I was asked to give a talk this week to the Albury-Wodonga chapter of the Australian Shareholders Association and given wide latitude on the topic. The freedom to pick a topic seemed to be more of a burden than blessing but it gave me an opportunity to say something that I’ve been thinking the last couple months.

We’ve all been yearning for a sense of normalcy after two years of COVID related disruptions. And there is clearly no appetite for taking a step back. Soaring COVID numbers earlier this winter were met with a collective shrug. However, there is one group that seems to be yearning for one aspect from the days of lockdowns, check-ins and border closures. That group is investors.

Investors have reasons to be nostalgic. Between March 23rd 2020 and December 31st 2021 the S&P 500 went up 119%. Not a bad 16 months. Simply replicate that return for 30 years and you could turn $10,000 into $258,874,490,163. Take that Warren Buffett.

Any examination of markets needs to start with the universal truth of investing. The market is forward looking. This leads to situations where the economy and the market can be in very different places. For instance, in 2009 the market started its assent far before the severe recession in the US showed any signs of reversing. In fact, when the market started rising in March of 2009 it was still another 10 months before the unemployment rate peaked in the US. This can be disconcerting as an investor because there is such a disconnect between what you can see outside of your window and what the market is seeing. And what the market was seeing in March of 2009 was a financial system that had been stabilised by a series of unprecedented actions by central banks and governments and a damaged economy that was starting to mend. In that case the market was right. The decade long market run until COVID was one of the strongest in history. After a brief bear market that ended in a blink it was off to the races again as central banks and fiscal stimulus unleashed a flood of money into the economy.  

And what does the market see now? To say investors are seeing the current situation through rose coloured glasses would be an understatement. While it is impossible to speak for every investor, the prevailing view seems to be some combination of the following. Team “transitory” has been awakened from their slumber and the recent aggressive interest rate increases have stabilised inflation. As inflation drops, interest rate increases are set to slow and then peter out. The economy may pull back and enter a mild a recession, but that will induce central banks to start cutting interest rates again. We can all go back to living in the world we blissfully envisioned a year ago when we looked forward to years of near zero interest rates with low inflation. This stroke of economic alchemy will allow growth shares, crypto and house prices to continue their march into the stratosphere. We can all go back to worrying about more important things like the best mooring locations for our boats.

I’ve already decided where my non-existent boat will live so I have time to worry about how this ‘best of all possible worlds’ scenario plays out. In my humble opinion we are putting a lot of faith in an economic future that resembles the period between 2009 and 2021 instead of hundreds of years of history. This is perplexing seeing as how we recently stumbled into a situation where inflation has reached high single digits in the US, the EU and Australia and managed to break 10% in the UK. Let those figures sink in for a bit. We are not in a Weimer republic wheelbarrow full of money to buy a loaf of bread situation. But we also didn’t moderately exceed central bank inflation targets. We’ve more than tripled them. Inflation “peaking” at 9% is a long way away from getting it back down to the 2 to 3% range. The last time inflation got to those levels it took a decade and a deep recession to get it under control.

The question investors should be asking themselves is if we are currently experiencing something out of the ordinary or was the post GFC period the anomaly. This is an important question because the answer will determine where the market goes from here and what kind of investments outperform in the future environment. The traditional relationship between rock bottom interest rates and high inflation was severed after the GFC. Seemingly we could have it all. Globalisation, technology driven efficiency, slow wage growth and low taxes / borrowing costs kept inflation in check and expanded corporate margins. Between 2000 and 2011 the margin on the S&P 500 was 6.2%. Over the past decade it accelerated to 13.4%. This was a huge boost to earnings growth. The low interest rate environment caused valuation levels to swell. Record valuation levels and record margins was like pouring petrol on a fire.

I am writing this on Friday morning in Sydney. We will wake up on Saturday to any news generated from a highly anticipated speech by Federal Reserve Chair Jerome Powell. Will he crush the optimism that has been building over the pat two months? We he drive the market into a renewed frenzy?

In next weeks editor’s note I will take a look at how different types of investments might perform under different economic scenarios. And one last thing. Woolloomooloo. That is where I would keep my boat.

More from Morningstar

Our conference tickets continue to sell fast. Please join us at the ICC in Sydney on October 13th or watch online from the comfort of your own home. We’ve packed the agenda with respected investment professionals with wide remits, facing similar choices to individual investors on where to allocate assets, where they see opportunities and how they’re navigating the current environment.

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