Today Dow Jones industrial average is hovering around 10000 level while S&P500 is at 1057. Of course we have come down slightly from highs of the year and that gives some investors an argument to make that stock market is undervalued or too cheap. I think this argument is totally baseless. In fact stock market is highly overvalued given the future earnings that actual companies are seeing. Recent spate of M&A activity is highly reflective of that. Companies are destroying stock holder value at a record pace in a bid to get a fictitious boost from the target companies. Recent examples of such offers are Dell and HP's bidding war for 3Par and BHP's bid for Potash (POT). These highly overvalued acquisition bids show one clear thing: that companies are so worried about holding their earnings (and thus trying to hold on to their market valuations) that they are ready to take highly expensive short-cuts. But if history is any guide, these short-cuts cost a lot of money to shareholders. I call these short-cuts because Dell, HP and BHP all have capabilities and resources to develop the technology of their targets quickly if they are willing to deploy half of bid amount into in-house development. This will also create a huge number of new jobs in the economy. But their urgency to not take this slightly longer route sends only one signal very loud and clear. These companies, as they stand now, do not have enough earnings in the future to support their current share prices (or market valuation) if they don't quickly get into newer domains. This comes at huge cost to existing share holders through unreasonable value destruction.
On the other hand, Federal Reserve is adamant on destroying the value of US dollar. Their hypothesis is revolving around avoiding deflation and stock market pressures. I can only see that by taking steps to further undermine the local currency, Fed will be creating a much bigger problem for citizens of USA. As we see everyday in report and data that US public is not earning enough to support big purchases. Credit card loans are lower because line of credit to many consumers has either been reduced by banks or has been completely pulled. Mortgage delinquencies are rising. In such a scenario, in desperate bid to support the stock market which is overvalued anyway, Federal Reserve is trying to stock inflation. I think even slight inflation will kill the economy completely and will send recovery into downward tailspin contrary to the common belief of it helping the economy. There are fundamental problems in the economy and until they are fixed, we'll not see a sustained recovery. The biggest of these are, highly unskilled workforce in USA as compared to countries like China and India, misplaced health care costs for the companies, aversion in work force to work for lower wages and extremely high dependency on credit with less savings culture. Of course, this is a longer path to correct these fundamental problems, so even administrations and central bank are busy in taking short-cuts.
These corporate as well as administrative short-cuts will be costing share holders and general public huge sums. But people don't learn the lesson until they see the results. But this time, in a highly integrated world where information travels very quickly, by the time policy makers see the results of their short-cuts turning out into nightmares, it might be too late for the country, currency and stocks to recover.
