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While everyone obsesses about a faulty CPI that underrepresents inflation by a factor of at least 50%, I'd like to point out something such as Black & Decker's (NYSE:BKD) profit warning on Friday. I don't follow this stock, but its a 'representative' general economy type of stock  that does not have enough overseas exposure to offset domestic weakness. Therefore it is a good proxy as it represents most of the small and mid cap stocks in the US indexes.

While the multinational larger caps might be able to offset (at least to some degree) domestic weakness with overseas sales, the companies which are reliant on the US consumer are in trouble. Hence why I have been using the UltraShort Russell 2000 (NYSEARCA:TWM) as my short against the market instead of something that shorts the S&P500. Thus far this has been the correct way to go, and I expect it to continue as smaller companies also get hit much harder by lack of access to capital.

One reason I am bearish on the market is I feel 2008 profits are very overstated (guidance). I said in January we will begin to get confession season - not necessarily on this quarter's earnings (although I think those will weaken more than people expect too for domestic-based companies) but the great hope is "this is just a rough patch" and things will rebound in a few months. I highly doubt it and I think the companies themselves will be telling you this soon enough. And eventually (although the market is in a state of denial now) stock prices follow profits. Profits go lower, so should stock prices.

Now with that said, there are many forces (invisible hand if you will - see Plunge Protection Team) which will do as much as possible to prop up stock prices as a double whammy of falling real estate prices and falling stock prices will crush consumer confidence. Going into an election year we sure wouldn't want that to happen. So one must be cognizant that everything (including the kitchen sink) will be tried to prop up this market...

So let's see what Black & Decker has to say about 2007:

  • Black & Decker (BDK) slashed its fourth-quarter operating earnings projections amid a product recall and a worse-than-expected slowdown in North America.
  • The Towson, Md., toolmaker now sees earnings of $1.03 a share for the fourth quarter and $6 a share for the year, excluding a gain from a tax settlement. Previously, Black & Decker forecast fourth-quarter earnings of $1.55 to $1.65 and a profit of $6.50 to $6.60 for all of 2007.
  • Analysts polled by Thomson Financial project earnings of $1.61 for the quarter and $6.55 for the year.
  • But the company's underlying results reflect weaker-than-anticipated conditions in North America as the housing slump cuts into demand for repair-related products. Black & Decker now expects a low-single-digit sales decrease for the fourth quarter, compared with its prior projection for "modest" organic sales growth.

So that's Q4 2007, in which I've been arguing things are degrading far faster (if you listen to the companies themselves) than any government report is telling us. And unless you expect a sudden pop back to nirvana in 2008, you can expect more of the same. I expect countless companies to lower 2008 estimates, amid uncertainty on the consumer, credit, and economy in general. Hence a "relatively good valued" market based on 2008 earnings suddenly will get quite a bit more expensive. But that is not priced into the market yet, in my opinion. Let's see how it plays out.

Disclosure: Long Ultrashort Russell 2000 in fund and in personal account