The first week of 2005 was no fun for equities, even if the holiday shopping season turned out a little better than expected. The Nasdaq Composite lost ground every day of the week, and the Dow Jones Industrial Average and S&P 500 were in the red every day but Thursday.

More troublesome for the Nasdaq, it reached a lower intraday low than the previous day all five days and a lower high every day but Friday when the index eclipsed Thursday's best by a whole 0.09 points before stumbling to another loss.

For the week, the Nasdaq lost 4% to 2088.61, the Dow lost 1.7% to 10,603.96 and the S&P dropped 2.1% to 1186.19.

Suggesting tax-related selling is a big factor, many of the best performing industries in 2004 have led the early 2005 downturn. Coal, steel, agrochemicals and homebuilders were all among the biggest losers for the first four trading days of the year after posting gains of 40% to 70% last year, according to Morningstar.

Only four of the 130 or so-odd industries tracked by Morningstar had gains. The only winners were managed care, led by Medco Health Solutions ( MHS), discount stores, led by Wal-Mart ( WMT), property insurers, led by AIG ( AIG), and specialty retailers led by Walgreen's ( WAG). Of course, amid Friday's losses, retailers including Wal-Mart sold off.

As for economic news, Friday's December payrolls report ended up being a snoozer as it did nothing more than confirm that the Goldilocks economy remains on track. While the Labor Department said employers added 157,000 jobs last month, slightly less than the average forecast, the shortfall was about equal to revisions to prior months that added 34,000 jobs. The bond market yawned and the yield on the 10-year Treasury note finished the week at 4.28%.

As contributor Tony Crescenzi sagely observed, the current rate of payroll growth is about enough to keep the economy on track and consumers happy while not prompting the Federal Reserve to go crazy with interest rate hikes.

Speaking of consumers: those overleveraged, real estate-rich spenders on whom two-thirds of the economy depends spent ( shocker!) enough so that the holiday season turned out OK for retailers. Thanks to a late surge of buying and another big year for gift cards, things turned out moderately jolly after all.

Pressure and Cherry-Picking

As expected, the season was better for high-end retailers catering to the wealthy than for those geared toward the lower end of the socioeconomic ladder.

The International Council of Shopping Centers said overall sales increased 2.7% in December from last year and 2.3% for the entire holiday season, including a 10.3% increase for the luxury goods segment.

"Luxury and high-end retailers again considerably outpaced expectations and posted the strongest comps," Morgan Stanley's retail analyst team concluded in their review of December sales results.

Nordstrom's ( JWN) said December sales increased 9.3%, Neiman Marcus ( NMGa) reported a 10.8% gain and Saks ( SKS) rose 12%. Neiman shares, up 19% the last two months of 2004, finished the week down 4.3%. Nordstrom, up 9% at the end of last year, gained 2.4% on the week. And Saks, up 19% at the end of the year, was virtually unchanged for the week.

Tiffany ( TIF) said sales jumped 12%, including a 6% increase at stores open at least a year. Coach ( COH) has said it is expecting to report a sales gain of 25%, as rabid U.S. purse shoppers overcame sluggish overseas consumption of its leather wares. Tiffany lost 1.5% for the week after gaining 9% in November and December. Coach fell 1.9% this week after gaining 21%.

Meanwhile, May Department Stores ( MAY) saw sales decline 3.5%; Sears ( S) said sales were down 3%; and Kohl's ( KSS) had to issue a profit warning after sales rose just 3% amid heavy discounting. Sears fell 2.6% this week, after gaining 46% in November and December thanks to the Kmart merger plan. May lost 4% this week after gaining 14% the previous two months. And Kohl's dropped 4.8% after losing 3% at the end of 2004.

"The pressure was intense in the moderate market where markdowns and advertising helped sales but in some cases will hurt profits," wrote Variant Research retail economist Richard Hastings.

The giant of the low-end discounters underperformed the giant of the high end, but thanks to the expectations game, came out on top in the market. Downmarket discounter Wal-Mart saw a sales gain of only 3% while more upscale discounter Target ( TGT), which features apparel by Isaac Mizrahi and kitchenware by Michael Graves, reported that same-store sales grew 5.1%, the high end of its forecast.

But Target said consumers "cherry picked" only deeply discounted goods, hurting margins and forcing the company to admit that it wouldn't meet analysts' fourth-quarter estimates of 94 cents a share from continuing operations. Sam Walton's big box creation, by contrast, had warned after Thanksgiving that it was suffering, so the 3% increase was a positive.

Wal-Mart, which almost hit $58 before the November warning and then fell as low as $52 in December, finished the week at $53.99, gaining 2.2% so far in 2005. Target, up 4% in the last two months of 2004, lost almost 6%.

The explanation for the big split between the high end and the low end is pretty simple. While lower-income consumers have been beset by higher gasoline and heating oil prices, the loss of tax-refund checks and weak employment and wage gains, the higher end has been bolstered by capital gains on stocks and real estate, lower taxes on dividend income and big bonuses paid out in the legal and financial professions.

Electronics including Apple's ( AAPL) iPod and big-screen TVs were among the must-have items. So shouldn't Best Buy ( BBY), tops in that segment, have done nicely?

With iPods available at seemingly every retailer on the planet and a price war erupting for big televisions and computers, Best Buy did OK, but not as well as expected. The company's same-store sales rose just 2.5%, or only half the higher end of its forecast. It also could be that the company's much-vaunted strategy of seeking to discourage 20% of its current customers from returning to shop at its stores backfired, as well.

Competitors in the same niche did even worse. Sharper Image ( SHRP) said sales fell 7% and Circuit City ( CC) said it had a 6% drop.

Shares of Best Buy, which were little changed in November and December, lost 7% this week. Sharper Image was down 9% on the week after losing 8% at the end of 2004. And Circuit City fell 13% on the week after falling 4% in November and December.

Looking ahead, gift-card redemptions have become an increasing part of the January sales picture, so a short-term rebound could be in store.
In keeping with TSC's editorial policy, Pressman doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback.

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