MIKE TOWNSEND: There has been a flurry of geopolitical developments over the last few weeks, including a major foreign aid bill approved by Congress, visits by two high-profile Cabinet members to China, the ongoing elections in India, disruptions to global shipping channels, and much more.
But the development that has made the biggest headlines here at home—and the one that may turn your kids into foreign policy experts—is President Biden signing into law a bill that requires the popular short-video app TikTok to be sold by its Chinese parent company or be banned in the United States next year. As my own teenager said, "Can they really do that?"
Meanwhile, the Fed may have held interest rates steady for the sixth straight meeting this week, but central banks around the world are sending signals that they may no longer be looking to the Fed to set the path forward. Several central banks are poised to begin cutting interest rates before the Fed starts doing so.
So what are the implications of all of these developments on the U.S. economy and inflation? And what does it mean for investors interested in opportunities overseas?
Welcome to WashingtonWise, a podcast for investors from Charles Schwab. I'm your host, Mike Townsend, and on this show, our goal is to cut through the noise and confusion of the nation's capital and help investors figure out what's really worth paying attention to.
In just a few minutes, I'm going to welcome back to the podcast Jeff Kleintop, Schwab's chief global investment strategist, to break down what's going on around the world and how it impacts the U.S. And to get the real answer to whether TikTok could actually be banned.
But first, here are three things to know about what's going on in Washington right now.
First, after six months of twists and turns, last week President Biden signed into law a $95 billion foreign aid package that seemed dead in the water several times along the way. The final bill includes more than $60 billion in aid for Ukraine; more than $26 billion for Israel, including money for humanitarian aid for civilian victims in Gaza; and about $8 billion for Taiwan and other Asia-Pacific allies to combat Chinese aggression in the region. And the package includes the TikTok divest-or-ban language.
In the end, it all passed with significant bipartisan majorities. But the path to get there was rocky because of internal divisions among Republicans in the House of Representatives. House Speaker Mike Johnson broke the package into pieces so that members could vote on each part separately. The long-standing unofficial rule for House Republicans has been not to bring a bill to a vote unless it has the support of a "majority of the majority." The Ukraine aid bill did not have that level of support, but Speaker Johnson brought it forward anyway. Just 100 Republicans supported it, while 112 opposed it. But all 211 Democrats voted for it, giving it a convincing win, even though it angered many in Johnson's party.
Johnson may pay for this transgression with his job, as Rep. Marjorie Taylor Greene of Georgia has made it clear that she will force votes on her motion to oust Johnson from the speakership. It is likely that Democrats will provide the necessary votes to keep Johnson in his job, preferring a known quantity to an unknown potential successor. But it all makes for an uncomfortable and odd balance in the dysfunctional House that will last right through this fall's election.
More broadly, in the span of about six weeks from early March to late April, Congress managed to get its act together enough to pass all 12 appropriations bills to fund the government for the rest of the current fiscal year, as well as this long-delayed foreign aid bill. And it leaves Congress with―not much on their agenda for the next several months, as both parties are eager to avoid controversy and anything that would potentially give a political win to the other side between now and the election. There is a deadline next week to deal with the expiration of funding for the Federal Aviation Administration, but it is expected that lawmakers will work that out. And in September, Congress will face an October 1 deadline for government funding for the new fiscal year, but, again, it is widely assumed that lawmakers will pass a short-term extension until after the election.
There are still some issues I'll be watching on Capitol Hill―there's talk of cryptocurrency-related legislation and perhaps putting some guardrails around artificial intelligence. But mostly I expect a lot of political messaging bills that lawmakers can point to on the campaign trail but have no chance of really passing, and a lot of short work weeks so lawmakers can go home and actually campaign. There are always unexpected issues that come up. But the bottom line is that it's shaping up to be a pretty quiet six months on Capitol Hill.
Second, in a move that perhaps underscores the lack of legislative urgency right now in Congress, the chairman of the House Ways & Means Committee announced a step last week with an eye towards the 2025 legislative agenda. Committee Chairman Jason Smith, a Republican from Missouri, formed 10 "teams" comprised of Ways & Means Committee Republican members. The plan is for them to spend the next several months exploring potential tax changes for the massive tax bill that will be the most significant issue on the 2025 agenda. That's because all of the 2017 tax cuts―including lower individual income tax rates, the lower corporate tax rate, the higher standard deduction, and the higher amount of inherited assets that are exempt from the estate tax―all those expire at the end of 2025. The House Ways & Means Committee has responsibility for writing tax law, so this panel will be ground zero for next year's fight.
What's notable about Smith's announcement is that it is another clear sign that next year's tax debate won't be just about those expiring tax cuts. Those are just the catalyst for a much larger tax reform debate that is looming. These teams of Republicans on the Ways & Means Committee will be coming up with ideas for parts of the tax code that need to be changed or updated, and they'll likely feed those into a larger plan for tax reform.
But Democrats have their own ideas about next year's tax bill. In his budget proposal earlier this year and in his campaign stops, President Biden talks frequently about increasing taxes on the highest earners via a "billionaire's tax," that would actually apply to anyone with more than $100 million in assets. And his baseline position since the 2020 campaign has been that taxes should not increase for anyone earning less than $400,000, but that those above that level should pay a little more. Democrats are likely to push for the top income tax rate to revert back to 39.6 percent, where it was before the 2017 changes.
The direction of all this won't really be known until after this fall's elections. But expect both parties to spend time in the rest of 2024 staking out their positions on tax issues on the campaign trail in anticipation of a blockbuster debate in 2025.
Finally, one financial planning note. The IRS recently announced that required minimum distributions on inherited IRAs are not required in 2024. This is the third year in a row that the IRS has provided this relief. It applies to anyone who inherited an IRA after January 1 of 2020. IRAs inherited after that date are subject to the "10-year rule," which means that the assets in the account must be liquidated within 10 years. At the time this provision was first passed into law as part of 2019's SECURE Act, it was assumed that, as the heir, you could distribute those assets in whatever way you wanted. You could take a bit out each year. You could take some out when you needed it. You could wait until the very last day of the 10 years and take it all out at once—whatever worked for you.
In 2022, however, the IRS proposed regulations requiring heirs to take out a minimum amount each year of the 10 years until the account was liquidated. And that threw everyone off, because more than two years had passed when no one was taking those distributions, or even knew that they had to. The IRS received a deluge of complaints and ultimately backed down, announcing that, until the proposal was finalized, no one would be required to take those distributions or penalized for not taking them. They repeated that in 2023, and now they've done so again in 2024. However, the IRS indicated that they do expect to finalize the long-stalled proposal later this year, at which time it will clarify what exactly heirs are supposed to do going forward.
Keep in mind, the IRS also said they would finalize the regulation before the end of 2022 and 2023—and they never got around to it. So we'll stay tuned and see if they make a final decision.
But if you inherited an IRA in the last few years, talk to your financial consultant about your situation. You'll still need to make sure that account is empty within 10 years—so it may make sense, depending on your tax situation, to start taking distributions even if the IRS isn't requiring it.
On my deeper dive today, I want to take a quick spin around the globe to talk about some key international issues and how they might impact U.S. inflation and global investing opportunities. I'm pleased to welcome back to the podcast Jeff Kleintop, Schwab's chief global investment strategist. Jeff, great to have you on WashingtonWise today.
JEFF KLEINTOP: Thanks for having me back on, Mike.
MIKE: Well, Jeff, I want to begin with China, where there is never a shortage of things to talk about. And there is one thing that is far from the most consequential issue right now, but probably the one that most people are aware of, TikTok. Last week, Congress approved legislation that requires TikTok's Chinese parent company, ByteDance, to sell the company within nine months, or TikTok would be banned in the United States. Now, with an estimated 170 million users here in the United States, that would be a pretty big deal, but selling TikTok will be extremely difficult. I mean, there aren't a lot of buyer options out there. So how do you think this will play out? Could TikTok actually be banned?
JEFF: Yes, Mike, I, actually, think ByteDance will opt for a ban. And that's because under a sale, the rebranded app would give away ByteDance's algorithms, and that would hurt ByteDance's value in other foreign markets, which make up well over 80% of TikTok's users. I'm talking about markets like Brazil and Indonesia, who have nearly as many TikTok users as the U.S. does. So that would undermine its global presence and its value, as foreign users in those huge markets may switch to the non-ByteDance-owned app. A sale would also create an opening for similar ultimatums by Washington in the future around Chinese companies. So that's something China wants to avoid. So Beijing is unlikely to give approval to a sale of TikTok.
Now, the nine-month time period is significant. I don't think ByteDance or Chinese officials will confirm their stance until after the new U.S. president takes office in January.
Under a ban, ByteDance and Beijing can take comfort, I think, in three things. First, there's always a chance of coming back at some point. Two, the ban would minimize the damage to ByteDance's value and presence in other foreign markets, as I talked about. And three, it would sow a divide between Washington and many American people, something Beijing would be happy to see.
Now, I don't see any material retaliation by China here. There's no similar American company operating in China to target. The major American social media and online platforms, like Alphabet's Google or Meta's Facebook and Snapchat, they've already been banned from the world's second-largest economy. And symbolically banning U.S. companies in less related businesses, well, that would just further risk curbing capital investment that China needs.
So I think they quietly go with a ban in the next year. And in the meantime, ByteDance can resort to a legal battle after the bill becomes law.
MIKE: Yeah, I think this is likely to be ultimately settled by the U.S. courts, and we certainly know how long that process can take. In the meantime, though, I'll tell my teenager to be prepared.
But more broadly, Jeff, with regard to China, one of the things that strikes me about all of this is that we're in an election year, and bashing China on the campaign trail is a proven winning strategy for candidates for Congress and for the White House. I mean, it's pretty easy to get voters riled up by talking about how the Chinese government is spying on our kids through TikTok. Earlier this month, we saw President Biden promise to triple tariffs on Chinese steel and aluminum exports. And at the same time, of course, the U.S.-China relationship incredibly important to both countries, and we are seeing some significant diplomatic outreach. President Biden spoke with President Xi by phone in early April. Treasury Secretary Janet Yellen, Secretary of State Anthony Blinken have both visited China in the last few weeks. During these visits, lots of tough talk, but there's also, I think, a genuine effort to find a productive way forward on any number of issues. So is this a case where the noise on the surface is what attracts everyone's attention, but what's going on beneath the surface is actually more important?
JEFF: Yeah, I think there's some room for give and take here. You know, it is an election year, but there are other timeframes that are relevant to why there's action on this now. The Biden administration has been working on what's known as the four-year review on the Section 301 tariffs that were put in place during the Trump administration. And this review enables the administration to either increase or reduce tariffs on a wide range of products. Now, we expect that Biden will look to raise tariffs on products like electric vehicles. But at the same time, the Biden administration is concerned about consumer inflation, and there are some tariffs on the original 301 list that they could look to reduce given those concerns.
Now, those China tariff cuts may get significantly less attention as they quietly argue that they're making tariffs more strategic than the tariffs that Trump put in place. But regardless, we expect a lot more noise around which candidate is tougher on China in the coming months, as Biden and Trump compete for voters.
MIKE: Well, one of the places where that noise, I think, is going to be part of this campaign discussion is this dispute over China's industrial overcapacity. China, of course, plagued right now by tepid consumer demand at home, is flooding the world markets with cheap goods in an effort to boost its economy. U.S. officials are delivering some fairly strong messages to China about this. So will the glut of Chinese goods impact U.S. inflation, or will the opposite happen if the president follows through with his threats of imposing higher tariffs on some of these Chinese goods? And what kind of impact is this having on other countries?
JEFF: China's first-quarter GDP report illustrated this imbalance between business investment in China, which is pretty solid, and consumer spending, which remains really weak. But I think it's misguided to believe that excess manufacturing capacity in China is going to result in an export of deflation from China through, you know, a flood of cheap goods to the rest of the world that will bring down stubborn U.S. inflation. And there are a few reasons for this.
First, among developed economies like the U.S., imports from China make up less than 2% of overall household consumption. With most of the current pace of inflation coming from services in the U.S., they're not impacted at all from China. Services, in fact, contributed 3.2% of the 3.5% inflation in the U.S. in March.
Second, import prices are only a small portion of the final price of a good. It's often more influenced by wholesale and retail services performed in the destination country.
And then third, China's infrastructure spending and manufacturing stimulus could actually add to global inflation pressures if greater demand boosts commodity prices like those for copper and other base metals, which are up sharply this year. And moreover, excess capacity in China is nothing new that would prompt a sudden trade shock. In fact, low levels of capacity utilization have been a feature in China for over a decade. It just rotates among different industries. Right now, the current excess is in the automobile industry. So I think it's unlikely that China is a solution to the U.S.'s inflation problem.
Counterintuitively, very low export prices may actually incite higher tariffs. If the export price is low enough that it prompts lawmakers to institute new and bigger tariffs in efforts to protect domestic industry, it can increase prices for consumers. And it would follow then that additional U.S. tariffs on Chinese-produced goods, such as the recently proposed rise to steel tariffs, may further boost U.S. inflation, and serve as a counterpoint to any arguments for deflationary effects from inexpensive imports.
MIKE: You know, Jeff, another angle to this is the United States bought more goods from Mexico than it did from China for the first time in two decades last year. A lot of Chinese companies are now manufacturing goods in Mexico. So is this kind of a way around broader U.S.-China trade tensions, and how big of a boon is this to Mexico?
JEFF: Well, when there's only one trade barrier, it's relatively easy to get around it. You know, Trump's 2018 tariffs targeting China did not lead to any deglobalization of manufacturing or a rise in inflation in 2018 or 2019 after they were implemented before the pandemic struck in 2020. And one reason for that, that inflation remains subdued, is that U.S. importers seem to be able to get around the tariffs by just importing from other emerging-market countries, rather than being forced to buy from U.S. manufacturers. The drop in imports to the U.S. from China was exactly offset by the increase in imports to the U.S. from Vietnam, Cambodia, and Thailand. And China's exports to those three countries increased by the same amount. So we were just seeing some kind of trade laundering taking place as these goods were just moving through different countries, and Mexico was part of that as well.
These countries, though, don't benefit as much as you might think, since they aren't really adding much value. They're largely just passing them along, maybe doing a little bit of finishing manufacturing on them. For the most part, they're not adding a lot of value. And so that same scenario could play out with additional tariffs.
But if the next round of tariffs are more widespread and also impact countries like Mexico, with the USMCA trade agreement up for its six-year review under the next U.S. president and Mexican president and Canadian president, in an environment that's now less friendly to trade, that could change. So if there's a lot of trade barriers up that could be more difficult to get around than when there was just one, and it was with China, and you could export goods through other countries.
MIKE: Well, Jeff, of course, whatever the trade barriers are and wherever the goods are coming from, whether it's China or Mexico or Vietnam or Thailand, they have to get here. And that is really affected by the global shipping situation. And I know you pay a lot of attention to how supply chains are functioning, particularly with shipping. Shipping goods around the world has become much more complicated, or at least more time consuming in recent months, for a variety of reasons—rebel attacks on ships in the Red Sea, a drought in Panama that is reducing the number of ships that can pass through the Panama Canal each day, even the bridge collapse in Baltimore, which has paralyzed a significant U.S. port. So where are you seeing the impacts of these challenges in shipping, and are you concerned that this could be another contributor to sticky inflation here in the U.S.?
JEFF: You know, as we consider potential regulatory disruptions to trade, you're right to point out these physical disruptions, which have taken place this year, and even brief shortages can impact prices in our very closely linked global economy. You know, despite all the talk of deglobalization over the past eight years, the U.S. still imports more goods than ever before, with a big surge seen in the first-quarter GDP report.
But hopefully, the worst of the shipping issues is now behind us. This winter's El Nino-driven drought that impacted the Panama Canal should begin to fade with new rainfall, allowing the number and size of ships passing through the canal to rise. And while most ships continue to take the long way around Africa, rather than risk the Red Sea and those Houthi attacks on their way to the Suez Canal, the initial delays that began in January have largely been accounted for, with a slight improvement in delivery times in March, according to the Purchasing Managers Index Survey of Global Manufacturers. Shipping costs remain elevated, but they've retraced more than half of their jump that they saw earlier this year that was seen on routes like from Asia to Europe or to the East Coast of the U.S. where they would go through the Suez Canal normally.
But supply chains still remain vulnerable to shocks. You know, competing claims in the South China Sea threaten disruption in one of the world's main shipping lanes. You've got tensions between China and Manila rising sharply in the past year. We've actually seen collisions between rival vessels. A clash involving a U.S. ally, like the Philippine Coast Guard, and a Chinese vessel could draw Washington and China into a maritime standoff that could impact the flow of trade. You know, an estimated $3 to 5 trillion in shipborne commerce transit the South China Sea each year. A crisis there would add pressure to already stressed global supply chains. If these bottlenecks were to linger or worsen as goods demand continues to recover, they could keep transportation costs contributing to elevated U.S. inflation.
MIKE: Yeah, Jeff, it's been fascinating here in Washington, just an hour away from Baltimore, where I think that the impact of shipping on global trade has been really brought into relief by the problems with the bridge collapse up there. So it feels like it's on everyone's mind here, and it's really interesting to hear your perspective on all the different things that affect shipping.
Well, I mentioned earlier the foreign aid bill that Congress passed, of course includes the TikTok ban, but the bulk of that bill is more than $60 billion in aid for Ukraine. So does this have the potential to change the direction of the Russia-Ukraine war, perhaps hastening an end to that conflict?
JEFF: Well, you know, here we are entering the third year of this conflict. I think near-term prospects for a lasting peace remain dim. Yeah, the U.S. aid package will probably help Ukraine stave off further losses and possibly retake some ground, but probably won't grant a decisive victory. For the global economy, the initial phase of the war, with Russia cutting off Europe's energy supply, was extremely disruptive. Inflation soared, and that forced the European Central Bank into an accelerated tightening cycle. But with that shock now passed, and despite the high human cost, the war is really no longer driving the global economy.
As for a near-term resolution, you know, former President Trump has questioned additional support for Ukraine, limiting Moscow's incentive to negotiate before the U.S. election.
MIKE: What about the impact here in the U.S.? Lots of U.S. companies make the things that Ukraine needs, so having this new flow of money supporting that effort must be good for those companies, right?
JEFF: You're right, Mike, most of the aid goes to weapons and military equipment produced by U.S. companies right here in the U.S., and that includes big defense companies but also smaller makers of artillery shells and gear that may see the biggest relative impact, given that's where the thrust of the spending is.
Now, 60 billion seems like a lot. It is a lot, but the annual amount of the defense budget spent on procuring weapons and equipment is about double that. So this isn't like some big 10-year surge. It's like half a year's worth of spending. And so the big defense stocks that operate more on long-term contracts, they aren't really rallying much on this news. Many of the small ammo and shell-makers across the U.S. are privately owned, so that's not really showing up in the markets either. But in between, the small-cap defense stocks, they're doing pretty well this year, and they're one of the few bright spots among smaller U.S. companies in 2024.
MIKE: Well, Jeff, I want to switch gears a little bit. A huge issue here in the United States is when the Fed will begin cutting rates and how much, and the view on both questions has changed dramatically since the beginning of the year. You wrote an interesting article last week about how other central banks around the world are signaling that they may not follow the Fed's lead and may move more quickly on cutting rates. What are the investing implications if it turns out that other central banks do begin cutting faster than the Fed?
JEFF: You know, as the Fed delays the start of cuts, other central banks are declaring independence from the U.S.'s Fed. You know, looking past June, the outlook for the number of rate cuts priced in for all of 2024 has slipped from between six to seven at the beginning of the year to between one or two for the Fed, but it still stands between three and four for the European Central Bank and a number of other major central banks. And this widening divergence between the outlook for rate cuts in 2024 for the Fed and for those of other major central banks has strengthened the dollar, since higher interest rates on cash can make holding a currency more attractive. And this could have multiple implications for stock market investors.
First, a stronger dollar could eventually hurt earnings for U.S. companies through making exports less competitive and weighing on the earnings growth of U.S. companies' overseas sourced profits. When those gains in euros or yen are translated back and reported in U.S. dollars, well, they simply are worth fewer dollars because the dollar is worth more. And earnings growth of non-U.S. companies on their U.S. sales could benefit for the exact same reason. The dollar is worth more, so they're not only getting those volume gains, but they're getting pricing gains as well.
So second, a stronger dollar also boosts commodity exporters, because crude and other industrial goods, like copper, are typically quoted in dollars. The energy and material sectors tend to benefit from that. Those are two of our favorite sectors for 2024. They've been real strong performers over the last few months.
And third, stock market valuations in countries where rates are likely to be cut more aggressively may rise, offsetting the drag on performance from a falling currency for U.S.-based investors. You know, we've been seeing this effect with the price-to-earnings ratio rising for much of this year for the MSCI EAFI Index of developed international stocks, and that's contributed to its total return and offset the drag from the currency impact.
MIKE: Yeah, it's a great point, Jeff, and a really good reminder to keep an eye on what other central banks are doing. And of course, that a diversified portfolio that includes an allocation to international investments is always really important and very important right now.
Jeff, I want to talk one more subject, and that's India. We could probably do an entire episode on India. India has just begun its presidential election, which takes several weeks, and has―and this totally blew my mind―more than 960 million eligible voters, which is about five times as many as there are U.S. voters. India's economy is booming. They're on track to become the third-largest economy in the world within the next three years. They are investing enormous sums in improving their infrastructure and technology. So what's your outlook for India, and what should investors be looking at when it comes to opportunities to get in on some of this growth?
JEFF: Well, as it pertains to the election, Prime Minister Modi and his BJP Party dominate Indian politics and are likely to do well in the elections, maintaining the favorable economic and policy momentum that's been in place.
Now, while India has demonstrated protectionist tendencies in the past, the Modi administration is shifting the focus towards further lowering trade barriers to increase India's share of global manufacturing exports, boosting growth of India's historically services-driven economy, trying to take some share away from China on manufacturing.
Now, we profiled India's economic rise last year, as it surpassed China to become the most populous country in the world, and it may soon also become the largest country weighting in the Emerging Market Index, as it narrows the gap with China. You know, just three and a half years ago, Chinese stocks made up nearly half of the Emerging Market Index, 43%. India comprised at that time only 8%. That was a gap of 35 percentage points. But that gap is now closed to just seven percentage points, as China has fallen to 25% of the index, and India rose to 18.
India is an exciting story, and one that will have an increasingly global impact. But it should be noted by investors that India's stock market trades near its highest price-to-earnings ratio of the past 20 years. So things have been going well, but that hasn't escaped the notice of the markets. I've been bullish on India for a long time, but should India's progress stumble for some reason, the stocks could be vulnerable to a pullback.
MIKE: So what's the best way for an ordinary investor who maybe doesn't have a lot of experience with India, or really any foreign country, to start doing the research and making some investments?
JEFF: Well, fortunately, obtaining global diversification has never been easier or less expensive. And with markets in Europe and Asia and even Canada performing well, you don't have to be overly selective here. You don't have to know a lot about an individual company or industry, and investment in a product or a solution that offers broad exposure to developed markets across the globe really makes sense, after more than a decade where those markets lagged the U.S. nearly every year but have been leading the S&P 500® since the current bull market began back in October of 2022.
Now, how much exposure outside your home country should you have in your portfolio? Well, that's going to depend on your risk tolerance and your time horizon. But it's clear to me from the data that most investors can broaden their opportunity set and diversify their portfolios simply by significantly boosting the international portion of their stock portfolios. Now may be a good time to consider rebalancing portfolios back towards international stocks after years of U.S. stock outperformance may have caused a drift away from those longer-term targets.
MIKE: Well, Jeff, great conversation, as always, and I'm not kidding about having you back on for a discussion that focuses just on India, but I'll leave it there for today. Thanks so much for making time to talk.
JEFF: I'll look forward to it. Thanks for having me on, Mike.
MIKE: That's Jeff Kleintop, Schwab's chief global investment strategist. Make sure you're following Jeff on X, formerly known as Twitter, @JeffreyKleintop.
That's all for this week's episode of WashingtonWise. We'll be back with a new episode in two weeks, where my colleague Collin Martin and I will discuss the bond market, how it's reacting to the slower-than-expected pace of Fed rate cuts, and what bonds might be telling us about the stock market. Take a moment now to follow the show in your listening app so you don't miss an episode. And if you like what you've heard, leave us a rating or a review—those really help new listeners discover the show.
For important disclosures, see the show notes or schwab.com/WashingtonWise, where you can also find a transcript.
I'm Mike Townsend, and this has been WashingtonWise, a podcast for investors. Wherever you are, stay safe, stay healthy, and keep investing wisely.
