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A more ominous development from the productivity report was the 1.9% annualized gain in unit labor costs. This is the fastest rate of increase in the last two years and if the trend persists, it will clearly put additional pressure on corporate earnings moving forward. There are only two ways for companies to reduce the pressure from growing labor costs; they either produce and sell more units or they reduce labor costs by laying-off more workers. We have seen continued declines in consumer demand and now inventories are beginning to rise as the economy weakens. In light of the horrendous labor report from last Friday, this doesn’t look good for future hiring. Today Reuters reported chain store sales growth slowing with data released from Redbook Research. “Sales at major retailers increased by 2.4% on a year over year basis for the week ended August 7, down from the preceding week’s 3.9% pace…” The slower sales growth was attributed to the absence of child tax credits that were handed out last year. It looks like we are going to need additional tax cuts, increased federal spending, and another round of lower interest rates to jump start the economy once again. I said there were only two ways to correct the problem of rising labor costs, but it looks like General Motors has found another way to improve the bottom line. The Reuters headline reads, “GM Jumpstarts Plant in Northeastern China.” The article goes on to say, “GM and its local partners are spending $3 billion over the next three years to raise annual capacity to 1.3 million units in a country it expects to become its number two market in 2004.” Foreign auto makers plan to invest roughly $13 billion by the end of the decade to triple capacity to around six million cars per year. China continues to build roads as its citizens demonstrate their preference of driving cars rather than ride bicycles to the jobs they inherit from the U.S. and other countries with higher labor costs. Automakers would not put out this much capital unless they see the growing demand in China as a continuing trend. As global demand for oil continues to increase, crude oil hit another record high as it broke through $45 per barrel, but later pulled back to settle today’s trading at $44.52. As the rising price of oil deepens its impact on economic growth, the Energy Department remained optimistic in its monthly report on the short-term energy outlook. They expect crude to average $41 per barrel in the third quarter before falling below $40 in the fourth quarter. For a longer-term perspective we can go back to 1998 when crude spent most of the year between $12-16 a barrel and since 2000 the price has generally been in the $25 to $30 range. Today we are seeing a decline to $40 as good news. Clearly we will need to see the supply disruptions subside for the Energy Department’s short-term outlook to be realized. As it stands, today marks the sixth day of fierce fighting in Najaf which has cut oil shipments out of Southern Iraq to about half the normal levels. Next week we’ll need to keep an eye on the developments in Venezuela’s recall elections for Mr. Chavez. The U.S. is the largest purchaser of Venezuelan crude oil and Mr. Chavez is blaming the coup for his ousting on senior U.S. officials. What a mess. Fed Raises Overnight Rate to 1.5% Well there you have it…the Federal Reserve continues its stance on low inflation and the economy being poised for stronger growth. The Fed statement goes as follows: “The Committee believes that, even after this action, the stance of monetary policy remains accommodative and, coupled with robust underlying growth in productivity, is providing ongoing support to economic activity. In recent months, output growth has moderated and the pace of improvement in labor market conditions has slowed. This softness likely owes importantly to the substantial rise in energy prices. The economy nevertheless appears poised to resume a stronger pace of expansion going forward. Inflation has been somewhat elevated this year, though a portion of the rise in prices seems to reflect transitory factors. The Committee perceives the upside and downside risks to the attainment of both sustainable growth and price stability for the next few quarters are roughly equal. With underlying inflation still expected to be relatively low, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability.” Once the Fed reassured traders the economy would continue to grow, the shorts were squeezed into a covering frenzy and the stock market resumed its climb with excessive optimism by going out on the highs for the day. The Dow Jones Industrial Average gained 130 points to close at 9,944, the NASDAQ Composite moved up by 27 points for a gain of 1.9% to close at 1,808, and the S&P 500 closed higher by 13 points at 1,079. The Fed retained flexibility for future rate hikes by keeping the indeterminate phrase “a pace that is likely to be measured,” but overall the statement was perceived to have a hawkish tilt toward inflation as the following quote from CBS MarketWatch reveals. “The Fed continues to have every intention to hike rates meaningfully further in the future,” said Sherry Cooper, chief economist for BMO Nesbitt Burns. “This is a more hawkish Fed statement than the markets expected.” Many analysts were thinking the Fed would express deeper concerns over the recent weakness in economic reports. Maybe they know something that we don’t…specifically, that they plan to flood the markets with ever increasing amounts of liquidity as we move closer to the November elections. Talking tough on inflation will support the U.S. dollar in the near-term as they consciously work to inflate monetary aggregates in the never ending support of financial asset prices along with the real estate bubble. As mentioned in their statement, “The Committee will…fulfill its obligation to maintain price stability.” I read this as their effort to avoid deflation at all costs by inflating, but remain vigilant enough to control the dollar decline and avoid hyperinflation. The Fed’s comments moved stock prices higher, bond prices lower, and strengthened the dollar for the time being. Spot gold stayed in a narrow range between $398.80 and $400.90 during New York trading hours, but was hammered for more than two dollars below $398 when trading began in the Access Market. All we can do is keep watching to see if these price movements for stocks, bonds, and the dollar are a one-day wonder or if we will see any significant follow-through in the days ahead. The Feds are walking the tightrope between inflation and deflation while juggling the innumerable financial and economic props in the air to keep the system afloat. From an investment perspective we must ponder who will win in the end, economic fundamentals or financial market intervention. You be the judge! Have a great evening! Mike Hartman
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