Largest Component of Inflation Decelerates, Productivity Remains Healthy, Inventories Rise

- Preliminary 2Q Non-farm Productivity rose 2.2% versus estimates of a 2.0% gain and an upwardly revised 3.2% increase in 1Q.
- Preliminary 2Q Unit Labor Costs rose 1.3% versus estimates of a 2.9% increase and an upwardly revised 3.6% gain in 1Q.
- Wholesale Inventories for June rose .7% versus estimates of a .4% increase and a .3% gain in May.

BOTTOM LINE: Hours worked rose at a 2.1% rate in 2Q versus a 1.1% gain in 1Q. The smaller-than-expected rise in 2Q unit labor costs is a big positive as these costs comprise two-thirds of inflation.

Stockpiles at US wholesalers rose more-than-expected in June, a sign that companies are rebuilding inventories as the economy picks up speed, Bloomberg reported. The inventory-to-sales ratio held steady at 1.19 months. Inventory building subtracted 2.32 percentage points from economic growth in the second quarter, the most since 2000. I expect inventory rebuilding to add to economic growth through the remainder of the year.

Links of Interest

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I-Watch Sector Overview
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Real-time Intraday Chart/Quote

Tuesday Watch

Late-Night Headlines
Bloomberg:
- Alexander Yakovlev, a UN procurement officer during the Iraq/UN oil-for-food program, pleaded guilty today to fraud and money laundering.
- The proposed combination of Adidas-Salomon AG and Reebok International will help the companies open more stores and compete against Nike for leadership in China, the world’s fastest-growing athletic gear market.
- Japan Prime Minister Koizumi plans a purge of his party, which may cause the biggest split in the ruling group in 12 years, to eliminate opposition to his planned sale of government-controlled savings bank Japan Post, the centerpiece of his economic overhaul.
- Crude oil futures traded above $64/bbl. In NY after Valero Energy, the third-largest US refiner, said a fire at its McKee plant in Texas will cut gasoline production for five days.
- US lawmakers are renewing their efforts to impose sanctions on Chinese imports, arguing that China’s currency revaluation last month – Its first in a decade – doesn’t go far enough.
- NASA’s Discovery will have opportunities to land at three locations across the US today, a day after cloudy, rainy weather in Florida forced a delay in the space shuttle’s homecoming.

Late Buy/Sell Recommendations
Goldman Sachs:
- Reiterated Outperform on EBAY, COH, DELL and HNT.
- Reiterated Underperform on SMP.

Night Trading
Asian Indices are unch. to +.75% on average.
S&P 500 indicated +.07%.
NASDAQ 100 indicated +.06%.

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Earnings of Note
Company/EPS Estimate
AIG/1.21
AES/.15
AQNT/.10
BBI/-.10
CVC/-.11
CSCO/.24
CCU/.40
DISH/.44
HANS/.90
MAY/.31
PNRA/.33
RL/.36
SNDA/.38
SLAB/.11
DIS/.38

Upcoming Splits
None of note

Economic Releases
8:30 am EST
- Preliminary 2Q Non-farm Productivity is estimated to rise 2.0% versus a 2.9% increase in 1Q.
- Preliminary 2Q Unit Labor Costs are estimated to rise 2.9% versus a 3.3% gain in 1Q.


10:00 am EST
- Wholesale Inventories for June are estimated to rise .4% versus a .1% increase in May.


2:15 pm EST
- The FOMC is expected to raise the benchmark rate 25 basis points to 3.50%.

BOTTOM LINE: Asian indices are mostly higher on gains in energy shares in the region. I expect US equities to open modestly higher and to decline later in the afternoon after the FOMC announcement. I expect the Fed to raise rates 25 basis points, maintain the word “measured” with respect to the pace of future hikes and to make other more hawkish statements. The Portfolio is 25% net long heading into the day.

Stocks Finish at Session Lows on Rate Fears and Energy Concerns

Evening Review
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In Play

BOTTOM LINE: Due to a scheduling conflict I am posting an abbreviated Evening Review. I finished the day 25% net long by adding to existing shorts. I will post the Tuesday Watch later this evening.

Stocks Modestly Lower Mid-day Ahead of Fed

Indices
S&P 500 1,225.63 -.06%
DJIA 10,547.92 -.10%
NASDAQ 2,169.92 -.37%
Russell 2000 661.67 -.17%
DJ Wilshire 5000 12,214.98 -.14%
S&P Barra Growth 588.12 -.13%
S&P Barra Value 633.02 -.02%
Morgan Stanley Consumer 584.57 -.07%
Morgan Stanley Cyclical 753.46 +.10%
Morgan Stanley Technology 502.28 +.02%
Transports 3,733.26 +.04%
Utilities 391.77 -1.05%
Put/Call .82 -29.31%
NYSE Arms .84 -22.74%
Volatility(VIX) 13.18 +5.61%
ISE Sentiment 129.00 -37.38%
US Dollar 87.91 -.17%
CRB 317.86 +.39%

Futures Spot Prices
Crude Oil 63.55 +1.99%
Unleaded Gasoline 186.00 +1.52%
Natural Gas 8.61 -1.03%
Heating Oil 178.40 +3.05%
Gold 440.30 -.61%
Base Metals 127.23 -.53%
Copper 164.60 -.18%
10-year US Treasury Yield 4.40% +.46%

Leading Sectors
Steel +2.80%
Energy +2.11%
Oil Service +1.71%

Lagging Sectors
Biotech -1.60%
Broadcasting -1.93%
Homebuilders -2.19%

BOTTOM LINE: The Portfolio is unchanged mid-day as gains in my Medical and Internet longs offset losses in my Semiconductor and Retail longs. I have not traded today, thus leaving the Portfolio 50% net long. The tone of the market is modestly negative as the advance/decline line is lower, most sectors are lower and volume is light. Measures of investor anxiety are mixed. Today’s overall market action is neutral considering the rise in rates/oil and recent gains. I like the announced acquisition of LabOne (LABS) by Quest Diagnostics (DGX). Both stocks are higher on the news. While a better entry point in Quest shares is likely in the near-term, long-term investors should consider the shares on any pullback. I expect US stocks to trade mixed-to-lower from current levels into the close on rising apprehension ahead of tomorrow's Fed decision.

Today's Headlines

Bloomberg:
- E*Trade Financial agreed to buy the online brokerage Harrisdirect from BMO Financial Group for $700 million in cash.
- Quest Diagnostics, the biggest US operator of medical-testing laboratories, said it will acquire LabOne in a cash transaction valued at $934 million.
- Whirlpool sweetened its offer for Maytag to $1.6 billion, topping a bid from Ripplewood Holdings for the third time.
- The UK today warned that terrorists in Saudi Arabia may be in the “final stages of planning attacks,” after the US closed its diplomatic missions in the capital, Riyadh, and in Jeddah and Dhahran.
- Crude oil in NY jumped to a record, approaching $64 a barrel, as a threat to the US embassy in Saudi Arabia heightened concern that supplies from the country could be jeopardized.

Wall Street Journal:
- Liberty Media Chairman John Malone said Rupert Murdoch’s News Corp. should increase returns to shareholders by buying back stock.
- Dell plans to sell a desktop computer for game playing using chips made by Nvidia.
- Benon Sevan, the official who ran the UN/Iraq oil-for-food program, resigned hours before the scheduled release of a UN report that’s expected to accuse him of taking kickbacks.
- Linux Corp. and other makers of “open source” software face demands from users for higher levels of service, support and software functions.
- US malls are turning to Israeli security specialists to devise programs to protect the some 1,200 US commercial shopping centers from possible terrorist attacks.
-An increasing number of research firms are being established in the US to collect information on companies by tapping their customers, suppliers, employees and competitors.

NY Times:
- Electronic Arts may be losing its creative edge as it plans to release 25 game sequels and one original game by the end of this year.
- Flights in the US have been so delayed that 2005 looks set to be worse for planes leaving late than any year since 2000; nearly 17% of flights left airports late in the year until June.

Financial News:
- Goldman Sachs has lost 146 of the firm’s 240 partners since its May 1999 IPO.