Great Expectations

There is a simple equation for happiness that not everyone quite grasps. Contentment is the difference between expectations and reality. Lower your expectations sufficiently, and almost any experience turns out to be pleasant or at least bearable.

But when expectations are too high, there is room for disappointment even if the actual outcome is fine, or even good. This is of course relevant at this time of year when people are making plans for their professional and personal lives, having spent time on the beach or around the campfire engaged in introspection. It is also particularly relevant for financial markets, where the known is priced in immediately, and therefore the surprises cause big moves.

As we reflect on last year, it is worth remembering that it started on a very pessimistic footing, with a widespread expectation of a recession, particularly in the US, but also in other major developed economies due to the rapid rise in interest rates. The only country where the outlook was for an improvement on the prior year was China, which was finally exiting lockdowns.

Defying predictions
Instead, the US economy defied the gloomy predictions and activity actually accelerated during the year, so much that third quarter GDP growth surpassed 5%! Despite this, inflation steadily declined to the point where rate hikes were no longer needed. The US Fed’s preferred inflation measure, the personal consumption expenditure (PCE) deflator excluding food and energy, printed 3.1% year-on-year in November but only 1.8% on a six-month annualised basis. It is moving in the right direction, in other words, and has not been achieved by pushing the US economy into recession and raising unemployment. Even in Europe where the economy is struggling, unemployment is still low even as inflation is declining.

The net result: the global benchmark MSCI All Country World Index returned almost 23% in dollars in 2023. Instead of a correction, we got a bull market. Global bonds also ended the year on a positive note despite suffering a big drawdown midway through. Ditto for listed property.

If nothing else, this is a reminder of how wrong the consensus can be, and how difficult it is to predict the future. The best strategy in most cases is simply to be diversified but to stay invested, irrespective of the noise.

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