By Brent Gloy and David Widmar
This article is a condensed “What We Are Thinking About (WWATA) Memo” that was published earlier on AEI Premium (Read the full-length memo, start a free trial, or learn more).
Purdue University’s latest survey on farmland values found top-quality Indiana farmland values 14% higher. The latest data confirms a dramatic improvement in the farm economy. This week, we step back to consider the idea of “how things are going” using the mental framework of a swinging pendulum.
The Pendulum Swings
In the book, The Most Important Thing: Uncommon Sense for Thoughtful Investors, Howard Marks spends a lot of time talking about the causes and consequences of cycles. In his view, one of the most powerful causes of cycles is the credit cycle, which kicks into gear at market extremes, adding lots of credit to the system when times are good and removing it when times aren’t so good, thereby accentuating market ups and downs. Marks makes the argument that it is next to impossible to perfectly time the peak and bottom of a cycle. To describe market cycles, he uses the simple illustration of a giant pendulum that swings from high to low. While it is very difficult to find the exact point at which the pendulum will switch directions, might it be possible to get at least an intuitive feel for where the pendulum is heading, and maybe even a small sense for whether it is accelerating or slowing?
To us, the idea behind the market pendulum and cycles is applicable and insightful to farmland. In his book, Marks provides what he calls a “Poor Man’s Guide to Market Assessment.” This guide provides some simple factors that you can use to help assess market conditions and give you an indication of where the pendulum might be in its swing from the top of the cycle to the bottom. An abbreviated version of Marks’s guide is shown in Table 1.
Figure 1. Taking the Market Temperature.
|Eager to Buy||Uninterested in buying|
|Asset Owners||Happy to hold||Eager to Sell|
|Markets||Crowded||Starved for Attention|
|Personal Qualities Deemed Ideal||Aggressiveness||Caution and Discipline|
Adapted From The Most Important Thing: Uncommon Sense for Thoughtful Investors, by Howard Marks.
As you look at Table 1, ask yourself which condition best describes the situation in farmland today and circle that word. For instance, if you feel the economy is doing pretty well, circle vibrant. If you think it’s not doing so well, circle sluggish. What about today’s outlook? Is it positive or negative? Continue through the table. As you complete the task, take a look at where things are shaking out.
If you notice, all of the things that are in the left condition column usually signal that things are going along pretty well, and prices are probably up. In other words, the pendulum is swinging upward in the cycle. It may not be to the top, but these factors tend to signal pretty good times, and prices tend to get overdone in good times. On the other hand, things in the right-hand column of conditions tend to occur when people become extremely skeptical of the future, and the pendulum is swinging toward the downward side of the cycle. Marks sums it up well by saying, “… if you find that most of your checkmarks are in the left-hand column… hold onto your wallet.”
We have found this list to be helpful in thinking about ag markets and farmland in particular. Today, it is absolutely clear several things are on the left side of the ledger, particularly the factors related to credit and credit availability. For example, farm interest rates are very low, and lending terms are pretty favorable for farmers. At this point, getting a loan to buy a farm is not really that hard.
For other things, it is perhaps too early to tell. The outlook has shifted very rapidly from really dire to really outstanding. It will be important to watch how expectations on this factor evolve, but it appears that they, too, are headed to the left side of the ledger.
Wrapping it Up
It is sometimes hard to believe that using such simple heuristics can be valuable but think back to 2013/14 and assess these factors. We think you’d find almost every check on the left. If you were around in 1987, ask yourself how you would have answered the questions then. Our bet is that most of the answers would have appeared on the right of the scorecard.
While these simple heuristics are never perfect, they do suggest that it is worth the time to step back and at least think about how others and the economic environment are influencing our judgment. Today it appears that the pendulum has again started its swing to the upside. How far it goes is difficult to predict, but at this point, conditions remain pretty positive. This doesn’t mean you should or should not buy farmland, but, as always, one should do so thoughtfully.
Finally, it’s also valuable to use this scorecard approach to review your observations and expectations every six to twelve months. Rather than getting caught up in current headlines or sentiments being shared on social media, this disciplined and structured approach challenges our thinking to review the entirety of the situation.