The question of whether or not to allocate capital in the environment is the subject of much debate, and as investors we are left, as we always are, with two options; 

1. Follow the herd, be invested, and avoid missing out on a buck

2. Seek the truth and make a decision that combines our principles with what we can see

As an Investor and Asset Manager for institutions and individuals who I respect and value, these choices and their likely outcomes are of paramount importance to me. By history and definition, most will choose to follow the herd, and, depending on timing and the element of chance, they may even make money! (unless its 1999, 2008, or 2020, but who wants to talk about that when the S&P is up!) For those of us, on the other hand, who wish to maximize the probability of building the most value over the long term, while taking on acceptable amounts of risk, we seek to employ as much truth in our decisions as possible by using all of the information available to decide when and what to invest in. Let us consider 4 realities of the current marketplace in rendering a decision;

1.) Earnings Multiples Are at All-Time Highs 

Never have price to earning ratios been this high, broadly speaking, since the heights of the dot com bubble, and we all know how that turned out. At the end of the day, when you purchase an equity, you are purchasing a piece of a company, and, as history and performance demonstrate time and time again, the value of that company will ultimately present itself in the value of the share that you own, whether it be by an exit, movement in market value, or share repurchase, among other ultimate realities. Some Investors have historically ignored and continue to ignore this at their own peril. Will you place your bets in hope of catching momentum by chance, or with a long term view of value actualization in mind and a well-founded belief in the intrinsic value of your equity investments?

2.) Real Estate Capitalization Rates are Priced for Perfection

Historically, the market-clearing capitalization rates, or the rates at which individual real estate assets would pay for themselves through operating on an annualized basis (or “Capitalize”), have hovered in the 10-20% range, rates that now appear absurdly high by any recent measure of asset values. There are some legitimate long term drivers of recent broad cap rate compression towards the 3-8% range, such as surplus capital accumulation, the maturity and liquidity of debt markets, and the increased participation in real estate investments on a global level, to name a few. That being said, given the current uncertainty of debt markets, household incomes, and employment at large, it would stand to reason that there should be some cap rate expansion to reflect increased risk and decreased financeability in the marketplace. While we observed this in certain distressed and high-risk segments of retail (a long time coming), we have not seen this reflected substantially in multifamily or commercial office asset values. It appears likely that, as near term unemployment, trends in remote work, and shaky debt markets set in, there will be rent compression, and, as a result, increased sellers relative to buyers at lower values in the real estate market place. So the real question is, does one wish to catch a falling knife, or wait for distress to set in and snap up a bargain?

3.) Current Rates Are Liquidity Driven and Unsustainably Low

For as long as most of us can remember, bonds and fixed income investments have been seen as a safe haven. Federal Reserve stimulus, capital market expansion, and increased demand for the asset class, among other factors, have continued to compress rates and increase values over the past 30-odd years, and the recent influx of fresh liquidity by the Fed is no exception. However, this begs questions of sustainability on the part of issuers (those who issue and pay back principal and interest on bonds) and how low rates can go before they are no longer attractive for investment (which would drive net selling and an increase in rates and a decrease in values. Well, if the 30 Year Treasury Rate (well below the historic rate of inflation) is any indicator, it seems difficult to see pricing go much further in its historically glib direction. Would you buy a 30-year bond to lose money on an inflation-adjusted basis for 30 years? Would you take a risk on a municipal or high yield offering to barely break even? If you wouldn’t, then why would anybody else? Is it simply enough to keep buying fixed income because “its always been a stable investment for as long as I can remember”, or does it make sense to wait and see what happens to the rate and price environment as stimulus runs dry, new economic realities begin to set in, and the market is left to its own devices? 

4.) Current Economic Solutions are not Long Term

Mass purchasing of market trades assets with manufactured liquidity. Massive unemployment benefits that are only sustainable and authorized for another few months. Record low rates that few investors would finance long-term. What do these three things have in common? You guessed it! They are all happening now, they are all impacting asset values considerably, and they are all hard to envision lasting more than a year. 

As Long Term Investors, do we lean into a market driven by these short term distortions? Or do we;

1. Observe, Listen and take pains to understand the world of assets moving forward in this new reality.

2. Seek assets that are long term durable in value, bear a strong return with relatively high confidence, and are connected to a world that we can see making some form of sense.

3. Purchase those assets when the price reflects reality or an outcome worse than anticipated reality, rather than short term exuberance.

These choices are hard. Missing out sucks, and there is no immediate glory in losing out of an opportunity to make money. But is that enough of a reason to roll the dice blindly? We cannot control outcomes or be certain of what the future holds, but we can choose the principles by which we live and invest- principles independent of the ever more prevalent daily distortions that we face in the current world. What are your principles?