Great Expectations

 In pondering global stock markets today, we invoke timeless advice quoted from Charles Dickens’ classic “rags-to-riches” novel, Great Expectations. The quote occurs at a point where Pip, the story’s orphaned protagonist, has just discovered the identity of his long-time benefactor, and it is not – as he has always assumed – Miss Havisham. In this exchange, Mr. Jaggers, his attorney, notes to Pip that the only “evidence” backing Pip's long-held assumption was.. Pip’s own assumption.

A basic truth about investing in stocks is this: their value is a derivation of the collective wisdom of the crowd. The foundation of this wisdom is not built on sand but on solid and measurable fundamentals such as sales, earnings and dividends. However, what matters to investors buying a stock today is future growth in the aforementioned fundamentals, and projection will always continue to involve assumptions and reflect either optimism or pessimism.

The past is useful to today’s buyer only because it should have some relationship to – i.e., should in some way be suggestive of - future outcomes. In this context it is a clear and useful reminder to us that expectations matter a great deal. Comparing your expectations to the those of the crowd is a vital piece of the valuation puzzle. Measuring the wisdom of the crowd is the subject of this note.

The University of Michigan Consumer Survey is one of the oldest opinion surveys in existence and was first devised in the late 1940’s. It is currently conducted as a monthly telephone survey of a minimum of 500 people. The survey asks 50 core questions covering personal finances, business conditions and buying conditions, and the below charts illustrate an “index” of rolling 3-month responses to these questions; that is, they chart the trend in survey participants’ sentiments on each topic. Upward trends correspond to positive expectations about the economy, stocks and financial security for families and individuals.

Source: University of Michigan Survey for August 2017. Data is 3-month rolling average.

Our observation: Consumers are optimistic about business conditions over the next 12 months. A solid job market, low interest rates, rising stock prices and home values probably all play a part in shaping positive opinions over the coming year.

Source: University of Michigan monthly survey for August 2017. Data is 3-month rolling average.

Our observation: One common behavioral bias in investors is outcome dependency; that is, the tendency to think “stocks have gone up, therefore they must be a good investment." Underlying fundamentals supporting stock valuation are strong and trending higher; however, this is old news for the market and, many market observers believe, discounted in stock prices.

Source: University of Michigan monthly survey for August 2017. Data is 3-month rolling average.

Our observation: Low interest rates are the bane of savers. Many retirees expecting bond yields to support cash flow needs have been disappointed. Higher stock prices for now overwhelm the paltry returns of income-oriented investments.

Our observation:

There are important insights to be gleaned from survey data measuring expectations; perceptions about consumer mindset often enough inform market participant behavior. However, it is important to note that expectations are opinions of the future and should not be regarded as staunch facts based on evidence. Economists often refer to survey or forward-looking data points as "soft data" whereas past information already recorded as “hard data." Both measures of economic and market conditions have their flaws. Hard data is not always predictive but often extrapolated into the future by forecasters. Soft data is notoriously volatile, as expectations can change instantly and much faster than the underlying fundamentals.

Expectations of the economy, stock prices and our ability to retire comfortably are currently at multi-year highs. Great expectations will not fall simply because we tire of feeling good about our future.  However, they are vulnerable to disappointment and a lowered view of the future if positive underlying fundamentals deteriorate. We will be watching closely.

Survey information retrieved from http://www.sca.isr.umich.edu/, and charts represent rolling 3-month index averages, with the rolling calculation performed by WST. Besides attributed information, this material is proprietary and may not be reproduced, transferred or distributed in any form without prior written permission from WST. WST reserves the right at any time and without notice to change, amend, or cease publication of the information. This material has been prepared solely for informative purposes. The information contained herein may include information that has been obtained from third party sources and has not been independently verified. It is made available on an "as is" basis without warranty. This document is intended for clients for informational purposes only and should not be otherwise disseminated to other third parties. Past performance or results should not be taken as an indication or guarantee of future performance or results, and no representation or warranty, express or implied is made regarding future performance or results. This document does not constitute an offer to sell, or a solicitation of an offer to purchase, any security, future or other financial instrument or product.