Disclaimer: I comment on our current political drama as it has significant implications for our thinking as long term investors. Significant effort is taken here to not offend anyone’s ideological sensibilities, nor do I wish any ill will to either of our political parties. The hope is for rational, sustainable federal, regional and local policies that strengthen this great American System and grow the pie so that we all prosper.
Rising government debt, rising interest rates, tariffs spawning trade conflict, rising nationalism and numerous other challenges are creating great headwinds to the recovery that began back in 2009. As Americans turn 65 estimated at an approximate rate of 10,000 people per day, labor shortages combined with restrictive federal immigration policy are creating intense cost and logistical pressure in many industries across the economy.
Punitive trade actions by the Trump administration have rattled the markets, but losses have not yet mounted. It seems that the size of the actual tariffs is quite small relative to the US annual GDP of $18T. The reality of the global supply chain is that mercantilism quickly becomes a game of Whack-A-Mole. Blocking LED components from China, redirects US buyers to Malaysia – it does not create conditions for the massive investment that would be required to manufacture specialized electronic components in the US. The history of tariff policy is filled with substitution and lobbying for exclusions and exemptions. The bark is likely way worse than the bite as the cost increases begin to mount and disruptions cause numerous industries to descend on D.C. with hordes of lobbyists seeking exceptions.
Barron’s noted on 6-22-18 that tariffs are filling market headlines while Quantitative Tightening (QT) is quietly accelerating. QT is the opposite of QE, where money supply is being reduced and interest rates and moving up. As the price of money rises, the economic cycle will ultimately slow. The hope will be for a “soft landing” for an economy that has expanded such a long way over the last ten years. It seems imminent that the market is due for a pullback. As the tide of cheap money recedes many imprudent operators and over levered businesses will be vulnerable. This does not mean that it can be predicted with accuracy or that our quality diversified portfolios should be altered. Bracing mentally for an overdue correction is advised.
The idea that “trade wars are good and easy to win” reminds me of the nonsense that was disseminated in the run up to the invasion of Iraq 3-20-2003. The tragic 2003 invasion of IRAQ is rarely mentioned, and the grandiose proclamations have been swept away with clips of VP Cheney predicting that “we will be greeted as liberators”. The current tension with traditional American allies in Europe and Japan mirrors the go it alone approach that the GW Bush administration employed. History shows that the US will struggle to unilaterally implement grand geopolitical strategies and achieve outcomes that are desirable. The demagogic populism of “America First” ignores this recent history.
The idea that globalization can be pushed back while operating in a nationalist mode seems unrealistic at best. Nostalgia for the post WWII era of American hegemony in manufacturing ignores the circumstance of that dominance. The US had extreme advantages post WWII and no-one would wish to again go through the destruction that put America in that position. Fear-mongering messages of decline seem to originate exclusively from a political strategy while ignoring the incredible progress of the US economy and living standards of the last 75 years. The US economy is a dynamic machine that is impossible to manage with blunt populist notions of bring jobs back. We have succeeded through innovation, a dynamic legal system, high environmental standards and many other factors. Nostalgia for some idealized past is not a strategy.
There are many reasons to remain politically optimistic while bracing against the feeling that we have never been this polarized. Ideological conflict is built into our system of governance and is not a sign of collapse. Perception of success and progress is difficult in real time as the innovation of technology, energy production, and agriculture push forward. Domestic politics will remain contentious until more calming personalities arrive on the scene. The world remains a crucible of conflict and difficulty. Dire challenges are not new and are as normal as the change of seasons.
The American Melting Pot has always been challenged. Look to the history delineated in the fascinating work of Adam Cohen in his book, Imbeciles: The Supreme Court, American Eugenics, and the Sterilization of Carrie Buck. Our system of government has persevered over many crackpot theories of bigotry and misinformation. The idea that people could be screened for intelligence and moral fiber and then the lower strata sterilized to improve our population was a tragic era of real American history. Many were mistreated and suffered greatly and yet our society persevered and righted some of these terrible wrongs perpetrated on innocent people.
America’s system of government is robust beyond imagination and will adapt as it was designed to do by the founders. Sophisticated investors do not get manipulated by political actions and slogans that have little basis in economic reality. Policies that are not based on sound principals backed by data are not sustainable. Avoid the stress of real time struggle as we seek to remember that economics is like gravity. Political operators that push forward with ideas that are not underpinned by rational financial principals will see the “policies” crumble like a bad movie. There is no time machine taking us back to the 1950’s. Much of this type of thinking is due to cognitive bias and lapses of rationality at the highest level. The world will plod, grind and stumble forward not backwards.
Hopefully many of the errors and miscalculations that are occurring now will be unmasked soon.
Fundamental Attribution Error (FAE)
“Psychologists refer to the inappropriate use of dispositional
explanation as the fundamental attribution error, that is,
explaining situation-induced behavior as caused by
enduring character traits of the agent.”
— Jon Elster
In social psychology, the study of Fundamental Attribution Error (FAE) error is extremely informative for our rational decision making as investors and in many important areas of life.
The notion that one’s achievements are due to hard work, guile and intelligence and that other’s success is more attributed to luck or circumstance is the essence of this thinking error. We often see our lives as fitting a unique thread and story. Less awareness of all of the randomness, circumstance and luck that occurs throughout our daily lives. The human mind is biased inherently to thinking our special qualities have gotten us here, yet it has a tough time giving others credit or understanding how failure and misfortune are so common.
Evolution has programmed us to think and believe the we are unique and special. It then follows that investing success should come from a diligent, high quality approach and construction of the portfolio. The variance of the global economy, interest rates and political trends should not matter too much as our unique approach will be rewarded. I invest; therefore, I make money, or so our feelings would say. Then the downswings will come and test our resolve. This is where courage, resilience and patience must protect against the natural “arrogance” of the fundamental attribution to the self as one who will undoubtedly succeed.
Ten years ago, discussions were centered on risk, loss and the turmoil of the financial crisis. Dramatic downswings day after day created a mass psychology that the financial crisis was changing everything. Seeking safety was intuitively the correct path. Fear of loss drove people to make big moves seeking the safety they thought would make for better outcomes. People had strong economic viewpoints, based emotion, not study or data. Making changes seeking “safety” moved some to miss the recovery. “I cannot afford to lose” was a common utterance. The idea that you can find the correct path in times of uncertainty is exacerbated by FAE arrogance – somehow the complexity of the world can be managed by your insight and view on the world.
Awareness of this natural tendency to give ourselves credit for skill and integrity reflects the greater need towards humility and grace. The humble notion that our special vision can get it right often misleads investors towards irrationality. The importance of seeing the mass of complexity that is bearing down every day on our lives demands this humble outlook.
FAE is present in the dynamics of money manager selection and the monitoring of large retirement plans. In a well-regarded study of how money managers are hired and fired, it is speculated that much of the changes are made inefficiently and that managers are often fired before the economic cycle allows the manager enough time and subsequently the terminated managers show robust results. The authors Goyal and Wahal also point out that “the hubristic belief among plan sponsors than they can time the hiring and firing decisions successfully” and “those in charge of the plan must show that they are doing some work to preserve their position.”
The Selection and Termination of Investment Management Firms by Plan Sponsors AMIT GOYAL and SUNIL WAHAL
THE JOURNAL OF FINANCE • VOL. LXIII, NO. 4 • AUGUST 2008
Let it be noted here that making changes for the sake of appearing to be “doing something” does not necessarily add value. Patience that allows a manager to perform through full and multiple economic cycles may offer the best chance for quality results.
We would assume that many of these plan fiduciaries and decision makers are smart, highly qualified professionals. Cognitive Bias is just as prevalent regardless of intelligence level. From my understanding, it may even be more of a error risk in decision making by high level professionals.
No one wakes up thinking, “I am going to make bad decisions today.” Yet we all make them. What is particularly surprising is some of the biggest mistakes are made by people who are, by objective standards, very intelligent. Smart people make big, dumb, and consequential mistakes. Keith Stanovich, a psychologist at the University of Toronto, argues that the intelligence quotient (IQ) tests we rely on to judge who is smart do not measure the essential raw materials for making quality decisions. “Although most people would say that the ability to think rationally is a clear sign of superior intellect,” he writes, “standard IQ tests devote no section to rational thinking.” Mental flexibility, introspection, and the ability to properly calibrate evidence are at the core of rational thinking and are largely absent on IQ tests.
Mauboussin, Michael J.. Think Twice: Harnessing the Power of Counterintuition (Kindle Locations 119-125). Harvard Business Review Press. Kindle Edition.
Blatant FAE is on full display in the immigration crisis festering in the US and across the globe. Note here that the issue of immigration has taken center stage and that the debate is filled with charged positions. For the GOP there seems to be great dissonance with the notion of a “nation of immigrants” and the current philosophy of the right-wing push to limit not only illegal but to greatly reduce legal immigration. Nativism is baffling because the vast majority of US citizens trace our origins to ancestors who came to America in search of a better life. And yet many decedents of immigrants continue to seek less immigration. Fundamental Attribution Error is revealed in assuming that we are “the good ones” and other new arrivals are coming for malicious, criminal or entitlement reasons. This flies in the face of much of the data. One would hope to see better policy going forward as our birth rate continues to fall and the demographics of the baby boom demand population growth to support Social Security and Medicare for this aging shift in the domestic population and globally.
Here are some things recently noted by Bret Stephens that will hopefully be considered soon:
First: The U.S. fertility rate has fallen to a record low. In May, The Times reported that women “had nearly 500,000 fewer babies than in 2007, despite the fact that there were an estimated 7 percent more women in their prime childbearing years.” That’s a harbinger of long-term, Japanese-style economic decline.
Second: Americans are getting older. In 2010 there were more than 40 million Americans over the age of 65. By 2050 the number will be closer to 90 million, or an estimated 22.1 percent of the population. That won’t be as catastrophic as Japan, where 40.1 percent of people will be over 65. But remember: We’ve only avoided Japan’s demographic fate so far by resisting its longstanding anti-immigration policies.
Third: The Federal Reserve has reported labor shortages in multiple industries throughout the country. That inhibits business growth. Nor are the shortages only a matter of missing “skills”: The New American Economy think tank estimates that the number of farm workers fell by 20 percent between 2002 and 2014, accounting for $3 billion a year in revenue losses.
Fourth: Much of rural or small-town America is emptying out. In hundreds of rural counties, more people are dying than are being born, according to the Department of Agriculture. The same Trumpian conservatives who claim to want to save the American heartland from the fabled Latin American Horde are guaranteeing conditions that over time will turn the heartland into a wasteland.
Fifth: The immigrant share (including the undocumented) of the U.S. population is not especially large: About 13.5 percent, high by recent history but below its late 19th century peak of 14.8 percent. In Israel, the share is 22.6 percent; in Australia, 27.7 percent, according to O.E.C.D. data, another indicator of the powerful correlation between high levels of immigration and sustained economic dynamism.
Finally, immigrants — legal or otherwise — make better citizens than native-born Americans. More entrepreneurial. More church-going. Less likely to have kids out of wedlock. Far less likely to commit crime. These are the kind of attributes Republicans claim to admire.
I wish that our country can embrace those less fortunate immigrants, seeking better lives while growing our population and economy. Ultimately, that could be a huge win-win for all.