The stock market's current beast of burden, stagflation, stepped into the road and stopped traffic Wednesday.
August's rally couldn't hold as the Labor Department released its revision to second-quarter productivity. Investors got the increase in productivity they were hoping for, but were slapped with an unexpected rise in wages, which drove up unit labor costs to unpleasant levels.
beige book report, noting slowing growth and wage pressure, revived some stagflation fears and worked to slide investor sentiment off of its equilibrium. Traders were jarred back to more concern about slowing growth amid higher inflation.
In reaction, the
Dow Jones Industrial Average
fell 0.55% to 11,4.6.20, while the
fell 1% to 1300.26, and the
declined 1.7% to close at 2167.84.
The Treasury bond market reacted to the data as well, selling off slightly on news of the productivity and unit labor cost revisions. The 10-year Treasury note ended the day down 6/32 to yield 4.81%.
As is often the case, the disappointing fundamental news coincided with some negative technical readings. With the Nasdaq up more than 9% from its July 21 low and the Dow and S&P up by more than 7% each since bottoming in mid-June, market watchers such as Don Hays of Hays Advisory Group and Dennis Gartman of
The Gartman Letter
were urging caution Wednesday morning.
Hays suggested investors raise cash positions to as much as 10%, citing rising bullish sentiment and the negative effect falling oil prices would have on energy stocks. Indeed, energy stocks such as
were notably weak Wednesday, as crude prices fell to their lowest level since April.
Gartman, meanwhile, wrote that "shares are now materially overbought and due for a correction ... add to this the fact that it is September, the worst month of the year to own stocks, and one has the makings of a very material selloff."
Among stocks in the news,
dropped 3.4% as investors dissected the company's announcement late Tuesday its plans to lay off 10% of its workforce. Shares of its competitor
Advanced Micro Devices
fell 6.45% as well.
Shares of automakers
were both on the move Wednesday, as investors responded to Ford's new chief executive and GM's announcement that it will extend its warranty to 100,000 miles on certain models. Ford's shares gained 1.91%, while GM's gained 2.4%.
The Labor Department reported productivity rose 1.6% in the second quarter, up from initial estimates of 1.1%. Higher productivity allows companies to absorb higher costs, including labor costs. But if wages grow faster than productivity, then the unit labor costs rise, and companies must either take a hit to profit margins or pass through the higher labor costs by raising prices.
Hourly wages rose 6.6% from initial 5.4% estimates, the Labor Department said, driving up unit labor costs by 4.9%, higher than the 4.2% initial estimate. The revision means labor costs rose 5% year over year -- matching the peak rate during the third quarter of 2000 and narrowly escaping matching the 5.2% peak during the fourth quarter of 1990, according to Michael Darda, at MKM Partners.
"If we have this much momentum in compensation growth, people should be a lot less worried about consumption falling off the table," says Darda, noting that expectations are overly optimistic that growth will slow enough to kill the inflation threat.
The Fed's beige book counterbalanced the labor fears somewhat, remarking that reports of raw-materials prices continued to be widespread, but "manufacturers found little ability to pass through higher costs into the prices of manufactured goods." That may prove rather backward-looking, however. Just this week,
announced plans to increase prices for its machines by as much as 5% and engines by as much as 7%, as of January.
The beige book acknowledged that the labor market "has been generally steady," but noted that some districts, including Chicago, reported shortages of skilled manufacturing workers and engineers. Broadly, "wage pressures were reported in a number of Districts, though they were most often limited to certain sectors and most pronounced for workers with specialized skills," according to the beige book.
With weaker productivity in this tight labor market, investors and traders are struggling to answer whether the increased costs of labor and raw materials will reflect lower profit margins or higher inflation. The bond and equity markets are pricing in lower profits and a weak consumer, but the wage growth and a weak dollar suggest there is still plenty of excess liquidity sloshing around. So, higher inflation is arguably still a significant risk.
On the growth side, the beige book expressed that economic activity continued to expand, but that five of the 12 districts reported deceleration. The Institute of Supply Management's nonmanufacturing index, also out Wednesday, read 57, up from 54.8 in July and 1.9 points higher than economists had expected.
The housing market is the number one culprit for the market's expectations of an economic slide. But a housing collapse causing a consumer-led recession is hard to imagine.
In the day's other economic news, the Mortgage Bankers Association (MBA) weekly mortgage applications index for the week ended Sept. 1 hit its highest level since the week ended July 14.
Still, the Fed reiterated its concerns about housing in the beige book. "Housing markets and home-construction activity weakened throughout the nation," read the Fed's report. Kansas City even reported "sizeable numbers of foreclosures."
But the U.S. has not had a consumer-led recession since 1981, says Brett Gallagher, head of U.S. equities at Julius Baer Investment Management. And for now, "the consumer is showing that they'll do everything they can to keep things going," says Gallagher.
The ever-resilient U.S. consumer presses on ... for now. Retail sales have been relatively strong as the first back-to-school data trickled in last week. And of all things, consumers are still refinancing their mortgages to tap the equity in their homes, reports Freddie Mac. About 90% of consumers who refinanced their homes in the second quarter took out a bigger loan than they retired, and at a higher rate, notes Gallagher. "People are desperate to maintain their spending level," he says.
Perhaps consumers are just postponing the pain. But for now, the market's hope for a slowing economy taming the inflation beast is suddenly looking a little less sunny.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click
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