When evaluating financial performance, whether of a nation’s economy or a stock, the key question is: relative to what? Focusing on a country’s or a stock’s situation is worthless without comparing it to others and to itself in the past and the future.
I don't purport to be Einstein, but a clever wordsmith could connect “relativity” with happenings in the equity markets. However, physics and economics are two different sciences driven by fundamentally different rules, so it’s important to understand “relativity” as it applies to the equities markets.
Economies function in a manner similar to large companies. Hot economic topics today include China’s slowed growth, the strength of the U.S. dollar versus other currencies, lower oil prices, Federal Reserve action to raise interest rates, aging global demographics and many more challenges and issues.
These are serious and worthwhile considerations, but most of us aren’t worried that big companies like General Electric or Caterpillar are going out of business. Their earnings may be less and their business models may be challenged in certain areas, but no logical analyst would suggest near-term bankruptcy for these companies.
While many variables drive share prices, ultimately the price reflects what people are willing to pay at any given moment. Pundits, including yours truly, attempt to put logic behind a trading day with explanations: "The market was up (or down) today because..."
But the only thing we factually know is the price of individual shares. We can discuss price-to-earnings ratios, stock buybacks and new markets, yet setting a price that everyone agrees on will never happen. Every share that trades today and on any day is based on willing buyers grabbing shares from willing sellers.
So what should you be looking for in terms of maintaining your mental health during volatile market times? The answer is “relativity.”
Let's use golf as an example. You can be a great golfer and have a bad score relative to your normal round, yet still wax your partners. Although you may be frustrated with your personal score, your buddies will still be picking up the tab on the 19th hole.
The same perspective applies to companies and economies. We live in the greatest country on earth with the U.S. economy accounting for 23% of the world’s gross domestic product. Apple (we are long the stock, for the record) produces nearly $50 billion of cash flow annually. Of course, that company isn’t going out of business.
But is our economy relatively stronger today than it was yesterday? Is Apple's future business going to continue to grow or merely maintain? In short, how is Apple’s performance relative to its game, not its competitors’ games?
Comparing the relative strength of your investments to their past performance is a critical part of understanding your nest egg. The question isn't whether or not the U.S. economy is stronger than Brazil’s for instance. That game is over.
The question is how either economy will function relative to yesterday. If the price for a stock was $10 yesterday, its value today is based on the trajectory, positive or negative, relative to its future performance.
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Joseph “Big Joe” Clark, CFP, is the managing partner of the Financial Enhancement Group LLC, an SEC Registered Investment Advisory firm in Indiana. He is the host of Consider This with Big Joe Clark, found on WQME and iTunes. Big Joe can be reached at [email protected], or (765) 640-1524. Follow him on Twitter at @Big Joe Clark and on Facebook at http://www.facebook.com/FinancialEnhancementGroup.
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