Before answering that question, permit us to define “weird”. It is the acronym for
Western, Educated, Industrialized, Rich, Democratic. Popularized by the American
psychologist Jonathan Haidt in his book The Righteous Mind (Why Good People are Divided by
Politics and Religion), the list of adjectives describes most well-to-do Americans and Europeans
and helps explain why they often struggle to understand non-Westerners or even Westerners
who are not highly educated or rich. Haidt argues that humans are “pre-wired” to be more
receptive to some moral attitudes rather than others. Among those attitudes are empathy for the
less fortunate, desire for individual autonomy (liberty), respect for authority and tradition, and a
sense of fairness.
People and cultures vary dramatically regarding which moral attitudes resonate with them.
People with different moral proclivities often “just don’t get each other.” Conservatives and
liberals in the US or Tories and Labour in the UK are obvious examples. The dissonance
expands when Westerners try to understand the more communitarian societies of Asia and the
Middle East. Most of us find it much easier to understand people who share our level of
“weirdness”. We are comfortable in our bubble of like-minded acquaintances.
Recently our old friend Mr. Q, who is weird in an endearing way, stopped by the office with
some questions for us. Although he’s retired, as a former banker he has retained a keen interest
in the economy and financial markets. Here’s some of our discussion.
Mr. Q: The US economy seems to be doing well with unemployment down to just 3.8% and
industrial production humming along at a healthy 3.5%. But a couple of things worry me—a lot.
PAM: What are your chief concerns?
Mr. Q: Well, first the Federal Reserve seems determined to keep raising interest rates despite
the prospects of a trade war with the rest of the world, especially China.
PAM: As we’ve said for years the Fed painted itself into a corner with its ultra-low interest
rate and Quantitative Easing (money creation) policies between 2008 and 2016. The current Fed
Funds rate of 1.75% to 2% remains very low by historical standards and by comparison to the
2% inflation rate. Paradoxically the Fed needs higher rates now so it can lower rates
later in the event of another financial crisis or recession.
Mr. Q: But don’t higher rates risk triggering the very crisis or recession the Fed wants to avoid?
PAM: The Fed acutely recognizes that higher rates might inflict “collateral damage” on highly
indebted borrowers both here and abroad, but it feels compelled to take that risk. The Federal
debt now exceeds $20 trillion and higher short term rates will not help. Most budget analysts
expect the Federal deficit will exceed $1 trillion by 2020. Higher rates also put enormous
pressure on the foreign countries and corporations which have borrowed over $10 trillion.
Mr. Q: What about the rising trade tensions with China?
PAM: Obviously an all-out trade war with the second biggest economy in the world would
not be good for the global economy. The US, however, does not depend on trade nearly as much
as China or other targets of the Administration’s disfavor such as the European Union, Canada,
and Mexico. Remember we are a $20,000 billion economy of which exports are about $1,500
billion, less than 10% of GNP. Our trading partners understand that fact.
Mr. Q: But won’t US producers suffer too?
PAM: Of course. Ironically our soybean and wheat farmers along with their suppliers such as
Deere and Monsanto will bear the blunt of any retaliation. China has already slapped 25% tariffs
on many US crops. With the farm sector in decline even before this trade dispute, we wonder
about the political fallout in the November elections. Farmers were a core constituency for
Republicans in 2016.
Mr. Q: I’m also sensing that many European banks are struggling. It seems everyday carries a
negative article about Deutsche Bank or HSBC or the Italian banks. Is another financial crisis
brewing?
PAM: Perhaps. As a group the European banks have not really recovered from the Great
Recession. Many procrastinated taking the tough medicine which US banks endured such
as aggressive loan write-downs, layoffs, and new capital raises. Italian, Spanish, French, and
German banks remain vulnerable. French banks, for example, have lent over $60 billion to the
profligate Italian government and a staggering $240 billion to Italian businesses.
Mr. Q: So what are the investment implications of the current financial environment?
PAM: We expect stock market volatility to remain elevated. The S&P 500 experienced more
1% up or down trading days in the first half of 2018 than it saw in all of 2017. In fact the
turbulent First Quarter saw more 1% swings than any year since 2009.
We recently positioned portfolios so they could better tolerate stock volatility, especially to the
downside. We also took steps to reduce bond portfolios’ exposure to rising interest rates.
Mr. Q: What keeps you up at night?
PAM: We worry that unforced policy errors could precipitate a global slowdown and a bear
market. Financial history shows that bull markets don’t die of old age—governments kill them
with economic blunders. If our trade war gets hotter or if the Federal Reserve miscalculates,
2019 could become quite interesting. And let’s not forget the European Central Bank and the
central bank of China as a potential sources of policy mischief. But remember too the famous
saying of that catcher with the weird name, Yogi Berra, “It ain’t over till it’s over!”
Bill Miller, CFA
