Stock Valuations Cannot Be Trusted

The markets as we knew them fail to exist anymore. They’re gone. POOF! Just like that. Think rationally about what markets were and what they represented conceptually when they were formed. Hardworking citizens put their HARD EARNED capital into businesses that they thought would prosper. Their reward for risking their capital was growth of capital. Their downside risk, if the business failed, was loss of capital.

Today the problem with government intervention is that supply of money is now unlimited. There is no limit to how much money that governments can print and use to purchase financial assets. This impacts valuations of stocks. This makes fundamental analysis completely useless.

Valuations are seriously inflated.

Valuation equals Net Present Value of expected future cash flows, discounted by an interest rate, (sometimes the 10yr treasury) - less all debt. Today’s valuations are all seriously flawed when the 10-year interest rate is used as a discount rate. It’s artificial. It’s lower than it should be.

Once inflation kicks in, the government will have no choice, but to try to absorb some of the cash that they’ve dumped onto the capital markets. When they do this, we’ll see interest rates start to rise. As rates rise, it will impact valuations of stocks. Today’s rally in the stock market is the result of huge cash levels being pumped into the system. Eventually this cash will have to be removed. When it is removed, stock prices will go down.

If the cash is not removed, then we will be dealing with very high levels of inflation. Take your pick. We can have either inflated stock prices and high inflation or lower stock prices and lower inflation. I would suggest that you cannot have both. This experiment has failed before. A review of history will prove it. The trap is being set for those unsuspecting buy and hold equity investors. The sharks are suggesting that the water is warm, come on in. As soon as all these investors are treading water waiting for the tide to rise, the sharks are circling right beneath their feet.

As I’m writing this, Bob Doll is on CNBC, telling people to start moving money out of safe assets into risky assets. He’s making all sorts of price comparisons about stocks. None of these comparisons hold water in my opinion. The levels of debt are extraordinary. Life is different today.

I would not want to be a buy and hold investor in this type of market.

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