Why great expectations tend to lead to small investment returns

Investors had high hopes when 2018 started – and that is a big reason why it turned out to be such a disappointing year across almost all the major markets



Andrew Williams
Investment Director

The highpoint of my fiancée’s year so far has been the discovery her all-time favourite restaurant – one she used to frequent when she was working in Singapore – has just opened a branch in central London.

The food, she promised me, would be amazing – the only snag being that lots of other people apparently feel the same way so, if you go along at anything like a normal mealtime, you end up queuing for hours.

So instead, like good contrarians, we went along at 4pm on a Saturday and, as you might expect after the rave reviews I had been reading – and especially the one I had repeatedly been hearing – over the course of the previous few days, I was suitably excited about the meal.

At that time of day, we only ended up queuing for about half an hour and the food was … well, the food was fine.

No, more than fine – it was really very good. But it was not mind-blowing.

To my mind, it was not the best meal I had had in London, let alone coming close to that extraordinary piece of fish I once had in Sri Lanka or that time at the unassuming little kiosk in India … which set me thinking – had those latter experiences really been objectively so much better than the one I had just had or is there something else at play here?

Let's get to the point

At this point, you may well be wondering what the great and not-quite-so-great meals of my life have to do with investment so let’s switch tack and consider the far less pleasant experience investors had in 2018.

Over the calendar year, all major equity markets fell, with the S&P500 down 6.2%, the FTSE All World index down 11.5%, the FTSE 100 down 12.5% and European and emerging markets indices down closer to 15% (past performance is not a guide to future performance).

Nor were the minus signs confined to equity markets, with commodities, real estate and fixed income largely also down over 2018 – to the extent the only positive returns across the main asset classes were the percentage point or two to be had from US treasuries and cash.

All of which might have you questioning just what kind of economic or financial calamity you managed to miss during the course of last year.

But of course you missed nothing.

According to the International Monetary Fund, at 3.6%, gross domestic product growth was in line with expectations and, while inflation may have ticked up slightly, it remained below its historical average.

What were up at an unreasonably high level at the start of 2018, however, were investors’ unrealistic expectations – not unlike like me at my fiancée’s beloved restaurant, in fact.

Investors' expectations were high

At the start of 2018, for example, the consensus forecast for earnings per share (EPS) growth for the S&P 500 was in the region of 25%, which was bullish (optimistic), to say the least.

After a torrid 12 months, though, investor sentiment is now more akin to mine as I ventured into that roadside kiosk in India, with more assets priced at levels that suggest more achievable expectations.

To be clear, we are by no means suggesting markets are cheap but there has been maybe a 10% rise in the number of stocks showing up on the valuation screens we run on a global basis here on The Value Perspective, to highlight potentially interesting businesses.

These are actually spread pretty evenly across the emerging and developed economies – with one notable exception.

In the US, our valuation screens are finding almost nothing to pique our interest – which is not unconnected to the fact expectations for EPS growth now stand at around five times the historical average of real growth.

In contrast, EPS growth expectations in the emerging markets and even in international equities outside the US are actually very low relative to history – and, as we say, that is where we as value investors are finding more ideas right now. 

In short, we are back to how markets are driven by emotion – they tend to do badly when people are disappointed and well when people are positively surprised. And the way investors can take advantage of that in a repeatable way is by searching out good businesses that, for whatever reason, have low valuations – for situations where short-term expectations are poor but the businesses’ long-term prospects are good.

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Andrew Williams
Investment Director


The Value Perspective
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