Despite the apparent values in retail stocks, there are few reasons to get excited about the retailers. Consumer spending will remain subdued for the next few quarters, and that will lead to retailers’ earnings estimates declining for the next several months.

OUTLOOK

The holidays are right around the corner. This is the most important period for retailers, as many generate about half of their annual sales during the holiday shopping season. The way things are shaping up, this may be one of the worst holiday shopping seasons in recent memory. Economic data from this summer suggest that consumer spending may have turned negative in the third quarter, which means the consumer was in tough spot before the credit crunch turned into a full blown crisis. The problems in the credit markets will only exacerbate the problems negatively affecting consumer spending. As a result, earnings estimates for retailers will continue to decline as we head into the retailers’ most important shopping season of the year.

After the holidays, retailers will continue to see their results suffer from the de-leveraging of the financial system. Consumers no longer have easy access to the credit markets. As the old saw goes, the only people that can borrow money today are those who don’t need it. Funds for mortgages, car loans, student loans, and even credit cards are becoming increasingly hard to come by for many consumers. This situation has also made it harder for consumers to refinance existing debts. For that reason, consumers are being forced to save more to pay off debt, which reduces consumer spending. Given the historically high levels of household debt in the U.S., it will take more than a few quarters for consumers to work through this de-leveraging process.

OPPORTUNITIES

We see few opportunities in the near term. Here are two company-specific stocks worth a look. The first is supermarket Kroger ([url=http://www.zacks.com/research/report.php?t=kr]KR[/url]). This is a defensive play, as consumers still need to shop for groceries even during recessions. Kroger is doing a good job of gaining market share by competing on price and selection. The second stock to look at is PetMed Express ([url=http://www.zacks.com/research/report.php?t=pets]PETS[/url]), which operates a nationwide pet pharmacy 1800PetMeds.com. The company markets its health products for dogs, cats, and horses. PETS’ revenue is holding up well in this challenging retail environment, and the company continues to trim costs. This is enabling the company to produce strong earnings growth.

WEAKNESSES

An overlooked but important consequence of this de-leveraging process is that consumer attitudes toward spending are changing. Being forced to increase savings and pay down debt, consumers have become more frugal in their shopping habits. This includes trading down from more expensive retailers to discount stores, foregoing brand name products for private labels, and rejecting the urge to "keep up with the Joneses." And with unemployment rising and economic growth slowing, consumers will continue to tighten their belts throughout 2009. This will cause retailers to retrench further next year by closing stores, reducing inventory levels, and looking for additional ways to cut costs. During this cycle, we would avoid the retailers until macro conditions stabilize.