In the last 10-15 years, asset valuations have jumped up quite a bit leading to lot of prosperity and also helping some people build unheard-before wealth. This has had resulted in people thinking of themselves as better-than-they-actually-are investors and also lulled everyone into believing this is how assets/investments actually work. A bit of roller-caster but in the long term everything goes up and to the right.
As we come out of Covid pandemic the fiscal stresses are laid bare and inflation is on a run. This has already roiled the equity markets YTD but not so much the real estate market. The housing market has had double-digit returns in the last two years. Yes, there are valid reasons behind it and people expect the housing market to continue to rise without breaking a stride.
However, there are three key reasons why investment climate won't be the same as the last decade -
- Interest Rates are going to rise
To combat inflation the main tool central banks have is to hike the interest rates and try slow down the red-hot economy. This sometimes works and sometimes has an unintended effect of bringing the economy to a halt instead. For the purpose of equity investments, in the Discounted Cash Flow (DCF) models - the interest rates are the denominator. And as the interest rates go up the price derived from the model goes down. Not just the model - it's how it happens in real world too. Investors naturally prefer to go after risk-free returns than to risk it on a company/asset.
We have had an abnormally long period where interest rates were artificially low and it played a big role in jacking up the valuations and asset prices. Clearly, we all have now become addicted to it and would like for it to continue forever. This is where the reality check happens or will happen! Lower Interest rates are supposed to stimulate the economy only for a short period instead of being a permanent feature. 
Housing Market and era of low interest rates
This period has already propped up the housing market by much - housing is now the biggest asset class globally. And it has generated socio-political quandary of its own.
No politician or central banker want to be responsible for the "reality-check" - withdrawing low interest rates and a downward spiral of re-evaluation of asset prices.
Reasons are a bit hidden but clear once you see them!
Older people vote more often and their net-worth is tied to the "propped-up" asset prices. So, if any politician even tries to streamline or fix the housing market - they immediately become unelectable. Infact, one can argue that the secret of stability of society is "housing prices always go up"!
Yes the next generation will pay for it as they will have to deal with the high housing prices and the fact that wages haven't (and most certainly will not) matched pace with the appreciation in housing prices.
2. Corporate Tax Rate is going to increase
Free Cash Flow (FCF) is determined as the money a company has left after fulfilling all it's obligations (taxes, expenses etc). For past decade or so, corporate tax rate has remained low with one or two exceptions. But now as countries face burgeoning deficits, money shortfalls for projects and public backlash against wealthy entities - corporate tax rate for sure won't remain the same. It only has to go up from here resulting in lower FCF for the company and lesser pie to be shared with investors and thus, lower valuations.
3. Quantitative Easing is over. Quantitative Tightening starts now
We have had a long period of Quantitative Easing since 2008-09 with a few minor blips i.e Central Banks have printed money to keep the market liquid. Coupled with low interest rates - access to capital was cheap and easy. However, bills are now coming due. National deficits, runaway inflation requires Central Banks to step back, stop injecting liquidity and instead start withdrawing the surplus liquidity sloshing in the system. This would look like selling bonds, higher interest rates. With less liquidity - access to capital would now become expensive and hard. Its impact on the economic activity would be inevitably visible. At the end, lower valuations and much slower appreciation of assets.
What should investors do?
In my view, investors need to retrain their mental models and unmoor it from the past. After-all, past performance is no guarantee of future success. What just happened might not happen again soon in the future. So investors may need to turn far more rocks than before for investment opportunities which can withstand turbulent times and still give them healthy returns.
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