Dorothy picks up Toto and clicks her heels together three times. Alice Wakes up dazed in the garden. Marty accelerates the DeLorean to 88 as lightning strikes the clock tower.

Each of these is a thrilling finish to an epic journey; the hero finally returns home after traveling to a strange world that grew scary. You’ve probably already named each movie above and visualized each memorable scene.

“Voyage and Return” is one of the 7 basic plots in every story. In each case, the hero returns home- themselves changed by their travels. Oftentimes- their home world is altered as well.

It feels like, socially and economically, we’re also completing a round trip. Social gatherings and travel have returned, store shelves are refilling with goods, and people are going back to the office.

We are dealing with a new version of “normal” though. There were clearly consequences to the fed’s cheap money policy, and rising interest rates have shocked the system. This re-normalization has led to dramatic changes in all asset classes:

Naturally, we spend a lot of time asking: “What’s Next”? 

1. Rising Interest Rates- When Will They End?

The Federal Reserve increased interest rates by nearly 2% this year (and counting) to combat recent high inflation. The ripple effect of money no longer being cheap has been dramatic; Houses are sitting on the market longer, bond prices are dropping, and tech companies, dependent on cheap capital, are laying off employees by the thousands.

One would expect the rate hikes to slow down once inflation has peaked. Prices of everything rose quickly for several reasons, higher wages being one of them. While you can’t roll back someone’s salary, the unexpected inflation caused by factory shutdowns, expensive transport, and high commodity prices appears to have peaked over the past few months.

Oil (Everyone’s favorite commodity) just dropped under $100 a barrel for the first time since Russia invaded Ukraine. The rest of the lot is coming down as well:

This gives us hope that inflation (and interest rates) will normalize soon. 

2. How Recession-Proof Are We?

The Fed is trying to raise interest rates without inducing a recession, but as is often the case in markets, prepping for one can become a self-fulfilling prophecy. Economic activity is slowing down in anticipation of an economic slowdown.

The bright side is that this may be the most prepared our country has ever been for a recession. GDP sits within a % of all-time highs, as do consumer balance sheets. There are still 2 job openings for every unemployment claim.

If a recession is in the cards, its actual impact should be softer than the past. We expect a recession, if any, to be shallow.

3. Will Optimism Return To Stocks?

Nearly every sector has taken it on the chin this year, and the market has circled back to early 2021’s price levels.

Of all of the hundreds of questions, there are about the stock market, they really boil down to one: What are investors willing to pay today for future earnings?

This valuation, called the “Forward Price-to-Earnings Ratio” changes daily as the economic climate changes. During times of crisis, investors are willing to pay less, and vice versa.

Today, investor sentiment is as low as it’s been in years, and the current multiple reflects that: Factset reports that the forward 12-month P/E ratio for the S&P 500 is 15.8x,

which is below the 5-year average (18.6x) and below the 10-year average (16.9x).

For the majority of 2020, the forward P/E sat around 22x.

Somehow people were nearly twice as optimistic about stocks when we were sheltered at home, being furloughed left and right, and vaccines were still being beta-tested. In many ways, they were right to stay bullish: company earnings now sit at all-time highs and growing.

The time to invest (or stay invested) is usually when others are fearful. Today, we’re there by every conceivable metric.  

History tells us that massive pessimism is a necessary ingredient for outsized investment returns.

Bonus: historical perspective An optimistic take from Barron’s (In 5/5 bear markets since World War 2):

“Bearish investor sentiment—a sign of fear and cautious behaviors—tends to be followed by above-average market returns.

When the S&P 500 was previously down at least 15% halfway through the year, the index has finished higher in the final half every single time, with an average return of nearly 24%.”

—Evie Liu and Janet H. Cho