Two important stories this morning…

1) I have stated countless times that 2008 estimates are far too high – in the end stock prices are a reflection of earnings. Not in the day to day white noise and emotion; but in the long run. For the bulls case to be true, if my thesis of 2008 full year earnings falling is accurate, than we need to count on PE multiples expanding just to stay FLAT on stock prices. As earnings fall, if PE multiples stay consistent, then prices must fall. Analysts have been flat out wrong… again, I point to how wrong they are just on the 1st quarter of 2008 [Mar 31: Classic Example of Analysts Overexuberance] I wrote:

….the herd got it very wrong

At the beginning of the quarter, analysts projected 4.7 percent earnings growth during the period. (folks that is 3 months ago…)
Last week? 5.5 percent decline projected
This week? Earnings for Standard & Poor’s 500 companies are now expected to fall 8.1 percent in the first quarter
So in the span of 3 months we have a 12.8% swing in earnings projections – and that’s for the 1st quarter which in THEORY should be the easiest to project for companies and analysts since it’s the nearest to when they made said projections.

General Electric (GE) which is notorious for always matching or beating earnings by 1 cent, since it has so many moving parts – missed by a whopping 7 cents. Bulls will say “yes but 5 cents was due to financial problems in March and that is the PAST – look to the future kiddo!” That’s the same refrain we’ve been hearing, and will continue to hear as we live in a world of denial. Now, why should I be happy about the future when GE itself now is dropping its full year forecast despite fantastic overseas growth? The (a) US market and (b) financial piece of GE are just that worrisome.

General Electric Co. pulled an unpleasant surprise on investors Friday, reporting a 6% drop in first-quarter net profit — largely over trouble in its financial-services businesses — and revising lower its 2008 outlook.
It was the first material guidance cut in memory, said Oppenheimer analyst Christopher Glynn in a note, reflecting the difficult U.S. environment.
From continuing operations, the Dow Jones Industrial Average component earned 44 cents a share, well short of the FactSet Research-compiled mean analyst estimate of 51 cents a share.
“Demand for our global infrastructure business remained strong, but our financial-services businesses were challenged by a slowing U.S. economy and difficult capital markets,” said Chairman and CEO Jeff Immelt in a statement.
GE is a poster child for what I have been saying – any company with material exposure to the US consumer/economy is going to take a hit; analysts are way too confidant in 2008 estimates; if you don’t have international exposure you are sunk. Analysts think Q4 2008 estimates are going to be 30%+ higher than 2007 Q4 estimates if you believe the hyperbole they are spinning. Do you believe that? In the fact of a recession that is just getting warmed up? If so you should be buying hand over fist. Because remember “everything will be fine in 6 months”. This continues to be a dangerous environment for both bulls and bears. It is dangerous for bulls because they continue to drink Kool Aid that everything will be fine in just a quarter or two. It is dangerous to bears because the bulls have a lot of sway and the Federal Reserve and Government will do everything in their power to keep asset prices (including equities) inflated as we live in denial.

2) Speaking of asset prices inflated, my favorite measure of TRUE inflation is out today and it is even more alarming than it has been in the past. If you are new to the blog here is the reality behind the lies being told to you in government reports – look at the chart in this link to show you what inflation would look like if the government was not constantly changing methodology to assure us that it only exists in our imagination [Mar 16: A Picture is Worth a Thousand Words - Inflation]. We import almost everything into this country now (save some food). Import prices have been flying for much of the past year [Dec 12: Real Inflation Showing in Reports Not called CPI/PPI] & [Jan 11: Another Myth Falling Flat - Exports Will Save the Economy] & [Feb 15: Today's Import Report Continues to Support my Stagflation Thesis] – we’ve been seeing 12-13%ish year over year import price increases. That is our REAL inflation.

What was last months figure? We are now up to 15%.

Import prices surged in March, lifted by not only oil but also the biggest jump in nonpetroleum costs on record, a worrisome sign for inflation.
Overall import prices rose 2.8% last month, after increasing an unrevised 0.2% in February, the Labor Department said Friday. Wall Street expected import prices to climb 2.1% in March.
During the 12 months since March 2007, prices increased 15%.
Prices excluding petroleum increased 5.4% in the 12 months since March 2007, nearly double the 2.8% climb between March 2006 and March 2007. The 1.1% March increase in non-petroleum prices marked the largest one-month increase since the index was first published monthly in December 1988. Driving it was a 3.6% advance in prices for non-petroleum industrial supplies and materials; that advance was pushed mostly by prices for unfinished metals, but natural gas, finished metals and chemicals also rose.
We have been living in a disinflationary world for the past 2 decades thanks to the chase for lower cost goods globally – first into Mexico, than into China. That era began ending a few months ago, and had a sharp uptick this month, as imports from China increased 0.7%. That’s a huge move… considering two months ago it was 0.1%

Import prices from China increased 0.7% in March. Prices for imports from Canada rose 3.2%. Import prices from the European Union advanced 1.6%. Japan inched up 0.1%.
We’ve been laying the groundwork for this since September in the blog [Sep 11: Chinese Inflation Highest in 11 Years - Why do you Care?] I wrote

Also, remember we import so much from this country of “CHEAP” labor. What happens when they demand higher wages so they can do minor things like… EAT. Chinese companies are already skimping in quality control since they are trying to outdo each other on pricing – and you see the results in dog food, kids toys, and I am sure I already forgot a few others in the near weekly recall news. So increased safety regulations, increased wages for their workers – and suddenly Chinese goods become more expensive…. and who pays? The US consumer – in the form of potential inflation.

And now we are bearing the fruit…[Feb 3: Chinese Inflation Hits American Price Tags]

Inflation is real. It has supply/demand imbalance and a “World of Shortages” theme behind it [Mar 24: WSJ - New Limits to Growth Revive Malthusian Fears] & is being fed by your Federal Reserve [Apr 4: To the Newbie Economists Out There - a Horde of Helicopters Has Moved In] . And it is the most regressive tax on the lower and middle class that there is. So instead of blaming oil companies, if people were financially educated they’d be taking their case to the government and it’s central banks for our policy of destructing the dollar.

If there is one post you read this week, it should be this one, and all the associated links. These are warnings I’ve been shouting for a long time, but all the pieces are coming together. The equity market can continue to disavow reality for only so long… but it pays to at least understand all the economics that are affecting you in your real life (Main Street) so you know why things are happening the way they are. It should anger every person that instead of fighting inflation, our system of little risk control, massive executive compensation even when a CEO fails, and bailing out banks is causing the Federal Reserve to do just the exact opposite of what it should be doing to fight inflation (raising rates). As each investment banking CEO rakes in bonuses, massive compensation & golden parachutes, funded by the Federal Reserve backstop of their balance sheet, the middle and lower class of the country continues to wither under the same policies. But that’s our form of capitalism; a system of “heads we win; tails you lose – either way we will be supported by the government because we are too important to fail” – moral hazard at it’s best.

Remember, all assets are inflated by these policies – including the equity market. I’ve been throwing around 12-13% as my gauge of what true inflation is. If that is accurate and multiple sources of analysis say it is, then one could opine the equity market is also overinflated by 12-13% due to said inflationary policies. Hence a market everyone calls “resilient”, I simply call overinflated due to the same “price inflation” we see across the board. Again, I repeat this weekly – a 8% stock return in a 12% inflationary environment, means you are losing money. Although in this case its a -6% stock market return instead of a -18% stock market return YTD due to “asset inflation”. So keep that in mind when cheering how the market shrugs off all bad news… an avalanche of liquidity has that effect. Take that flooding of paper money out of the system, and I’d opine that the market would be down another 12-13% that the “inflation bonus” is causing.

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