For this year's back-to-school outlook for retailers, the macro-economic backdrop leaves much to be desired. Consumer sentiment is near its 25-year low, reflecting inflationary pressures, weakening employment trends, and volatile financial markets. Despite a recent 22% [$32] drop in the price of oil to $113 per barrel since its July high, it remains a whopping 58% above the year-ago level and has cut into discretionary spending, most explicitly due to the average price of gas hovering at $3.81 per gallon, up 37% year-over-year. Higher energy costs have also led most consumer products companies to raise prices due to cost pressure on raw materials or distribution.

Although 2008 is working out to be a year of necessities, not frivolities, we believe there's a silver lining: Most back-to-school purchases are necessities. This year we expect to see more trading down and a focus on value as consumers come to terms with reduced spending power. The implications for holiday spending are not good, by our analysis, and in fact, we see domestic per capita spending declining during 2008's holiday season [November to January], offset in part by international shoppers at flagship locations boosting the aggregate spending.

However, for now we focus our attention on the back-to-school season. With the National Retail Federation [NRF] projecting $51.4 billion [up 2.4%] in back-to-school/back-to-college [BTS/BTC] purchases this year, the following are S&P Equity Research's stock picks and pans for the 2008 season.

Our picks are:

-- Abercrombie & Fitch (ANF): ranked strong buy -- American Eagle Outfitters (AEO): ranked strong buy -- Best Buy (BBY): ranked strong buy -- Deckers Outdoor (DECK): ranked buy -- J.C. Penney (JCP): ranked buy -- Nike (NKE): ranked buy -- Under Armour (UA): ranked strong buy -- Urban Outfitters (URBN): ranked buy -- VF Corp. (VFC): ranked buy -- Wal-Mart (WMT): ranked buy

Our pans, which are all ranked sell, are:

-- Dillard's (DDS) -- Sears Holdings (SHLD) -- Timberland (TBL)

Each of these companies has been selected based on its exposure to favorable [and unfavorable in the case of the three sell recommendations] trends the S&P Consumer Discretionary Retail group expects this fall. For example, strong consumer electronics demand underpins our Best Buy recommendation, while contracting disposable income supports our positive stance on Wal-Mart.

We see VF Corp. benefiting from its leading backpack and denim market positioning and J.C. Penney from being a leading BTS shopping destination in the mall, while downtown, Urban Outfitters clothes the college-bound with the latest "must-have" fashions. Under Armour is the leading supplier of team sports apparel and is growing its product lines and consumer base.

The Big Picture In our view, the major negative for the economy is that home sales and prices continue to slide. S&P believes we are more than halfway through the downturn in home sales, but prices are not expected to bottom out until late 2009. Lower housing values have restricted the ability of households to withdraw home equity through cash-out refis or home equity loans, curtailing consumer spending.

Other negative trends include lower payrolls, lackluster consumer confidence, food and energy inflation, and high gasoline prices. With housing values and investment portfolios down, consumers are less "wealthy" than in the recent past.

In sum, although the current data are still mixed, we believe that it sure feels like a recession.