But pessimism on the part of American consumers has persisted through October, and the retail sector is now extending a downturn ahead of its make-or-break holiday season.

Concerns about consumer spending were actually spreading before Katrina sent gas prices through the roof. A 12% swoon in the S&P Retail Index stretches back to the start of August. That compares to a slide of about 5% in the

S&P 500

over that span. Last week, the retail sector helped pace a sudden deterioration of the

Nasdaq Composite

, climaxing Thursday with a 1.7% selloff.

Bargain-hunters stepped in Friday and might be on the prowl for opportunities. But Hugh Johnson, chief investment officer with First Albany, cautioned against buying into the weakness.

"Retail stocks are going down for good reasons," Johnson said. "A strong case can be made that consumer spending will slow in the fourth quarter and into next year, and it will not be the driver of the economy that it has been."

Bears have been fretting about rising debt levels in America for years, predicting a slowdown in consumer spending that has so far not come to fruition. Johnson thinks the market is entering a period that will offer them some vindication.

"Energy prices are high, interest rates and debt levels are rising and savings rates are low, so consumers are likely to spend less and save more as we move through 2006," he said. "Also, I think the market is telling us that we are in the later stages of the economic cycle, and at this stage, when the

Federal Reserve

is raising interest rates, investors historically have migrated away from consumer cyclicals and toward safer sectors like health care and utilities."

Last year's biggest retail winner,

Sears Holdings


, has reversed course. The stock, off more than 25% since the beginning of August, dropped like a stone in Thursday's Nasdaq rout, down more than 5%. Elsewhere,


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was down 1.6%,

American Eagle Outfitters


lost 3.4%,

Pacific Sunwear


lost 3.7%, and

Hot Topic


was down 5.1%.

All of those companies recouped some of those losses Friday, buoyed by a government report of a strong 3.8% growth rate in GDP for the third quarter. Still, news from the University of Michigan that its consumer sentiment index slid unexpectedly further in October to 74.2 from the earlier reading of 75.4 stood as a reminder that the mood remains negative.

In government, various corruption charges are being brought against officials after support for President Bush's latest nominee to the Supreme Court withered on both ends of the political spectrum. That follows what was widely viewed as a government failure in responding to Hurricane Katrina, and it unfolds against a backdrop of more than 2,000 U.S. soldiers killed in the war in Iraq, which is losing public support according to media polls.

Meanwhile, plans for rebuilding New Orleans, which could provide stimulus for the economy, have also brought the threat of federal deficits back to the fore. With the changing of the guard at the Federal Reserve, Chairman Alan Greenspan's successor, Ben Bernanke, will take the reins in the midst of a yearlong rate-tightening campaign aimed at slowing inflation that has been goosed by high oil prices. A growing chorus of speculators is expressing concern that years of record-low interest rates have led to a credit bubble in the economy, and that may have powered the real estate market, putting consumers' main source of asset wealth at risk.

In a worrisome sign for the housing market, new-home sales reportedly rose 2.1% to an annualized 1.222 million in September, below the 1.25 million expected by Wall Street economists. In addition, August sales were revised down by 3.2% to 1.197 million, the lowest rate in seven months. The average price of a new home also fell to $285,700 in September, from $287,500 in August. Last year, prices for new homes rose 17%.

"It's very clear to me that there was a housing bubble in 2004, and we've moved from the stage of speculation characterized by euphoria to the stage of financial distress," Johnson said. "Still, we just don't know what the outcome of this will be. Will the bubble break, bringing prices down in a way that will demoralize consumers? I think there's a very good chance of that."

Now, investors are looking increasingly defensive heading toward the holiday season as they gauge whether the market can climb the growing walls of worry. On the other hand, contrarians like Craig Johnson, president of Customer Growth Partners, are licking their chops.

"Prices are coming down and people are getting scared," he said. "If you remember, people got all nervous before the holiday last year, and things turned out OK. I don't pay attention to consumer surveys. The hard numbers show that the economy is still rocking, and consumers are its engine."