The Market’s Expectations

“So much of school is a waste,” he said, “it took 4 years of accounting classes to learn what took 3 months at my firm.”

(I should note that this is a post about expectations, particularly in investing. I’ll get to that in a minute.)

When my friend made that statement recently I didn’t have a good response. We went to college together, and he now works as an auditor. I was over that day to get his thoughts on which prospective UCLA accounting class would be most useful, but  after a few hours I left his apartment without a recommendation. This conversation got me thinking, however, about the following question: what things in adult life does college fail to prepare us for?

There are many responses. My friend believes that college often concentrates on the theoretical at the expense of what’s practical. David Brooks has opined that given its outsized impact on one’s happiness, colleges should offer courses on who to marry. James Altucher says skip it entirely and start a business. My first thought was about the art of managing others’ expectations, a concept I’ve learned a lot about since graduating. I’ve been surprised to find that people can tolerate all kinds of terrible developments, so long as they don’t feel blindsided by them. At the time I was finishing school, however, the only relevant wisdom I had was: 1) better to under-promise and over-deliver, and 2) the worst way to drink Absolut is when you thought the cup contained water.

Expectations are a powerful force, as we crave having even a hint of what’s next. It’s gratifying when what we expect comes to pass, as we’re able to appropriately calibrate our emotions ahead of time. Doing so allows us to avoid situations where – because of a surprise invalidating our expectation – we respond with irrational emotions. Being wrong about an expectation is often worse than not having one at all. The most devastating curveball, for example, is one the hitter doesn’t expect. We see it constantly in the market, when companies hitting or missing earnings expectations can be the impetus for wild price movements. In recent months, hearing “shares rose after company XYZ beat expectations” has been a welcome and prevalent sound bite.

What’s maddening in the markets is that the reaction to hitting or missing analysts’ consensus predictions is not always rational; Apple announced staggering profits a year ago, but because they didn’t sell enough iPhones that quarter, their shareholders were promptly rewarded with a 14% price drop (you can probably guess why I’m still bitter about this). So it goes… but what can be done about it? One individual can’t teach the entire financial system not to irrationally overreact because some analysts’ expectations were invalidated. In fact, I wouldn’t want to, since great opportunity awaits when the herd is being irrational.

A relatively famous investor once said, “… try to be fearful when others are greedy and greedy only when others are fearful.” The quote’s fine print is that following this advice is scarier than advertised. There’s comfort being amongst the herd; everyone succeeds or fails together. For the investor with low self-belief, the fear of failing alone often overshadows the potential of succeeding alone. But if you aspire to do better than the herd, looking to profit off the market’s irrational reactions is an excellent place to start. If you don’t feel comfortable with taking unpopular positions in unpopular companies, then you’ll save time, energy, and heartbreak by buying a low-cost index fund and letting the market work its magic. But if you’re feeling bold, the opportunities are out there… and on this blog I’ll be looking for them.

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