Considering KZ looks considerably better than anything on any console, and it's a launch game, I would say your expectations were too high.
But that's the least we can expect, right?
Yeah, i think diminished returns are definitely here. Not surprising either. Games are pretty right now, so making them a little prettier isn't going to necessarily blow people away. By the end of this gen the games will be more impressive, of course, but this next generation of graphics aren't going to have the same wow factor.
That's why everybody is trying to push other aspects.. Social gaming, off-screen play, media-hub capabilities, apps, downloadable games, streaming games, etc..