Stocks are Priced for Perfection

I wanted to jump on and discuss the big earnings reports that came out after hours tonight on Starbucks, Apple, and Amazon. Apple and Amazon beat earnings estimates while Starbucks had a big miss. Whats interesting to me is the market reaction to the news after hours. Now obviously after hours trading volume is light but its a good indicator of what we will see tomorrow.

All three stocks were down on the news in after hours trading and all three warned of lower guidance going forward. This could become a recurring theme because stock expectations for the second half of the year are way too high. Here are the earnings reports for each:


Apple

Starbucks

Amazon

Starbucks missed big time and made this startling statement:

``The current economic environment is the weakest in our company's history,'' Howard Schultz, who returned as chief executive officer in January, said in the statement.
Second-quarter earnings were 15 cents a share, Starbucks said. Analysts in a Bloomberg survey estimated average profit of 21 cents."

One of the problems that stocks now face going forward in 2008 is the estimates set by analysts are pricing in a second half recovery. Everyone is now waking up to the fact that with rapidly rising inflation and $120 oil, it simply isn't going to happen.

You have a better shot at seeing Santa Clause in the second half of the year versus an economic recovery.

Equities have not yet priced in the fact that things might get WORSE in the second half of the year versus the first half. I listen to the talking heads on CNBC who see a big recovery in the second half of the year and we are now in the middle of the market bottoming process. Yeah right. Here is what I see:

I see a deteriorating economy with rising inflation that now faces the risk of rising interest rates and a consumer that is on its knees. These higher rates are inevitable because if the Fed doesn't raise rates then the banks will because they are insolvent and are in no condition to lend right now.

Higher rates will then destroy housing. These economic pressures combined with helpless financials and a crippled consumer will then push the economy into a deep recession. Rates cannot stay low because of the rising risk of massive inflation or worse: hyperinflation. I don't think anyone wants to see the starvation/class warfare that hyperinflation can cause.

If it comes down to the Fed making a choice on rates then they MUST pick the lesser of two evils and raise rates to prevent out of control inflation. The ECB realizes this and has already warned they will raise rates to control inflation even if they are heading into a weaker economic environment.

Bloomberg today:


"April 23 (Bloomberg) -- European Central Bank officials are raising the prospect of interest-rate increases for the first time since the global credit squeeze began last August, stepping up their battle to keep inflation in check.
Comments by policy makers including Axel Weber and Christian Noyer are forcing investors and economists into an about-face after they previously bet the bank would follow the U.S. Federal Reserve in cutting rates to shore up growth. "

Europe realizes the risks of inflation. We cannot continue to cut if they decide to raise rates because inflation would then spiral out of control. Expect the Fed to slow way down on the rate cutting if the inflationary pressures continue. The Fed will raise rates if they are forced too because in the end, destroying parts of the financial system sure beats having your people starving to death due to hyperinflation.

Expect the analysts to start cutting estimates as these companies report earnings and lower guidance for 2008. This will not be good for the Wall St. boys and their stocks.