Everything is Relative

Whenever we make a judgment or form an opinion, we make it relative to something else. Our brains have a difficult time interpreting absolute data. For example, if your portfolio return next year is 5% is that good or bad? If the market is down double digits, you are thrilled. If the market is up double digits, you will be unhappy and likely make some changes.

Relativity of Mortgage Rates

Mortgage rates have soared recently and the average is now around 7%. Potential new homeowners and those who need to relocate are upset, and some may put their purchasing plans on hold. Ben Carlson recently opined, “One of my biggest worries is an entire generation of young people is going to be forever pissed off about the state of the housing market.” Why?

In the late 1990’s when my wife and I bought our first property – a condo in San Jose, CA, the rate was 7 1/8%. That didn’t stop us from buying. But then again, we weren’t used to seeing mortgage rates in 3% range for many years. Would we have held off on buying if rates had been much lower in the years prior to our purchase? Perhaps. Because we know we are affected by the value of something relative to what it was previously. I’m glad we didn’t face that issue. We simply bought something we could afford given the mortgage payment, escrow, and PMI (mortgage insurance) that the lender required we purchase.

Relativity of Inflation

Inflation is also soaring, which is the reason interest rates and mortgage rates have been increasing. Is inflation high today? Yes and no. It depends on what you are comparing it to. If you compare it to the last decade, inflation is high. If you compare it to the 1970’s inflation is still low.

Relativity of Market Opinions

Many people wonder how the market will improve. Inflation is clearly going to be around for a while. Even when the Fed starts to get ahead of inflation, it will likely persist for a while…so why invest (or stay invested) in stocks? Well, the market will improve when bad news is not as bad as we expected.

Inflation doesn’t have to go down a lot. A change in direction from increasing to decreasing, even slightly, could be a positive catalyst for the stock markets. A cease fire in Ukraine and/or agreement agreement between Russia and Europe to supply more oil could be a positive catalyst. We don’t need great news in order for markets to go higher. We just need news to be better than it has been recently. That explains why the market, or an individual stock, can go up even when the news is bad.

Is the market cheap? That is relative to what data and assumptions you are making. One may posit the market is expensive while the another claims it is cheap. The challenge is that even when we have the exact same data, we interpret and apply it differently. And then no one knows the future, which is why trying to predict the market is a fool’s game.

Relativity of Investing

What investors are really concerned about at the end of the day is how much their portfolio may go down, whether it will come back at some point, and how that ultimately affects them today. Unfortunately, those important questions can only be answered in hindsight (but they will be speculated ad nauseam in foresight).

For investors investing with the present uncertain and the future unknown, the biggest question to ask themselves is do they want to make investment decisions relative to their feelings or relative to their personal investment plan.


(c)2022 Behavioral Finance Network.