An earnings warning from Lowe's Cos Inc and a slashed September sales forecast from Target Corp hammered retail stocks on Tuesday as skittish consumers rein in spending, fueling concerns that the holiday shopping season could be the weakest in years.

A drop to a two-year low in the Conference Board's consumer confidence index added to the jitters, helping send the Standard & Poor's Retail Index down almost 3 percent.

The American consumer has been taken through a very rough period. They are cautious; they are careful; they are fearful; and they are acting accordingly, said Kurt Barnard, president of Barnard's Retail Consulting Group. There's very little that can take place between now and December 31 that is going to materially change that.

In addition to Target and Lowe's, most retail stocks fell on Tuesday. Two of the biggest losers were home goods retailer Pier 1 Imports Inc, which dropped more than 10 percent, and apparel retailer J Crew Group, which fell more than 5 percent.

Sluggish spending looks to persist, said Colin McGranahan, analyst at Bernstein Research. We wouldn't make a group bet (on retail stocks) at this point as fundamental risks to discretionary spending are material.

Target, the No. 2 discounter behind Wal-Mart Stores Inc , on Monday said that it now expects sales for the five weeks ending October 6 to rise only 1.5 percent to 2.5 percent, below its previous forecast of 4 percent to 6 percent.

Also Monday afternoon, home improvement retailer Lowe's said earnings for the current fiscal year would be at the low end of or slightly below its forecast range of $1.97 to $2.01 a share.

Lowe's shares fell $1.56, or more than 5 percent, to $29.00 and Target's fell $2.54, or 4 percent, to $61.77.

HO-HO-NO?

Analysts and retailers already are expecting a weak holiday selling season, the key November-December period when many retailers typically book 20 percent to 25 percent of their annual sales.

The National Retail Federation last week said it expected U.S. holiday sales to rise 4 percent, the lowest increase in five years and below the 10-year holiday sales average of a 4.8 percent increase.

Many retailers have already warned that the second half of the year will be worse than the first as consumers confront a weaker housing market, see their adjustable-rate mortgage payments jump and pay more for food and fuel.

The weak outlook could spark early discounting by retailers looking to clear inventory, which could weigh on profit margins, Barnard said.

Last year, Wal-Mart undertook what its chief executive called its most aggressive pricing strategy ever, and more of the same could be seen this year. Wal-Mart is the world's biggest retailer.

We believe that Wal-Mart Stores Inc and Sam's Club will be very committed to price leadership during the holiday season, which should make the competitive environment challenging, Lehman Brothers said in its holiday outlook presentation. Sam's Club is Wal-Mart's warehouse club division.

Some analysts have voiced concern about a coming U.S. recession, especially after August payrolls fell by 4,000, the first contraction in four years.

The Federal Reserve cut the federal funds rate a hefty half-percentage point last week in a bid to shield the economy from the housing slump and financial turbulence. Rate cuts typically take several months or more to filter through the economy, though credit card interest rates likely fell in step with the move.

Nigel Gault, U.S. economist at Global Insight Inc, said the consumer sentiment index is still above recession levels by about 20 points or more, but reports point to slower growth in spending.

We often say that it is more important to watch what consumers do than what they say. Sentiment can sometimes be a misleading indicator of spending. But gloomy reports from Target and Lowe's this week suggest that consumers have become more cautious, he said in a research note.

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