April 6th, 2010 
Paul Smith
The retail rally is starting to look a bit rich.
Investors have flocked to once beaten-down retail shares amid an earnings rebound and broader recovery in consumer spending. Catalog retailers were the third best-performing sector of the S&P 500 last year, gaining 178%. The SPDR S&P Retail, one popular exchange-traded fund, has nearly tripled from its Nov. 2008 lows to close at $42.24 on Wednesday, within striking distance of its all-time high of $45.51.
Retail excitement is likely to reach a fever pitch Thursday, with the release of March chain-store sales. Industry-wide, sales are likely to be up 6% to 10% from a year ago, marking a clear end to the sharp declines seen during the recession.
Yet there’s a good chance retail shares may be ready to plateau. For one, it will be tougher for retailers to sustain such gains. Retail sales were exceptionally weak last spring but improved through year-end, which will raise the bar for sales gains in the months ahead. In addition, investors’ loftier expectations this time around could leave retail shares vulnerable to disappointment.
The exuberance for “turnaround” stories like Abercrombie & Fitch Co. and Bebe Stores Inc. in particular may have gotten ahead of itself.
Shares of those retailers have surged more than 40% this year even though their sales and margins remain among the weakest in the retail sector. Abercrombie’s stock, for example, is trading at roughly 30 times estimated 2010 earnings, nearly twice the valuation of the broader market.
Meanwhile, as oil and other input costs rebound from their recessionary lows, supply-chain price pressures are slowly beginning to rear their head. If gasoline prices nationwide head back towards $3.50 a gallon this summer, as some expect, it may also start eating into consumers’ discretionary spending. As retailers seek to regain pricing power, they may see pushback from consumers who have gotten into a bargain-hunting mindset over the past two years.
Still, many investors remain unabashedly optimistic. David Berman, founder of hedge fund Durbin Capital, describes the current rebound in sales on top of pared-back inventories as “retail nirvana.”
The risk is that this glimpse of heaven proves all too fleeting.
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