The discerning investor may well ask, admissibly cynically, what the productive allocation of capital means. Fair enough, as the metric of investing is whether it makes money or not, not whether it is productive or not.
However, an investment can be sound and gainful, only if it is generative of a juicy income stream with adequate provisioning of risk – how we define the productive allocation of capital. But that no longer need be the case so long as central banks can engineer a fall in the discount factor to disproportionately boost the present value of a otherwise meagre income stream. It’s the reason why so-called value-investing ostensibly fails as a fall in the discount factor lifts all boats.
With central banks in play, the focus shifts from income stream to discount factor. The disproportional impact of a small fall in the discount factor on the present value of an infinite income stream of a capital asset, generates a forceful trend. As the trend feeds on itself and sucks in capital, investors take on increasing risk in relation to the future income stream.
The key is to keep track of in-built risk premium in relation to a realistic prognosis for growth and inflation. The erosion of risk premium symptomatic of the misallocation of capital, eventually ends in bust and wealth destruction.