STREET DOGS

SLUGGISH reaction to bad news holds lessons for investors on managing expectations to minimise disappointment. Every year like clockwork we start out bizarrely optimistic about future results and then “walk down” our expectations as the release of the bad news draws closer. The greater the uncertainty the longer the wait until the final collision with reality.

Analysts are not immune from what University of California psychology professor Kate Sweeny calls the process of “sobering up”.

“Analysts always tend to be more optimistic when looking far ahead,” Thomson Reuters analyst Greg Harrison agrees. “They don’t see the latest negative news as affecting the company that far out. Then, around 90 days before the earnings announcement, they cut their forecasts in a collective rush. Finally, as the announcement approaches, reality sets in and analysts cut their estimates again, often to a level below the final number the company will report.”

Such farcical behaviour is part of human nature. You probably think you are less likely to get cancer, be divorced or fail in your career than the average person. So does just about everybody else.

The thing to be aware of is that rose-coloured glasses work more powerfully at a distance. So the sooner you “sober up” the better. “A year in advance,” says Sweeny, “you have a lot of time ahead of you before your prediction can be disproved, so your motivation to fix it is that much lower.”

Nor should you assume the cynical deferral of bad news is bound to crush the market when it finally hits home. By sobering up on negative guidance shortly before results are released investors enable companies to beat lowered expectations. That often produces a “surprise” that reinvigorates the market.