Pop quiz: Should you have bought Greek equities or the Shanghai Composite?

The easiest way to win a dinner party bet in 2012 begins with the question, "Which equity market performed better this year, Greece or China?" The shocking truth is that Greece's primary equity benchmark has outperformed the Shanghai Composite by almost 28 per cent, providing a stark investing lesson in the importance of exceeding expectations.

The Greek economy continues to slide into the abyss as evidenced by recent data showing a 7.3 per cent year over year decline in industrial production. But investors in the country's equity market have done remarkably well. The Athens Stock Exchange has jumped 21.2 per cent year to date led by the 36 per cent appreciation for its largest company, Coca Cola Hellenic Bottling, and a doubling in the value of Alpha Bank stock.

The Shanghai Composite, by contrast, is lower by 6.4 per cent for the year. How is it possible that equities in Greece can outperform those in China, where the economy is growing at more than seven per cent annually? Because Greek companies beat low expectations and Chinese companies fell short. Stocks like Athens-based Alpha Bank were priced for bankruptcy in January and surged after the worst case scenario failed to materialize. Chinese stocks, on the other hand, were priced for a strong economic recovery and slid lower as economic data improved more slowly than expected.

Professional investors use the term "second derivative" or, more confusingly, "change in the rate of change" to explain the phenomenon. It isn't the company with the fastest earnings growth that generates the highest returns, it is the company with the greatest improvement in the rate of growth. In many cases, a company that hits an announced 25 per cent profit growth target will be a less profitable investment than a company that increases its earnings growth rate from 10 per cent to 15 per cent.

The surprising divergence in the performance of Greek versus Chinese equities underscores the importance of expectations in generating portfolio returns. Set the bar low enough, and a modest improvement turns into a world-beating return; the search for positive surprises is often most lucrative method of investing.