The Federal Open Market Committee (FOMC) did what it was expected to do and raised its key interest rate-the Fed Funds Rate-by 25 basis points to 1.5%. After the interest rate hike was announced, FOMC Chairman Alan Greenspan acknowledged that there was a "soft patch" in the economy and it was threatening to become more severe. He also noted "improvement in labor market conditions has slowed." The "soft patch" that created the weakness was blamed on the increase in energy costs since January. Was the "soft patch" motivated by the "oil patch?"
Greenspan went on to state this slowdown should be short-lived. He felt the economy was "poised to resume a stronger pace of expansion going forward." Most analysts studying the remarks made by Greenspan have come to a consensus-if the economy hadn't had that expected improvement by September's FOMC meeting, there would be no more interest rate increases until after the presidential election.
The next FOMC meeting is scheduled September 21. Most analysts believe another rate increase would be predicated on whether job creation will have increased considerably. It's my opinion the FOMC doesn't care about job growth. Its only real concern is with real interest rates (nominal rates minus inflation) and dollar value.
The Dow and the NASDAQ reacted positively to the FOMC's rate increase. The Dow moved up 130 points after flirting with a low around 9800 and the NASDAQ gained 34 points. However there are two factors negatively affecting prices, for the longer-term: the drop in productivity during the second quarter and the new highs in the price of crude oil.
Productivity is important because it predicts the cost per hour to produce or complete a job. During the third quarter of 2003, productivity was at 9%. It is currently at 2.9%, representing a considerable increase in labor costs, thus price inflation.
This could be one of the reasons job creation is weak. Labor costs are too high and businesses have slowed hiring. Eventually businesses will be forced to accommodate the needs of their labor forces and rising energy prices. They will have to increase wages and hiring to make up for the drastic decrease in productivity. Until that happens, the Fed has no choice but to go slow, even to the point it is guilty of allowing inflation to rise.
The stock market held above 9000, where I thought it would find support. A better point of support was the past low of about 9862. The Dow is currently above 9900 again. A double bottom is now in place, suggesting a move back into the Dow's past trading range. Whether this move back into the trading range means the low end of 10000 or the high end of 10500 remains to be seen. If it's in the low end, things will not have looked too bright to the markets. A high end move in the trading range would suggest some light at the end of the tunnel.
A warning-it is entirely possible the Dow could again test its 9862 low. The good news is if it holds above the 9862 low, a triple bottom would be in place and would be even more positive than a double bottom.
Six weeks ago I advised the Dow could see a low around 9000. My advice then was to keep your stock buying low (a few thousand dollars) or no more than 5% of your portfolio until the "slow patch" has been resolved. My advice hasn't changed.
Let's hope the resolution of the "slow patch" comes in weeks, not months. If the economy signals a major improvement, I will update these comments. STAY TUNED!
Kenneth Coleman
