Just this Week…
I’m very blessed that I have a career that revolves around meaningful conversations, with great people, on an important topic – money.
These conversations are typically the inspiration for these weekly missives. I look for themes, recurring questions, and common misconceptions to help formulate these articles.
This week, I’d like to address two very different questions that both relate to the same truth. First, there was a conversation about the price of specific stock, and second, there was a conversation about where mortgage rates are headed.
But, first, before we jump in, I’d like to share a quick personal story…
Love Thy Neighbor
Have you ever heard one of those sermons that you just couldn’t stop thinking about? The type of message that opens your eyes and plants a truth that absolutely changes your perspective. My good friend is a pastor and he’s delivered quite a few of these life-changers.
The one that stuck out to me was love. We’ve all heard a message or two on “love thy neighbor,” but he was diving into one of the major obstacles that limits our capacity to love others well. He submitted that our expectations of others can often get in the way of love. The pressure expectations places on others and how unmet expectations can lead to disappointment can be destructive to a healthy relationship. He encouraged us to think of love and expectations like a balance scale – as expectations increase, love decreases, and vice versa.
Healthy relationships communicate well on what those “preferred” expectations are, they operate in transparency, candor, flexibility, and grace. These are the rhythms of a relationship steeped in genuine love.
Don’t Worry Be Happy
Before we route this train back to personal finance, let’s talk about happiness for a moment.
In a world riddled with anxiety and depression, the topic of happiness has become quite popular. Books, research, documentaries, and the like have all been dedicated to the study of happiness.
The ultimate question everyone seeks to answer is: what drives happiness? Having read quite a few of these studies, it seems like the conclusion is quite consistent: people with low expectations are typically more happy.
Charlie Munger, the famed investor and business partner of Warren Buffett, said it this way: “The first rule of a happy life is low expectations.”
Why so? Low expectations limit the chances of disappointment and increase the probability of being pleasantly surprised.
I remember training as a competitive cyclist with one goal in mind – to qualify for a main event at a national competition. Eventually, I accomplished that goal, and the bar was raised to winning at a national level. At that point in my journey, anything less than first place was a disappointment. What was once an aspiration evolved into an expectation.
How Prices are Set
Now, back to where we started – what sets stock prices and mortgage rates? Expectations.
Stock prices are not based on what a company has done in the past or even what a company will do in the future. Stock prices are based on how people expect a company to perform.
So, when an investor outlines an investment thesis around good company culture, an admirable CEO, and/or a solid product, I often ask them this question, “Is there such a thing as a great company but a bad investment?” The answer is yes. The attractiveness of a stock is based on price, and the price is set based on the expectations of future performance (revenue, margins, profits, etc.). What can high expectations often lead to? Disappointment. In the world of finance, disappointment could result in a stock price getting cut in half.
Mortgage rates work the same way. If/when the Federal Reserve lowers the federal funds rate in September, should we expect mortgage rates to tick down? No, because current rates are already pricing in that future expectation. For rates to nudge, there would need to be a surprise – rates lowering more dramatically and faster than expected – and then a new price would be set with a new expectation about the future.
Once you get the framework down, you start to understand the domino impact of different published economic data. So, for example, if inflation cools faster than expected and unemployment ticks up greater than anticipated, then the federal reserve may act more swiftly on rate cuts which could drive down mortgage rates. Perhaps not intuitive, but bad jobs numbers could create more attractive mortgage rates.
A Beauty Contest
The famed economist John Maynard Keynes described markets as a beauty contest. He used this analogy to articulate how difficult it is to predict market prices.
Here’s the setup. Keynes says that a newspaper puts out a contest in which the participants need to pick out the six prettiest faces from the hundred photos provided. The winner would be the person who picks the six most popular faces.
The goal here is not to pick who you think is the prettiest, but rather what you think the consensus opinion would be, as the prize is for the person who best matches not personal opinion but popular opinion.
Keynes says it this way, “It is not a case of choosing those [faces] that, to the best of one’s judgment, are really the prettiest, nor even those that average opinion genuinely thinks the prettiest. We have reached the third degree, where we devote our bits of intelligence to anticipating what the average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”
If you think expectations alone cause a lot of trouble, welcome to financial markets where the multivariate layering of expectations is commonplace.
What’s Trending
It’s important to remember that our expectations aren’t always grounded in reality. Furthermore, our corporate or communal expectations can also get way off base.
These days you can gamble on just about anything. Whether that’s how long the national anthem will run at the Super Bowl or who will win the opening coin toss.
Here’s a simple example of misplaced expectations and how our emotions – or “what’s trending” – can cloud our judgment. Any respectable sports analyst would’ve told you that Bronny James was lucky to even be drafted in the 2024 NBA Draft. Yet, who was trending as a popular bet for the first overall pick? Bronny James. These sky-high (unrealistic) expectations simply meant a profitable endeavor for Las Vegas.
Life Advice
So, as a recap, what sets stock prices? Expectations.
What drives mortgage rates? Expectations.
Happiness? Expectations.
For a happy life, for love to flourish, for an attractive investment? Low expectations.
I realize that this truth is simple, but in all my daily conversations, I can say that this is one simple truth that is often misunderstood and rarely applied.
I hope this friendly reminder about expectations will have a positive impact on your finances and your life.
Trevor Cummings
PWA Group Director, Partner
tcummings@thebahnsengroup.com
Blaine Carver
Private Wealth Advisor
bcarver@thebahnsengroup.com
