Would You Rather

<March 27, 2026>

Before smartphones and social media, people—especially young people—would meet and spend time simply talking. Shortly after college, I remember meeting a group of friends at the beach. We stood in the ocean under the bright sun and started a game of Would You Rather. It’s a simple game where you’re given two options and have to choose one, no matter how ridiculous. I remember that particular game because the choices were so absurd.

Would you rather have a giant beach ball or a bowling ball permanently attached to your left hand? Would you rather wear ski boots for the rest of your life or a Steve Martin “arrow-through-the-head” headband? And my personal favorite: would you rather have “Say It Ain’t So” or “Hot Shots” tattooed across your forehead?

Looking across today’s financial markets, asset allocators appear to be playing a similar game of Would You Rather—forced to choose between unattractive, and at times equally absurd, options. While the choices are unappealing, most professional investors feel pressured to play. With markets deep into an extended cycle, many believe they can’t afford to sit out what appears to be an endless period of asset inflation.

With few willing to leave the party, capital doesn’t exit the market, it simply rotates between asset classes, sectors, and market caps. Would you rather own the S&P 500 trading near 40x cyclically adjusted earnings and 3x sales, or the Russell 2000, where nearly half of the companies are unprofitable and the index, on an unadjusted basis, generates little to no earnings? In our view, these are very uncomfortable choices, but for many investment advisers, they are choices that must be made.  

Small caps are often cited as one of the few remaining areas of value in today’s market. We disagree. In our view, small caps are nowhere near inexpensive, especially when valued on normalized margins and earnings. Much of the “small caps are cheap” narrative depends on excluding money-losing companies and relying on adjusted earnings to make valuations appear more reasonable. When evaluating small-cap valuations, buyer beware—how the “E” in P/E is calculated matters more than the multiple itself.  

If choosing between large- and small-cap equities isn’t appealing, how about alternatives? Would you rather own private equity or private credit? It’s a fair question, but a difficult one to answer without transparency around pricing and liquidity. Are these assets truly marked to market?  Can they be liquidated when needed? Without clear answers, the choice lacks conviction.

What about bonds? Would you rather own corporate debt or government bonds? Corporate spreads are extremely tight, offering minimal compensation over Treasuries, which are ultimately backed by the Federal Reserve’s ability to create money. While government bondholders are likely to receive their principal at maturity, what that principal will purchase is far less certain. The Federal Reserve has cut interest rates and resumed quantitative easing (QE) even though inflation has remained above target for years. 

Are you a trend follower or a contrarian? Put differently, would you rather own what’s working and makes you look smart, but is very expensive, or an out-of-favor sector that is underperforming and makes you look foolish, but offers more attractive valuations? Semiconductor stocks and food and beverage stocks are good examples.  

For asset managers, the choice can be unforgiving—hug a benchmark, or deviate and risk losing your job. As small-cap absolute return investors, we face a similar dilemma. Do we buy overvalued small caps to keep pace with one of the longest bull markets in history, or invest in T-bills and wait patiently for better opportunities? What appears to be an easy decision in theory is much harder in practice.  

The current investment environment is filled with challenges and crosscurrents: rising government debt and persistent fiscal deficits, emerging stress in private credit, excessive equity valuations, rising commodity prices and interest rates, the return of quantitative easing in an inflationary environment, and, more recently, uncertainty driven by extraordinary AI investment and geopolitical tensions.

The last time we experienced this level of uncertainty was during COVID. The difference then was how asset prices responded, with small-cap stocks at one point falling 40% from their highs. That is not the case today. It's not just the abundance of uncertainty, it's that asset prices are not responding, and in our opinion, investors are not being adequately compensated for risk. Whenever the market tries to adjust to rising risks, each dip is quickly bought, with the S&P 500 sitting only 5% below its all-time high.

In a bull market that feels never-ending, investors have been emboldened and rewarded for ignoring risk and expensive valuations. As the label implies, during the “Everything Bubble,” almost everything has worked. After years of significant asset inflation, we believe current prices and valuations are not adequately compensating investors for the risks being assumed. Margins of safety are low, while risks are high and rising.

Instead of playing this investment game of Would You Rather and choosing between increasingly unattractive options, we have the ability and willingness to sit this one out. For those who feel compelled to remain fully invested in stocks, the risks of profit and valuation normalization are, in our view, very real. At this stage of the cycle, we believe the opportunity cost of patience is far lower than the risk of permanent capital impairment. In fact, when valuations have reached these levels in the past, equities have fallen as much as 50%. A similar decline today would simply bring valuations back to historical averages.    

Say it ain’t so.     

Eric Cinnamond

eric@palmvalleycapital.com

The Palm Valley Capital Fund can be purchased directly from U.S. Bank or through these fund platforms.

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There is no guarantee that a particular investment strategy will be successful. Opinions expressed are subject to change at any time, are not guaranteed, and should not be considered investment advice.

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Definitions:

S&P 500: The Standard and Poor's 500, or simply the S&P 500, is a stock market index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States.

Russell 2000: an index made up of approximately 2,000 small-cap stocks, representing the smaller end of the U.S. equity market.

Cyclically adjusted earnings: Average earnings over an extended period to smooth out fluctuations in corporate profits that occur over different periods of a business cycle.

Price to Sales: The price-to-sales (P/S) ratio is a valuation ratio that compares a company’s stock price to its revenues. It is an indicator of the value that financial markets have placed on each dollar of a company’s sales or revenues.

Corporate credit spreads: measurement of the extra yield (interest rate) investors demand to hold a corporate bond instead of a safer government bond.

Philadelphia Semiconductor Index: an index composed of leading semiconductor manufacturers and related companies, designed to measure the overall health and performance of the chip sector.

The S&P Select Food & Beverage Index: a stock market index that tracks the performance of publicly traded U.S. companies involved in producing food, beverages, and related products.

Normalized earnings: Normalized earnings are a company’s average or representative earnings level smoothed over a full business cycle (boom + downturn), rather than a single-period snapshot.

Normalized margins: The average profit margin a company earns over a full business cycle, reflecting its sustainable profitability as a percentage of revenue.

P/E: The P/E ratio is the price investors are willing to pay for each dollar of a company’s earnings. The P/E ratio is often used by investors to judge how expensive a stock is relative to earnings.

EPS: Earnings per share (EPS) is the portion of a company’s profit allocated to each outstanding share of its common stock.

Maturity: the date on which a bond’s principal is repaid to the investor and the bond contract ends.

Quantitative easing (QE): is a monetary policy where a central bank creates money to buy financial assets—usually government bonds—to increase liquidity and stimulate the economy.

T-bills: Treasury bills (T-bills) are short-term debt securities issued by the U.S. Department of the Treasury that mature in one year or less.

Margin of Safety: the difference between an asset’s intrinsic value (underlying value of the business) and the price you pay for it, providing a buffer against errors, uncertainty, or bad outcomes.