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Retailers' earnings are expected to slow in the fourth quarter and into the new year, but that's done nothing to squelch the speculative whirlwind that has lifted the sector following the merger of


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At this point, the enthusiasm appears a little frothy.

Kmart and Sears took off last week after hedge fund guru Ed Lampert unveiled a plan to merge the struggling icons into a $22 billion department store behemoth. Other retail stocks have caught fire in sympathy, including


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, up 25%;

Federated Department Stores


, up 13%;

May Department Stores

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, up 13%; and

Toys R Us


, up 9%.

The S&P Retail Index is up more than 7% for November, as Wall Street appears convinced that the Sears-Kmart bombshell will kick off a wave of consolidation and real estate restructuring in a sector that is ripe for a shake-up. In some ways, the excitement is reminiscent of the euphoria that gripped the markets after

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merged with America Online.

Now, as then, investors should ask themselves if the industry's fundamentals are likely to catch up with the current animal spirits.

Daniel Barry, an analyst with Merrill Lynch, pointed out in a recent research note that the retail rally didn't precisely start with the Kmart-Sears announcement. In fact, the advance began when

Vornado Realty Trust

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, a widely respected real estate investment trust, revealed that it had accumulated a 4.3% stake in Sears.

That was after Kmart had completed its stunning turnaround, quintupling its stock price in little more than a year after emerging from bankruptcy in the spring of 2003. Although Kmart has begun posting quarterly profits on a consistent basis, its sluggish top-line performance suggests it has yet to succeed at making itself fully competitive with its rivals.

Instead, investors bet on Kmart because a series of property sales orchestrated by Lampert (with Sears, among others) showed that its real estate assets had been undervalued in the bankruptcy process. Subsequently, Vornado's disclosure was viewed as evidence that Sears was sitting on a similar treasure trove. Its stock rocketed over 23% in one day, and investors began clambering into other retailers whose real estate might be similarly discounted.

Barry said the hullabaloo is shortsighted.

"We believe that these events neither indicate a wave of asset sales in the retail industry nor the beginning of a wave of consolidations," he wrote. "Rather, as investors begin to focus again on the fundamentals, we expect the retailers that were bid up in the recent speculation will return to their respective fair values over the next few months."

He dismissed the idea that hidden real estate values in retailing bolster an argument for higher stock prices, and lists factors that could bring retail stocks back to earth in the near term. They include rising interest rates, a decline in earnings and high gas prices.

In the case of Sears, the true value of its real estate could be realized soon. According to the blueprint drawn up by Lampert's team, the new company is expected to switch a slew of off-mall Kmarts into Sears stores over the next few years in an effort to take advantage of both companies' strong suits.

As for what remains, the picture is murky, at best. A trend has been in place for years in which consumer spending has moved away from malls to big-box retailers like

Home Depot

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Best Buy

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"Given trends that show consumers moving to off-mall shopping, who would want to move back into these mall locations?" asked Morningstar analyst Kim Picciola. "Sears itself is trying to move off-mall."

Ian Weissman, an analyst with UBS, said that monetizing Sears' mall-based real estate assets is an entirely different proposition than monetizing Kmart's off-mall locations.

"It's very difficult to monetize mall real estate," Weissman said. "There is some going market value for it, but typically it's at the hands of the existing landlord, who is going to be able to capitalize that. The landlord is only going to want to do it if they have a better option for the real estate. Right now, there's no guarantee of that."

Weissman acknowledged that traditional department store chains are looking to consolidate and re-evaluate their existing real estate situation, but that doesn't mean investors should count on any valuation gains like the ones seen at Kmart.

And although it may be tempting to extrapolate recent successes in shares of Sears and Kmart out to other retailers, Barry maintained that their gains came from a confluence of unique circumstances.

"We believe the Sears-Kmart merger was an unusual deal with unique synergies and a unique catalyst," Barry wrote. That catalyst was "hedge fund manager Eddie Lampert, who owns equity positions in both companies."

While betting against Lampert might be crazy, trying to imitate him could be even crazier.