Last year, I attended a lecture on money by the Irish economist and comedian David McWilliams. It is difficult to imagine an economist who can be both fascinating and hilarious, but he had us in stitches at an early morning lecture.
He reminded us that money is tied to inflation. Policymakers set interest rates relative to expected inflation to protect the value of their currencies. Higher interest rates put pressure on most asset prices.
Inflation expectations are therefore crucial to the whole system.
At the start of this year, there was a near-unanimous agreement that inflation would remain benign and that interest rates would decline in most countries. When the US attacked Iran at the end of February this year, that picture changed. What followed was the largest supply disruption in history because the war prevented oil from moving through the Strait of Hormuz.
We've already seen dramatic price increases for fuel, fertiliser, and transport, and the downstream impact is yet to be felt.
Looking back now, it seems inflation expectations were probably too optimistic.
There were signs of escalating tension between the US and Iran throughout 2025, and the US began increasing its military presence in the Middle East. Yet the market, in general, ignored these signs.
But this is not unusual. David McWilliams reminded us that at times we believe in ridiculously optimistic futures. It is part of human nature. There is a cycle of FOMO.
Fantastic asset returns, as we experienced in 2025, lull people into believing the future can only be bright. These overly optimistic expectations set us up for disappointment. Even now, we may still be clinging to hopeful outcomes for the war. We are still in disbelief, and hope that things will return to normal.
We have probably not yet fully understood the long-term impact of oil prices remaining at these elevated levels. When a new normal is being set at current levels, expectations are likely to sour, and the cycle will turn downward.
The best we can do is not to be surprised by the inevitable because financial markets always go through these cycles. The business cycle runs on human psychology; we swing from overoptimism to overpessimism. And it is all about expectations that extrapolate the most recent past into the future.
Looking at it this way, we have not evolved. We behave in primitive ways. We lack imagination. In general, humans lack the ability to see a future that differs from their current reality.
Our current reality determines our expectations. Our expectations shape our future reality, which makes it difficult to adjust to changes forced on us. When reality disappoints, we rebel against change in some way.
In our investment portfolios, having reasonable expectations about long-term returns and anticipating that markets will occasionally correct after a heady run can help us stay the course and leave our portfolios to work for us over time.
In our lives, the same principle applies. We can improve our well-being by keeping our expectations grounded and by not being surprised when reality disappoints. It helps too if we can adjust to a new normal as quickly as possible rather than clinging to the future we wanted.
PS. I am taking a break from the blog for a few weeks with fresh perspectives that always come with travel.
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Kind regards,
Sunél
