So What Did You Expect?
Why do financial markets sometimes move up on bad news and down on good news? Why do these unanticipated fluctuations seem to bother us so much?
We have a deep human compulsion to explain the relationship between cause and effect, so much so that we sometimes create connections when they don’t exist.
We sacrifice the prime bull to make the harvest better. Athletes (and fans!) go through complex rituals to ensure the outcome of a game. We knock on wood so we don’t jinx ourselves.
On a day when the market twisted in the wrong direction, a colleague provided a simple explanation: “It’s not what you get that makes you happy. It’s what you get compared to what you’re expecting.”
As an example, suppose you walk into a four-star restaurant, but based on the reviews you’ve read, or comments from a friend, or the décor or outrageous prices, you expect five stars. You are set up for disappointment if the meal is in fact four-star.
Conversely, my wife and a friend recently went into a ramshackle building that was the only restaurant in the area. Their low expectations meant they were thrilled with the three-star meal they received.
If you expect a 10 percent move in some market statistic or return but discover only 8 percent, your expectations are shattered. It’s less than you expected.
When surprise is involved, there’s an amplifying effect that ramps up the reaction even further.
If the weather forecast prediction is for mostly cloudy but it rains, it’s not so bad. It’s still close to what you expected. On the other hand, I’m reminded of how angry a friend of mine from Maine was years ago when he complained that, “I just shoveled eight inches of ‘mostly sunny’ off my front porch.” Negative surprise is tougher to deal with.
Several years ago, I had a chance to chat with someone who was introduced as a “future Nobel Prize winner” for his work in behavioral economics (explaining the relationship between psychology and money). The markets were gyrating at the time, and I asked him what he recommended saying to reassure panicked investors when they called.
His response was simple: “Don’t tell them anything.”
In our highly regulated investment world, that’s not possible. However, here’s a tip on expectations that fitness trainers and weight loss experts use to help gain greater progress against goals: It’s OK to aim high, but start small.
Manage expectations by biting off a small chunk, and then celebrating when you get there. You won’t be so disappointed, whether you can explain what’s going on in the market or not.
Quick Experiment: Surprise vs. Expectations
Fill three bowls partway with water, the left one cold (you can even put in a few ice cubes), the middle one room temperature, and the right one hot (but don’t scald yourself).
Simultaneously hold your left hand in the cold bowl and your right hand in the hot bowl for about 45 seconds
At the same time, remove both hands and put them in the center bowl
React in amazement at what your body tells you as compared to what you expected when you put your hands in the identical bowl of water