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The End of Easy Living

The late-August FOMC meeting looms on the horizon like the first signs of winter.
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Late afternoons toward the end of August are, for me, suffused with a faint but insistent melancholy. The approaching end of summer makes itself felt in the earlier fading of daylight and, at some deep animal level, I'm aware of the inevitable onset of winter. And yet, with dark, cold days impending, this is somehow the best time of year. With its generous bounty of corn, tomatoes and peaches, August offers up the sweetest of kisses before dying. At this time of year, I often find myself with tears in my eyes.

But that's probably just the ragweed.

It was touching to observe the gratitude with which Friday's


report was received by the market. The


rebounded by 3.5% in what was palpably a relief rally. The

S&P 500

at last Tuesday's close had come within 1% of breaching its 200-day moving average, with the recent weakness centered in the high-multiple growth names that stand most exposed to


fear. The late-week rally made up roughly one-third of the ground lost in the past month by such broad averages as the S&P 500,

NYSE Composite

and the Nasdaq.

In a symmetry that provides insight, the sectors that heaved the greatest sigh of relief on Friday were the same ones that have had the most difficulty since mid-July: the interest-sensitive financials and the lofty-multiple computers and telecoms. The sectors that have gains to show for the past month are the plug-uglies that tend to benefit in the same environment in which the Fed becomes less friendly: oil and gas, metals, chemicals, machinery, paper and forest products. There has been trench warfare going on this year between value and growth styles, between cyclicals and so-called consumer stocks. Value and cyclicals have prevailed so far as the market has grudgingly come to sense that global weakness and the easy monetary policies it breeds will not persist into the near future.

It was a better-than-expected PPI that generated the sense of relief that sparked the rally. It's not easy to see why. In broad context, July's 0.2% increase in finished goods (and 0.0% ex-food and energy) should not have much effect on the


conclusion on August 24. This is a body that has gone to more than a bit of trouble to be relatively transparent in its operating style. The words and music of the past two months from

Chairman Greenspan

, with their repetition of "preemptive when we can be ... forceful response ... tight labor markets ... skewness of risk ... difficult to sustain inflows from abroad," will be rendered meaningless if a single monthly number negates them.

The upstream evidence is less favorable than the finished goods data, with core intermediate and crude goods prices up at annualized rates of 4% and 22% respectively over the past three months. But having said that, I should downplay it because these upstream prices, being volatile, don't correlate well with what ends up in finished goods prices. Still the pattern is one in which the metals, chemicals and papers are doing better in their selling prices as well as on the floor of the exchange. The anecdotal

Beige Book

evidence last week was replete with phrases such as "widespread labor shortages ... shortages of raw materials ... supply constraints ... construction bottlenecks ... low inventories." And the


"prices paid" index has ticked higher in every month so far this year.

But perhaps the market is well-advised to focus primarily on finished goods and services prices, such as PPI and


, as the best means to feel for the Fed's pulse. This seems to be the conclusion that Alan Greenspan himself came to in June during testimony before the

Joint Economic Committee

. "This all leads to the conclusion that monetary policy is best primarily focused on stability of the general level of prices of goods and services as the most credible means to achieve sustainable economic growth. Should volatile asset prices cause problems, policy is probably best positioned to address the consequences when the economy is working from a base of stable product prices."

Maybe so, but that is a judgment yet to be tested. The Fed historically has shown an institutional antipathy to the idea of simple rules, to being bound to perform against an objective standard that is observable and well understood by the multitudes, including most particularly the posturing multitudes on the Hill. Under a sequence of chairmen, it has used a variety of indicators to advise it on policy judgments, including such arcane concepts as reserves available to support private nonbank deposits or adjusted base money or target cones for money growth. It has flirted with gold prices, commodity baskets, yield curves and exchange rates. But through it all, the nation's central bank has jealously preserved its privilege to act on the basis of its own discretion.

Thank goodness. It would be frightening to have our monetary system tied to a simple rule, any simple rule, which might not be pertinent to whatever situation might arise in a complex and volatile world. But that then puts a premium on human judgment of a broad array of evidence to get the policy dials tweaked into proper position.

The broad evidence suggests that global economic conditions are recovering from the heart attacks of 1997-98. Japan's strong first-quarter GDP report, scorned as a hopeless mismeasurement when first announced, was revised up last week. Its data on industrial production and on machinery orders came in much better than forecast in the second quarter. Ditto for Germany's manufacturing orders. Southeast Asia has gone from bust to something more closely described as boom and Latin American production is once again on the expansion path, with only Argentina (of the major nations) still shrinking.

A stronger global economy means less "imbalance" with that of the U.S. and less of a cooling effect from abroad. If a central banker is going to insist on his discretion to use a variety of evidence to come to his judgments, it would seem advisable to cast the net as wide as possible -- and it would also appear critical not to get caught using a closet PPI standard.

I conclude that the market will not be able to persist in hoping for an August 24 free pass. Alan Greenspan has painted himself and his colleagues into a corner. He can't talk as tough as he has been talking and get away with timid behavior. He can't make policy on a crypto-standard of goods and services prices and not be smoked out by a recovering global economy. The bottom line for me is that the broad averages are going to have some trouble in the near term regaining the peak levels of July, while interest sensitive sectors and high multiple stocks with distant earnings will have trouble keeping pace with the plug-uglies.

That late-August sadness I feel as the easy-living summer draws to a close -- maybe this year it's not about the seasons. With the Fed rising as an unfriendly factor, it may be more than summertime that is coming to an end.

Jim Griffin is the chief strategist at Aeltus Investment Management in Hartford, Conn. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. Aeltus manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at