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Glad to see the markets take a sigh of relief, albeit a big one, after learning that the eurozone isn't crumbling apart after all.

Post announcement of the $1.4 trillion stabilization fund package, and banks agreeing to take a 50% haircut on Greek bonds, the uptick was as sharp as the downward movement, something that we have learned to expect from the markets over the past several years. At this point, I might seem quite wrong on the bullish premise on emerging stocks back in August, though last week's action thankfully took the MSCI Emerging Markets index past 1010, about 3% over August levels. I stand by my bet though, given the fact that economic growth seems intact and inflation is possibly contained in major emerging market economies, especially China. The U.S. market probably has too much optimism priced in at this point, given the lack of details in the Europe plan and the fact that domestic recovery is still in weak territory.

Given the impending onset of the holiday season, let’s take a look at the retail sector. We heard positive surprises in numbers related to household spending in Q3 (up 2.4%) and reported increase in consumer confidence in October (above 60). To understand overall trends, let us take a look at the snapshot below - macro numbers do not surprisingly point to any marked negative trend, but is difficult to sustain in a real sense.

The first two rows show plain non-cumulative y-o-y quarterly numbers, derived from raw data from the U.S. Bureau of Economic Analysis. I like looking at quarterly y-o-y as against q-o-q. The next two rows are from the U.S. Bureau of Economic Analysis and the U.S. Bureau of Labor Statistics, respectively.

Q12010

Q22010

Q32010

Q42010

Q12011

Q22011

Q32011

Personal disposable income growth Y-O-Y

2.97%

3.68%

3.20%

3.84%

4.25%

4.52%

4.91%

Personal consumption expenditure Y-O-Y

3.29%

4.12%

3.69%

4.28%

4.63%

4.82%

5.13%

Savings as % of disposable income

4.9%

5.6%

5.6%

5.2%

5.0%

5.1%

4.1%

Unemployment rate

9.6%

9.6%

9.6%

9.4%

9.1%

9.2%

9.1%

*Home sale prices have meanwhile stayed in negative growth territory y-o-y, since 2007, the latest reading being -3.9% y-o-y for September 2011.

The good news is that growth in total personal disposable income has been reasonably healthy year-on-year over the past three quarters as compared to 2010. However, it has to be noted that increased consumer spending (which drove higher GDP growth in Q2 and Q3, to a large extent), has been at the cost of a marked dip in savings rate. Customers are also possibly swinging back to a greater amount of credit card spending, as evidenced by a pick-up in credit card spending as reported by Master Card and Visa. Though the above definitely does not paint a negative picture, it is difficult to sustain or improve on this trend. A real sustainable pick-up has to be supported by either a marked drop in unemployment levels or a pick-up in home prices, both of which looks highly unlikely for the next few quarters. Though the above does not provide a clear direction one way or the other regarding Q4 consumer spending, there is hardly anything to suggest robust holiday spending to keep up in pace with the trend set in 2010.

In fact, as per the National Retail Federation's 2011 holiday consumer spending and actions survey, 70% plus of holiday shoppers predicted spending lesser in 2011 as compared to last year, with average predicted personal spending down to $704, down from $715 in 2010. Gallup poll data too show a flat-to-negative spend in 2011 as compared to 2010. As per results of the survey, customers visiting several retail names including Gap (NYSE:GPS), Nordstrom (NYSE:JWN), J.C. Penney (NYSE:JCP), Toys R Us, Best Buy (NYSE:BBY), etc,. are expected to spend lower this holiday season as compared to 2010. Given the macro data above and results from consumer surveys, a few retail picks seem ripe for a downward correction.

Abercrombie & Fitch (NYSE:ANF) - Agreed that this one's a difficult pick to bet against, but at a level close to its 52 week high (not too far from its 5-year high in fact), and at a P/E of close to 33, it’s difficult not to expect downward pressure. A 10-15% pullback seems plausible.

J.C. Penney (JCP) - I have commented on this one on and off over the past 12 months, and its now back in to rich territory. At a P/E of 20+, its quite richly priced as compared to competitors like Macy's (NYSE:M).

On the other hand, stocks like Costco (NASDAQ:COST), Ross (NASDAQ:ROST) and TJX Companies (NYSE:TJX) still have some upside left, given the strong value positioning and alignment with current shopper sentiment.

In general, it is a safer bet to stay away from retail stocks for the 2011 holiday season. If you do want to play, it is preferable to go short on certain retail picks which are rich in current valuation, while holding on/going long on some of the notable value plays as mentioned above.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: Holiday Season 2011: Safer Bet To Stay Away From Retail Stocks?