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In the US, there has been both fiscal stimulus and monetary stimulus. These stimuli aren't showing up in increased economic activity, therefore, they must be causing inflation somewhere. Most goods and services are not seeing inflation, so that inflation has been directed to the stock markets.

In looking at a chart of the S&P 500, it's recent bottom was on March 23. The CARES act was signed on March 27. The Fed's bond purchase program was announced that same week. Those two actions appear to have halted the stock market slide.

In the mean time, Q1 GDP was down at about a 5% annual rate. Q2 GDP may be down as much as 25% to 35%.

Granted, this is all short term stuff. As a value investor, I know that the vast majority of a stock's value lies in future business profits, not the next quarter. On the other hand, a business needs to survive the next quarter and the quarter after that to realize those future profits. And with drops of this magnitude in business activity, some businesses will not survive.

Therefore, my personal theory is that the US stock market and the US economy have become disconnected from each other. That fits pretty well with the idea that in the short run markets are a voting machine, while in the long run they are a weighing machine.

Right now, stocks are popular and the prices of stocks have been bid up. The big problem I see is that both wheat and chaff are at inflated prices, but chaff is way ahead of wheat. There are plenty of firms that are not situated to survive such a steep drop in economic activity. And there are also firms that ARE so situated. But you can't tell them apart by their stock price or valuation metrics. You have to dig into balance sheet strength - a rather unpopular task in some corners of investment analysis.

For businesses that survive this economic downturn, I don't see a huge change in their long term valuation. You might need to push specific valuation estimates out a year or two from where those were at the end of last year to account for the current economic situation.

The broad valuation hit is to those firms that should be valued near zero today because their survival through the next year or two is (or should be) in serious question. I believe that is the current irrationality in stock prices.

--Peter
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