However, expectations of a return to a pre-crisis normality may ultimately be disappointed. “We remain concerned about the potential for an ultimate inflationary workout but prior to that deflationary concern are likely to re-emerge as the wind-back of the monetary stimulus commences. “We also note that while banking systems have been pulled back from the precipice, the IMF estimates that so far banks have recognised only half of their expected losses. “Investors have moved from terror to complacency at an alarming pace.”

The principal 40-scenario set is relatively positive about the recovery and the future performance of Australia but MLC believes that the extent of positive news already factored into prices creates a vulnerability in the event that the outcomes disappoint. Liquidity has been the key driver of market behaviour and what happens next depends as much on monetary policy as the real economy. Gosling says: “There remains considerable risk of further short-term equity market volatility and fluctuating expectations about both the strength of economic growth and inflation versus deflation should be expected. My own view is that ultimately higher inflation will be a feature of the path back to normality but there is a wide range of views on this.”

The chart shows expected listed equity returns remain below long-term normal levels with positive returns in the December quarter reducing return potential. This is offset by changes to probabilities for Australian equities in particular but is reinforced for unhedged global shares by the assumption by MLC of a higher equilibrium level for the Australian dollar. The return potential of unhedged global equities is assumed to be more modest than previously but the sector is relatively risk controlled.