How do we invest today given that future investment returns are unknown?
First, by fighting the natural tendency to seek shelter when times get tough and join the party when it is raging; and instead, do the opposite as summed up by Warren Buffett, “be fearful when others are greedy and greedy when others are fearful”.
Second, by estimating long-term cash flows available from the spectrum of investments and then investing in the most attractive opportunities and avoiding the most overvalued.
Looking at the current market yields, the most overvalued opportunities are investments with cash flows locked in at exceptionally low interest rates. Investing in 5 year Government of Canada bonds earning 0.9% makes no sense to us and extending term to 10 years at 1.6% or 30 years at 2.2% makes even less sense.
On the other hand, owning businesses earning free cash flow of 8%, paying dividends of 4% a year, expected to grow cash flow and dividends by 5% a year seem sensible provided long-term investors are prepared to put up with short-term ups and downs.