Thursday, January 6, 2011

Its Relative!!

Story Highlights:

All too often, an absolute view of the world tips the scales toward an unrealistic assessment of events.

But market forecasting is all about relative thinking—successful long-term portfolio management doesn’t happen without it.

Every time you fret 2011, ask yourself, “Compared to what?” Your portfolio might thank you for it.

The ability to think relatively is one of humanity’s great strengths—especially in investing. Macro market forecasting is one never-ending balancing act. The endless stream of events is chopped up, each piece labeled positive or negative and assigned a weight. You take the aggregate positives in one hand and the negatives in the other—whichever one is heavier wins the day.

Example: Greece might default on its debt and take down the eurozone [very bad]. Framed relatively: Greece might default on its debt and take down the eurozone, but the huge eurozone can easily afford to support tiny Greece and likely will [not so bad]. You get the picture. Forecasting is all about relative thinking—and successful long-term portfolio management doesn’t happen without it.

Yet, all too often, we’re influenced by the absolute, not the relative. The mere existence of financial crisis, recession, lower than usual income growth, infant mortality rates, rampant poverty, and war convinces us the world is in terrible shape.

There’s no question sorrow exists—in an absolute sense, it’s as old as humanity. But try framing the problem like a market forecaster. Is there more or less badness now compared to the halcyon days of yore? What’s the trend? Making that comparison actually yields some surprising results. Here’s a great article highlighting just a few facts about the world today.

Absolute: 25,000 newborns won’t make their fifth birthday.
Relative: That’s 4,000 fewer infant deaths than in 2000.

Absolute: 920 million people will fall below the poverty line in 2015.
Relative: Twice as many people lived in poverty in 1990—with a population 1.5 billion less than today’s.

Absolute: Five wars rage across the planet.
Relative: That’s the fewest conflicts since before 1960.

A classic line goes, “Capitalism is the worst system, except for all the others that have been tried.” What an insightful and completely relative concept that is. None of this is to say we should ignore the bad stuff—but don’t let it run you over. In an absolute sense, 2011 will have plenty of problems. But there will be good news out there too. Before you reach a conclusion, break out the scales and ask yourself, “Compared to what?” There’s no time like the present to abandon the absolute for the relative. Your portfolio might just thank you for it.


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