Happiness Equation

November 10, 2022

Years ago when Windermere was just starting out, my dad and I met with an owner of a successful investment advisory firm in Boston. He was sharing his perspective on a variety of things along with best practices for building out a large-scale advisory firm. Many of him comments and lessons have escaped my consciousness at this point, a decade later, but one simple phrase has stuck with me all this time.

“happiness equals reality less expectations”

Give that some thought and you too will realize how true that is. We find ourselves feeling the happiest when our reality surprises to the upside (a fun trip, a raise, a positive diagnosis). But, we can also readily find happiness if we keep our expectations in check and things work out better that we thought they would. Pay attention and you may just see this equation come true in your day to day life!

Happiness being relative to expectations certainly holds with markets – as was clearly illustrated this week by two events that moved markets in two different directions – the midterm election and the October CPI report.

Let’s start with the midterms. In this case (at least as of two days post election), reality was worse than the market’s expectations and as a result, markets sold off (Reality< Expectations = unhappy market). Why was this the case? In general, markets tend to favor republican control – or even better, gridlock (ie: control split between democratic and republican). Why? Typically, republican administrations are more favorable to markets with lower regulation, lower taxes, and more “pro business” policies. And with gridlock, while some pro-market initiatives may stall out, the chance of anything too harmful for businesses and their cash flows being passed declines.

Going into the midterms, pollsters, media, and the markets were expecting a “red wave” of Republican victories. However, after Tuesday’s election, it remains unclear which party will control both the house and the senate. Key races are still being tallied and it is already know that Georgia will require a runoff election in December to determine its senate seat. When it came to the midterms, according to markets, reality was “less” than expectations resulting in unhappiness (ie: a notable sell off).

On the flip side there was Thursday’s CPI report and corresponding rally. The reality of Thursday’s inflation report was better than expected and markets showed their happiness (with the S&P 500 rising 5.5% and tech-heavy NASDAQ increasing 7.3% ). Why did these increases occur?

Simply put, the reality of inflation readings for October were better (lower) than expected. Month over month results were 0.4%, better than the forecasted 0.6%. And year over year inflation rate came in at 7.7%, compared to an expected level of 7.9%. The reality of the numbers were better than expected = happiness! And markets showed their joy by increasing by staggering amounts. Yes it was one day, but still – a clear response to the reality vs. expectations.

It goes without saying that these are still elevated inflation numbers. But as we always say, in investing the trend matters more than the absolute numbers. Thus, even though these readings are still high, they are getting better – and that is a positive trend line for markets. (This is an oversimplification, but the thought is lower inflation will allow the Federal Reserve to stop raising rates (the now-named “pivot”, which is a positive for equities)

We as investors can be well served by remembering this happiness equation and using it as a reminder that your expectations can have a major impact on your happiness level. Keep this in mind as you establish your expectations for your financial journey and investment portfolio. Sure, the reality can always surprise to the upside too but in some cases, just a slight recalibration of expectations can have an even bigger impact.

Wishing you happiness, no matter how you calculate it,

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