Why Now is Not the Time to Buy; 4 Reasons that Current Market Values in Equities, Real Estate and Fixed income are Not Reflective of Reality
From: Adam Ibrahim
The question of whether or not to invest capital in the environment has been the subject of much debate and, as investors, we always have two options.
1. Follow the herd, invest, and avoid missing out on a dollar
2. Find the truth and make a decision that connects our principles with what we can see
As an investor and asset manager for institutions and individuals I respect and value, these decisions and their likely outcomes are of paramount importance to me. By history and definition, most will choose to follow the herd and, depending on the timing and chance, may even make money! (Unless it’s 1999, 2008, or 2020, but who wants to talk about when the S&P is up!) On the other hand, for those of us who want to maximize the likelihood of creating the greatest value in the long run, we’re going acceptable though Take risks, but try to use as much truth as possible in our decisions, using all the information available to decide when to invest and what to invest in. In making a decision, let’s consider four realities of the current market.
1.) The profit multiplier is at an all-time high
By and large, value for money has never been this high since the heights of the dotcom bubble, and we all know how that turned out to be. At the end of the day, when you buy equity, you buy a piece of a company, and as history and performance show time and again, that company’s worth will ultimately show in the value of the stock you own, whether through an exit, a change in market value or a share buyback, among other ultimate realities. Some investors have historically ignored this and continue to ignore it at their own risk. Are you going to place your bets hoping to gain momentum by accident or with a view to a long-term update in value and a good faith in the intrinsic value of your stock investments?
2.) Real estate capitalization rates are set for perfection
In the past, clearing capitalization rates, or the rates at which individual property assets would amortize on an annual basis (or “capitalize”), ranged from 10% to 20%, which now seems absurdly high by a current measure of the assets. There are some legitimate long term drivers for the recent compression of the broad cap rate toward 3-8%, such as: For example, excess capital accumulation, maturity and liquidity of the debt markets and increased participation in real estate investments worldwide are a few. However, given the current uncertainty in debt markets, household incomes and overall employment, it would seem natural that the cap rate should be increased to take into account the increased risk and reduced affordability in the market. While we have seen this in certain distressed and high risk segments of retail (long time), we have not seen this materially in the values of multi-family or commercial office real estate. It is likely that with short-term unemployment, trends in remote working, and shaky debt markets, there will be a compression of rents and, as a result, an increase in sellers versus buyers with lower values in the property market. So the real question is whether to catch a falling knife or wait for distress and grab a bargain.
3.) The current interest rates are liquidity-driven and not sustainably low
For as long as most of us can remember, bonds and fixed income investments have been considered a safe haven. The stimulus from the US Federal Reserve, capital markets expansion and increased demand for the asset class have, among other things, further compressed interest rates and increased values over the past 30 years or so, and the recent influx of new liquidity from the Fed is no exception. However, this raises questions of sustainability on the part of issuers (those who issue and repay principal and interest on bonds) and how low interest rates can be before they are no longer attractive to investment (resulting in net sales and an increase in interest rates would) and a drop in values. Well, if the 30-year base rate (well below historical inflation) is an indicator, it seems difficult for pricing to go much further in its historically smooth direction. Would you buy a 30 year bond? Lose money for 30 years after adjusting for inflation? Would you take a risk if a municipal or high-yield offer barely break even? If you didn’t, why would anyone else? Is it easy enough to keep buying fixed income because “It has always been a stable investment for as long as I can remember,” or does it make sense to see what happens to the interest rate and price environment when the incentives run out to new economic ones Set realities and the market does this leave it to its own developer?
4.) Current economic solutions are not long-term
Bulk buying of market deals with created liquidity. Massive unemployment benefits that are only sustainable and won’t be approved for a few months. Record lows that few investors would finance in the long term. What do these three things have in common? You guessed it! They are all happening now, they all have a significant impact on the assets and they are all hard to imagine if they last more than a year.
As long-term investors, are we sitting back in a market driven by these short-term distortions? Or do we do it?
1. Observe, listen and strive to understand the world of assets as it evolves in this new reality.
2. Look for assets that have lasting value over the long term, generate strong returns with relatively high levels of confidence, and are connected to a world we consider meaningful.
3. Buy these assets when the price reflects reality or an outcome that is worse than expected reality than short-term exuberance.
These decisions are difficult. Missing sucks, and losing the opportunity to make money isn’t immediate glory. But is that reason enough to roll the dice blindly? We cannot control the results or be sure of what the future will bring, but we can choose the principles by which we live and invest the principles regardless of the increasingly common daily biases we face in today’s world . What are your principles