This is something from Forbes...
Make no mistake about it: The summer rally is over.
Not that it was much to speak of in the first place.
It fizzled out in mid-July after a mere three weeks,
and since then the market has slumped back to
pre-rally levels.
What's holding back Wall Street? The answer is
simple: interest rates. Bond yields jumped last week
amid signs of burgeoning wage inflation. Higher bond
yields sent the stock market lower in textbook
fashion. And the bond market will continue to set the
tone for stocks this week, with the crucial jobs
report slated for release on Friday morning.
In the end, interest rates are the single most
important determinant of stock prices. Sure,
corporate earnings growth is great. But even good
earnings can't sustain the market on their own. Over
the past few years, valuation growth has outpaced
earnings growth by far. Price to earnings ratios for
the companies in the S&P 500 Index of large-cap
stocks are now at their highest level in history.
Such sky-high valuations are only justifiable in a
low-interest, steady-growth environment. And now
interest rates are rising again with the anticipation
of another rate hike from the Federal Reserve. Fed
Chairman Alan Greenspan has indicated several times
over the past few weeks that he has his finger on the
rate trigger. The main culprit: creeping wage
inflation.
For Greenspan and his cohorts on the Fed's Open
Markets Committee, wage inflation is the greatest
threat to stable economic growth. If the labor market
gets too tight, the theory goes, wages will begin to
rise too quickly. And wage inflation will soon spill
over to consumer prices and eat away at economic
growth.
Last week's employment cost index, which rose at its
fastest pace in eight years, seemed to suggest that
the labor shortage is finally beginning to translate
into bigger paychecks. That shouldn't be a problem as
long as productivity growth offsets the rise in labor
costs. But the rise in labor costs couldn't have come
at a worse time. The economy may finally begin to cool
down, as last week's gross domestic product report for
the second quarter suggested.
In other words, paychecks are beginning to balloon
precisely at the point where productivity growth may
be peaking.
Against this backdrop, it's no wonder that Wall Street
is nervously awaiting this Friday's unemployment
report. Greenspan said in his semiannual report to
Congress last week that a further decline in the
jobless rate from its recent range of 4.2% to 4.3%
would be "one indication that inflation risks were
rising."
Most analysts expect the unemployment rate to remain
at around 4.3% in July, the same as it was in June.
But at the same time, labor costs probably continued
to rise as employers struggled to find skilled
workers.
If productivity growth and labor costs are indeed
parting ways, Greenspan will have little choice but
to raise rates. And he'll have to act fast. It's too
late to step on the brakes once you've driven off the
cliff. What's more, fears of a Y2K-fueled economic
downturn will prevent him from tightening monetary
policy early next year.
With the next Fed meeting scheduled for Tuesday,
August 24, Wall Street is facing four rocky weeks.
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