Did Everyone @ Fed Forget Valuation 101

Why are all the financial press agreeing with the Fed’s easy money bandaid? 

Every course I took at Yale School of Management and every book I read on stock valuation talks about the fundamentals of the business being valued.  Sure, some valuations are based on unicorn market domination projections and not on balance sheet and cash flow statements plus other financial data. And there are temporary hot areas where M&A considerations may escalate the value of a stock. But for the Dow components and the majority of the S&P 500 these are businesses where the majority of the valuation components must be driven by forward-looking financial projections, including a factor that estimates the variance of those projections due to economic changes, competitive landscape or internal issues (capital shortage, the health of a senior manager, etc.)

If we are entering a recession and the consensus is that the recession will have a material impact on earnings for companies, no amount of Fed-generated liquidity will create consumer demand where there is none. Yet we see headlines today such as:

1. U.S. Stocks Drop Despite Fed’s Latest Stimulus Move WSJ
2. The Fed Goes All In With Unlimited Bond-Buying Plan – The Federal Reserve will buy bonds as needed to calm markets NYTimes
3. Wall Street closes lower in spite of Fed ‘bazookas’ Financial Times

Consumers and businesses won’t borrow unless they absolutely have to, so leveraging up the consumer and the small business with cheap capital has a limited stimulus. Small business owners, in particular, have to sign personally for business loans and it’s challenging enough to justify that as a small business owner in optimistic times. When the sky is falling in the minds of the small business owner, a loan with a personal guarantee isn’t seen as the optimal way out.  Layoffs are far higher on the list, and that’s what drives the overall economy into a downward spiral. 

Liquidity is great, but it’s clear that liquidity alone is not working. The stimulus must come from other sources.