Charlie Munger, who was Warren Buffet’s main business partner until his death in November 2023, famously said that the key to happiness is low expectations. In certain contexts, this statement can feel counterintuitive. For example, sport psychology suggests that players can increase their success by envisioning themselves winning a match or a tournament. In other words, achieving reasonable success is unlikely to be prompted by setting goals of performing reasonably. However, the idea of lower expectations has less to do with optimal achievement than with dealing with disappointment. For example, if the player does not win the match or the tournament, expectation management determines whether the player bounces back quickly to perform at their highest level in the next event.
In our daily lives, we frequently experience this phenomenon. Often events that we look forward to the most tend to disappoint when they finally arrive. Think about that long-awaited vacation that ended up being too much effort, costing too much money and not being restful at all. By contrast, an event that we dread for months can often turn out to be far more pleasant than we expected.
The unifying explanation is that we compare our actual experience with what we expected it to be. We are more likely to be disappointed with an event that we eagerly anticipate, as our expectations have been set higher than what the event can possibly deliver. Conversely, the more we believe an experience will be truly awful, the more scope there is for us to be pleasantly surprised.
Importantly, human beings (with their expectations) make investment decisions. Quite often, a stock market reaction to company news or results depends less on fundamental content than what investors expected the outcome to be. This is why a company can report a decrease in profits of 20% and still see an increase in its share price, provided that investors expected even worse news.
While these may appear to be relatively well-known and simple principles, the size of some stock market reactions attests to the fact that they matter. At a cognitive level, we grasp these facts quite well, but when disappointment strikes our emotions often trigger a knee-jerk reaction. Therefore, to avoid suboptimal and emotional decisions predicated on disappointment, we should constantly check our expectations and assess the likelihood of lower outcomes.
The two phenomena in current markets, which have triggered me to revisit my own expectations and ability to manage them, are the Artificial Intelligence (AI) boom and the Government of National Unity (GNU) rally in South Africa.
Artificial Intelligence (AI)
While the revolutionary nature of the technology is not in doubt, AI requires widespread adoption for its promises to fully realise. A barrage of daily news updates about the revolutionary impact of AI creates the impression that widespread adoption has already arrived. This raises our expectations for the companies expected to benefit from AI and increases the risk of disappointment. For example, a survey conducted in April 2024 found that no more than 7% of adults in any one of six different countries, including the United States and United Kingdom, used AI daily. While this rises to 18% in the United States when measuring on a weekly basis, the numbers still appear low when I check against my own expectations for these countries. This is not to say that AI does not offer investment potential, but it highlights the risk that actual outcomes (at least in the near term) could fall short of expectations. The resulting disappointment is likely to materialise in volatile share prices for the darlings of the AI boom. If we do not incorporate such volatility within our own expectations, we could easily make emotional and suboptimal investment decisions when share prices reflect the extreme reactions of those who had been expecting a smoother ride.
Government of National Unity (GNU)
The formation of the GNU in South Africa has created expectations that a turning point has been reached for the local economy. Over the past few months, we have seen substantial rallies in both local equity and bond markets. While there still appears to be value in South African assets after the recent rally, especially compared to other markets, it is worth remembering that government’s goal is to raise GDP growth to 3.3% by end 2025. This represents an improvement from recent years, but still falls far short from the levels of growth needed to effect substantial changes in the economy. Therefore, when we currently assess South African assets for investment, we should carefully evaluate the growth on which we base our value assessments. Furthermore, a GDP growth rate of around 3 – 4% is not much different from that of developed markets. Under such conditions, research suggests that the return on a passive equity portfolio is likely to be lower than the inflation plus 6% assumption that is often touted in South Africa. The good news is that active management can potentially add additional returns compared to a passive portfolio. Nevertheless, we should continue to ensure that we safeguard ourselves against emotional decisions by checking the realism of our original expectations.
Managing our own expectations is a key part of avoiding emotional decisions and suboptimal investment returns. Constantly checking expectations against new data and the views of others is therefore a key part of achieving long-term success.