Daily Insight

Following a steep run-up in recent weeks on the strength of better-than-expected earnings, stocks fell for the second consecutive day as investors take pause amid a lull in new economic data and focus attention on today’s Fed policy decision. It is widely expected the Fed will hold interest rates steady at near zero, but the group’s economic assessment will be closely studied to determine the state of the economy.

All ten sectors finished lower with financials dropping the most on concerns that the sector’s earnings may pull back and the possibility of higher interest rates. Volume was relatively low with only 1.2 billion shares trade on the Big Board.


Market Activity for August 11, 2009
Productivity and Wholesale inventories

Productivity surged between April and June, increasing at an annual rate of 6.4%, marking the largest gain in almost six years and easily beating the Bloomberg forecast of 5.5%. The growth was not a result of improving production, but rather a result of employers cutting the number of hours worked faster than the decline in output. These efficiency gains, however, provides the basis for a recovery in corporate profits and investment in the second half of 2009 – aggressive cost-cutting helped many companies exceed earnings expectations last quarter despite weak sales. Solid productivity growth also keeps the lid on prices and inflation, which gives the Fed justification for keeping rates lower for longer.

Meanwhile, unit labor costs fell 5.8%, the biggest decline since 2000 and far more than the expected drop of 2.5%, which may be read as a positive signal for the employment since companies may not need to layoff as many workers as sales stabilize.

Wholesale inventories showed a 1.7% decline in June, larger than the expected 0.9% drop. Durable goods, particularly in the professional equipment sector, led the decline. Total sales rose 0.4% thanks to a 4.5% boost in the automotive sector. The inventory-to-sales ratio – the amount of time it would take to deplete inventories at the current sales pace – improved from 1.28 months in May to 1.26 months in June. No surprise that after ten straight months of decline, inventories sit at the lowest level in more than two year. Companies’ hesitancy to restock in the face of weak demand has added to the severity of the downturn, but retail volumes are showing signs of stabilizing and there is a strong possibility that production will ramp up with even the slightest increase in demand.

Rising productivity and falling inventories fits well with the general consensus that a big inventory rebuild is going to boost both GDP and corporate profits. The inventory destocking in the second quarter took away from GDP, so even if inventories are flat in the third quarter, the drag to GDP would disappear. This idea that the inventory dynamic may mathematically provide a temporary boost to GDP is valid, but the sustainability of such an upturn is seriously questionable because inventory can again be a drag on future GDP if it is slowly depleted. In other words, people won’t necessarily buy stuff just because its there.

In our minds it all still hinges on consumer demand, which will be slow to recover in light of a weak job market, stagnant wages, and falling home values. Without strong consumer demand, any inventory dynamic that boosts third-quarter GDP won’t be lasting, and the odds of a letdown in the fourth quarter or 2010 become greater.


FOMC
The markets will be carefully attuned today to the Fed’s meeting statement, searching for clues regarding how soon and how aggressively the Fed can withdraw its support of the economy. The statement released following the June 23-24 FOMC meeting showed a modest upgrade of their assessment of the economic, which in turn lowered the probability of deflation even though the statement indicated, “Inflation will remain subdued for some time.” Today’s remarks will likely continue to reflect cautious optimistic view so as not to spark inflation concerns.

The first Fed rate increase is not likely to occur until late 2010 or even 2011. Historically, the Fed has never lifted rates when unemployment was rising, it has always occurred when unemployment started to move substantially lower. Despite last week’s July employment report showing improvement, sub-par growth will keep the unemployment rate higher than in a typical recovery. As a result, policy makers are expected to be extremely measured in their removal of policy accommodation.


Have a great day!


Peter J. Lazaroff, Investment Analyst