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The Treacherous Psychology of Ramped-Up Investor Expectations

Investors tend to ignore market data that doesn't fit their wishes

by Bob Stokes
Updated: May 05, 2017

There's a sizeable gap between investor expectations and historical market returns. Chalk it up to ramped-up optimism and what psychologists call "information avoidance." Two surveys and one chart are revealing.



[Editor's Note: The text version of the story is below.]

You might recall this famous line from the film "A Few Good Men":

"You can't handle the truth!"

Financial markets are an entirely different arena than a military courtroom, but I couldn't help but think of that line after I read an April 28 Wall Street Journal article subtitled:

Investors have a hard time looking the truth square in the face

The article says:

In one recent survey, wealthy individuals said they expect their portfolios to earn a long-run average of 8.5% annually after inflation. With bonds yielding roughly 2.5%, a typical stock-and-bond portfolio would need stocks to grow at 12.5% annually in order to hit that overall 8.5% target. Net of fees and inflation, that would require approximately doubling the 7% annual gain stocks have produced over the long term.

One in six institutional investors, in another survey, projected gains of more than 20% annually on their investments in venture capital -- even though such funds, on average, have underperformed the stock market for much of the 2000s.

It all boils down to runaway optimism, and, as the article notes, what psychologists term "information avoidance." In other words, people often downplay information that conflicts with their wishes.

This same sentiment is shared by public pension fund managers. Our April 2017 Elliott Wave Financial Forecast said:

Public pension funds' unfunded liabilities are up from $292 million in 2007 to $1.9 trillion in late 2016, and they continue to assume unrealistically high rates of return for their portfolios. Bloomberg reports that the reason they do so is that "many cities and states would buckle under the weight of more realistic assumed rates of return." [emphasis added]

Today's optimism extends to other investor groups. Our May Elliott Wave Financial Forecast showed this chart [entire wave labeling available to subscribers] and said:

Investors Take Stock notes that in nearly 30 years, fewer than 10% of months have seen investors hold 52% more in stocks than in cash: most were during the late 1990s, which led to a decade-long bear market. ... The all-time high spread between stocks and cash for the American Association of Individual Investors (AAII) members is 64% in December 1999, at the end of [a significant advance]. It will be interesting to see if investors challenge this record as the Dow's [wave structure unfolds].

The financial uptrend that started in March 2009 may not end tomorrow, but our read of the market's Elliott wave pattern suggests that we're closer to a major trend change than most investors realize.

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