U.S. Capitol building. (Photo: Mike Scarcella/ALM)
Former U.K. Prime Minister David Cameron met with a small group before his speech at CFA Boston's Annual Market Dinner. It was inspiring to speak to a political leader who offered a balanced and well-informed perspective about the world's policy challenges. Cameron's objectivity was a welcome contrast to the polarizing approach that dominates political debate today, with far too many politicians framing complex issues in black and white terms.
Government policy historically was an important investment consideration only at major inflection points for fiscal, monetary or regulatory policy. Absent a major inflection point, government policy was typically subordinate to other investment considerations. The global financial crisis was game-changing, as government and central bank actions created market distortions that investors ignored at their peril. In the aftermath of the crisis, many major investors added significant analytical resources devoted to public policy issues.
Trade policy was a major factor influencing markets in 2018 and the initial weeks of 2019. Uncertainty about trade and supply chains is one of the causes of the recent economic growth slowdown. Worries about trade tensions were a major factor in December's market downturn, while optimism about a potential trade deal between the U.S. and China contributed to the rebound to start 2019.
The natural tendency may be to react emotionally to headlines about divisive policy issues, but Cameron's pragmatic mindset is a positive example to emulate. An analytical approach to thinking about the potential investment implications of different policy initiatives includes the following three steps:
1. Incorporate the "outside" view: Nobel Memorial Prize winner Daniel Kahneman's "Thinking, Fast and Slow" is a helpful guide to decision-making, as is work by investor and Columbia Business School adjunct professor Michael Mauboussin. In Mauboussin's words, "Are there similar situations that can provide a statistical basis for making a decision. There is considerable information out there. … Rather than seeing a problem as unique, the outside view wants to know if others have faced comparable problems, and if so, what happened."
Investors who considered past experience were unsurprised at the initial results from the imposition of steel tariffs. According to Commerce Secretary Wilbur Ross, U.S. steelmakers added about 1,000 jobs since the imposition of 25% tariffs on imported steel. Unfortunately, steel consumers paid a steep price for the incremental boost in steel employment. The cost to four major users of steel — Ford, GM, Caterpillar and Whirlpool — estimated that tariffs cost them more than $2 billion. Retaliation to steel tariffs also created a consequential impact apparent to those who studied the outside view: China shifting most of its soybean purchases from the U.S. to Brazil. The resultant fall of nearly 20% in U.S. soybean prices made American farmers a casualty of the early skirmishes in the trade war.
The outside view is also relevant for investors considering the implications of policies gaining favor with progressive politicians. Wealth taxes aren't a new phenomenon, and an examination of recent experiences with a wealth tax in France may provide valuable insight. There is also considerable historical data about the implications of high marginal tax rates on economic growth and investment returns. The Beatles song "Taxman," inspired by the high marginal tax rates of mid-1960s England, is a cautionary reminder of a period of time in which the country was known as the "sick man of Europe" because of poor economic performance.
