Productivity and Unit Labor Costs Revised Higher, Service Sector Healthy

- Final 2Q Non-farm Productivity rose 1.6% versus estimates of a 1.6% increase and a prior estimate of a 1.1% gain.
- Final 2Q Unit Labor Costs rose 4.9% versus estimates of a 4.0% gain and a prior estimate of a 4.2% increase.
- ISM Non-Manufacturing for August rose to 57.0 versus estimates of 55.1 and a reading of 54.8 in July.

BOTTOM LINE: Productivity slowed and labor costs rose last quarter, Bloomberg reported. Compensation to American workers rose 6.6% in the second quarter, almost twice most measures of inflation. Productivity growth rates had averaged 3.2% each quarter since the expansion began in 2001 compared with 2.1% during the prior 10-year expansion. Job cuts announced by US employers fell 7.5% in August, a sign the labor market remains healthy, according to a recent report from Challenger, Gray & Christmas. I continue to expect productivity to remain relatively high and unit labor costs to remain subdued over the intermediate-term.

Growth in US service industries in August accelerated as business surged at transportation companies, utilities and retailers, Bloomberg reported. An unemployment rate at low levels by historic standards and a drop in gas prices are boosting consumer spending. Gas prices dropped about .21/gallon just in the month of August. The new orders component of the index fell to 52.1 versus 55.6 the prior month. The prices paid component fell to 72.4 from 74.8 in July. I expect the service sector to continue to decelerate to around average levels over the intermediate-term. There is no evidence to suggest a sharp consumer spending slowdown is at hand, which is what the many market bears have been warning about for months. Better-than-expected retail sales this holiday season will likely provide another catalyst for broad market gains this fall.

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Wednesday Watch

Late-Night Headlines
Bloomberg:
- Australia’s economy expanded at the slowest pace in three years as higher interest rates and fuel costs curbed consumer spending and companies ran down stocks.
- The Bank of Japan will probably keep its overnight lending rate at .25% this week, judging that the economy isn’t expanding fast enough to require a second increase in two months.

Economic Daily News:
- Nanya Technology Corp. expects its prices DDR2 dynamic random access memory chips to rise between 5% and 10% this month, citing Vice-President Pai Pei-lin.

Late Buy/Sell Recommendations
Morgan Stanley:
Reiterated Overweight on (MBT), target $45.50.

Night Trading
Asian Indices are -.50% to unch. on average.
S&P 500 indicated -.07%.
NASDAQ 100 indicated -.14%.

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Earnings of Note
Company/EPS Estimate
- (HOV)/1.10
- (MATK)/.15

Upcoming Splits
- (RDY) 2-for-1

Economic Releases
8:30 am EST
- Final 2Q Non-farm Productivity is estimated to rise 1.6% versus a prior estimate of a 1.1% gain.
- Final 2Q Unit Labor Costs are estimated to rise 4.0% versus a prior estimate of a 4.2% gain.

10:00 am EST
- ISM Non-Manufacturing for August is estimated to rise to 55.1 versus a reading of 54.8 in July.

2:00 pm EST:
- The Fed’s Beige Book

BOTTOM LINE: Asian indices are mostly lower, weighed down by technology stocks in the region. I expect US equities to open mixed and to rally into the afternoon, finishing modestly higher. The Portfolio is 100% net long heading into the day.

Stocks Finish Near Session Highs on Another Fall in Energy Prices and Less Pessimism

Indices
S&P 1,313.25 +.17%
DJIA 11,469.28 +.04%
NASDAQ 2,205.70 +.57%
Russell 2000 727.50 +.82%
Wilshire 5000 13,150.60 +.25%
S&P Barra Growth 609.57 +.11%
S&P Barra Value 701.63 +.23%
Morgan Stanley Consumer 645.46 -.15%
Morgan Stanley Cyclical 816.44 +.78%
Morgan Stanley Technology 513.12 +.71%
Transports 4,305.78 -.11%
Utilities 438.12 -.74%
Put/Call .97 -3.0%
NYSE Arms .82 +21.52%
Volatility(VIX) 12.63 +5.60%
ISE Sentiment 69.0 unch.
US Dollar 85.0 +.38%
CRB 327.08 +.51%

Futures Spot Prices
Crude Oil 68.70 -.71%
Unleaded Gasoline 166.25 -4.15%
Natural Gas 6.02 +2.52%
Heating Oil 194.20 -1.29%
Gold 646.90 unch.
Base Metals 235.07 +2.45%
Copper 362.40 -.01%
10-year US Treasury Yield 4.78% +1.21%

Leading Sectors
Gold & Silver +2.92%
Steel +2.53%
Oil Service +2.27%

Lagging Sectors
Broadcasting -.93%
Disk Drives -1.24%
HMOs -1.30%

Evening Review
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Afternoon Recommendations
Citigroup:
- Rated (MRVL) Buy, target $29.

Banc of America:
- Upgraded (AFL) to Buy, target $50.
- Upgraded (HIG) to Buy, target $97.
- Downgraded (AMP) to Sell, target $41.
- Downgraded (NFS) to Sell, target $45.

Afternoon/Evening Headlines
Bloomberg:
- Gasoline futures fell to their lowest price in almost six months as the peak-demand driving season came to a close with US inventories of the motor fuel above normal levels.
- Ford Motor(F) unexpectedly named Boeing(BA) executive Alan Mullaly to replace CEO Bill Ford, great-grandson of the struggling automaker’s founder.
- Merrill Lynch(MER), an also-ran in the growing market for mortgage securities, agreed to buy National City’s home-loan unit for $1.3 billion.
- Viacom(VIA) Chairman Sumner Redstone ousted Tom Freston as CEO after the media company’s stock dropped 10% following a split with CBS Corp.

Dow Jones:
- European economic growth will slow in 2007, according to a document prepared for a meeting of the region’s finance ministers.

BOTTOM LINE: The Portfolio finished higher today on gains in my Semi longs, Computer longs, Medical longs, Internet longs and Retail longs. I did not trade in the final hour, thus leaving the Portfolio 100% net long. The tone of the market was positive today as the advance/decline line finished higher, most sectors rose and volume was about average. Measures of investor anxiety were mostly higher into the close. Overall, today's market performance was bullish. I suspect a test of the S&P's cycle highs is coming very soon which will likely lead to a short period of consolidation before a more substantial push higher occurs during the fourth quarter. Unleaded gas futures fell another 4.3% today and have plunged about 30% in a month. This is a significant positive. Today’s announcement of a huge oil find in the Gulf of Mexico is a substantial psychological negative for the many oil bulls that believe the world is imminently running out of oil.

Stocks Higher into Final Hour on Another Fall in Energy Prices and Less Pessimism

BOTTOM LINE: The Portfolio is higher into the final hour on gains in my Computer longs, Medical longs, Internet longs and Retail longs. I have not traded today, thus leaving the Portfolio 100% net long. The tone of the market is positive as the advance/decline line is higher, most sectors are rising and volume is about average. The ISE Sentiment Index plunged 42.0% this morning to a very depressed level of 40.0 This is the second lowest reading on record since the index began almost two years ago. Moreover, the 20-day moving average is at 106.8, a record low. This reading bodes well for a continuation of the recent stock rally. Apple Computer (AAPL) trades especially well and appears to be breaking free from the options worries that have engulfed the shares for months. I still expect Apple to test its all-time high of $86.40 during the fourth quarter. I remain long AAPL. I expect US stocks to trade mixed-to-higher into the close from current levels on short-covering, more optimism, bargain hunting and declining energy prices.

Today's Headlines

Bloomberg:
- Gasoline futures fell to their lowest price in almost six months as the peak-demand driving season came to a close with US inventories of the motor fuel above normal levels.
- Chevron Corp.(CVX) said it completed the deepest successful test of a Gulf of Mexico well, showing it may be possible to produce billions of barrels of oil from a new undersea deposit.
- European service industries from banking to telecom, the biggest part of the economy, expanded at the slowest pace in seven months in August.
- Abiomed Inc.(ABMD) won US approval to sell the first artificial heart that allows patients to walk away from a power source for an hour at a time.
- Compagnie Generale de Geophysigque SA agreed to buy Veritas DGC for $3.1 billion to become the world’s biggest surveyor of oil and gas fields as energy exploration surges.
- Katie Couric begins trying to lift CBS News from the ratings cellar tonight by becoming the first network tv anchor to go live on the Internet.
- Phelps Dodge(PD) dropped its $17.7 billion takeover bid for Canadian nickel-miner Inco Ltd.
- The Fed can be “patient” in considering whether to raise interest rates again, said St. Louis Fed President William Poole. He also said a housing crash is “very unlikely.”
- A tropical depression in the central Altantic Ocean developed into Tropical Storm Florence, making it the sixth named storm of the Atlantic hurricane season.

Wall Street Journal:
- Moody’s Investors Service will today publish its first public rating on a hedge fund, a move that brings some transparency to the industry, which has $1 trillion in assets.
- Some US hospitals are paying as much as $50/hour for replacement nurses to cope with a growing number of strikes and staff shortages.
- The World Health Organization, the Global Fund to Fight AIDS, Tuberculosis and Malaria and the World Bank are looking for new heads to help set strategies to combat global health risks including AIDS and pandemic flu.
- Large US companies are doing a better job of managing cash, a development that often lets them boost cash flow.

NY Times:
- American Eagle Outfitters(AEOS), Abercrombie & Fitch(ANF), Pacific Sunwear of California(PSUN), J. Crew Group(JCG) and Gap Inc.(GPS) are targeting post-collegiate customers with new clothing stores.
- TiVo will offer subscribers previews of CBS’s four new series this fall, while a majority stake in ITN Networks will be purchased by a group that includes Sony Corp.(SNE).

AP:
- Iranian President Mahmoud Ahmadinejad today called for a purge of liberal and secular faculty members from Iran’s universities.
- U.S. oil and gas reserves could grow by more than 50 percent as three companies said Tuesday that results from a deep-water exploratory drilling project in the Gulf of Mexico indicate a significant oil discovery.

Interfax:
- Kazakhstan produced 42.6 million metric tons of crude oil and gas condensate in the first eight months of the year, 4.5% more than in the year-earlier period.