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WashingtonWise Investor: Episode 1

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Big technology firms are facing increasing Congressional scrutiny. What could it mean for the tech sector?

In this episode of WashingtonWise Investor, Mike Townsend looks at the U.S. trade war with China, what Congress must do to avert a government shutdown, changes to retirement savings rules, and the 2020 presidential election.

Mike is joined by Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research. They discuss Congress’s heavy focus on big tech firms and what investors should be watching for when it comes to the tech allocation in their portfolios.

You can follow Randy Frederick on Twitter @RandyAFrederick.

WashingtonWise Investor is an original podcast from Charles Schwab.

If you enjoy the show, please leave a rating or review on Apple Podcasts.

Click to show the transcript

MIKE TOWNSEND: When it comes to Washington, there is never a shortage of news, and the 24-hour news cycle is unrelenting. There is no denying that policy and political decisions have a real-time effect on the markets and your investments, so knowing what to focus on and what to let go of is paramount.

Welcome to the inaugural episode of WashingtonWise Investor, an original podcast from Charles Schwab.

I’m your host, Mike Townsend, vice president of legislative and regulatory affairs here at Schwab.

On this show we’re going to explore the policies and politics of Washington through a non-partisan lens, focusing on the issues that matter most to investors.

A good place to begin each episode is with a quick look at the hottest topics in Washington right now that could impact investors.

This week I’ve got three to share, so let’s get started.

First, there’s no question that the most significant issue affecting the markets is the ongoing trade war with China. On September 1, a new round of 10% tariffs on about $150 billion in Chinese imports kicked in.

But tariffs on another $150 billion or so in imports have been delayed until December 15. Products like laptops, cell phones, video game consoles, certain toys, and certain clothing items are among those that made the list for a delay until December.

Why?  Because that means those tariffs—and the potential increase in prices that comes along with the tariffs—won’t kick in until after the bulk of the holiday shopping season is over.

And the president knows how important the holiday season is for our economy.

China has responded with a variety of steps, including imposing its own tariffs on U.S. imports, reducing its purchases of U.S. agricultural products and, in August, devaluing its currency to the lowest point in relation to the U.S. dollar in 11 years.

In Washington, most observers anticipate a drawn-out standoff, with negotiations coming in fits and starts, but no deal on the horizon. In fact, there’s a growing sense that China would prefer to wait until after the 2020 presidential election to return to serious negotiations—perhaps in the hope that the White House will have a different occupant.

Second on my list is the lingering concern of a government shutdown. At the beginning of August, Congress approved, and the president signed into law, a two-year budget agreement that sets federal spending caps for Fiscal Year 2020 and Fiscal Year 2021.

That bill sets the total government spending amounts—but now Congress must pass 12 appropriations bills that divvy up that spending among every federal agency and program.

If they don’t get it done before the start of the government’s fiscal year on October 1st, we could face the second partial government shutdown of 2019.

Now, typically markets don’t over-react to government shutdowns. In fact, during the 35-day partial shutdown that lasted from just before last Christmas until January 25 of this year, the S&P 500® actually went up by more than 10%.

But a shutdown this fall would further complicate an already complex market environment.

Now, both parties fear a public backlash over another shutdown, so while there is a chance it may happen, it’s much more likely that Congress will finish most of the appropriations bills and then pass a temporary extension in order to finish the other bills.

Still, we’ll be keeping an eye on this.

And the third thing I want to bring up is the SECURE Act, a bill that would bring major changes to the retirement savings landscape.

It passed the House of Representatives but is hung up in the Senate. We think there is a good chance—but not a certainty—that the bill gets approved this fall by the Senate.

Among the most significant changes for investors is a provision to raise from 70½ to 72 the age when individuals must begin taking required minimum distributions from their retirement accounts. It would also allow savers to continue contributing to an IRA after age 70½—current law prohibits such contributions.

Investors should also be aware that, if the bill becomes law, it would change the rules for inherited retirement accounts.

Individuals who inherit a retirement account would be required to draw down those accounts within 10 years, and would no longer be able to spread out distributions over their lifetime, as current law allows.

There are some exceptions, but it’s a potential change that could have ramifications for estate planning.

It’s not clear when the Senate will act, but it could happen this fall.

So that’s the rundown of stories at the top of the news. Now let’s move to another thing we’re going to do each show. I’ll look at a recent story that you may have missed and share with you why it matters—what I think the implications are for investors.

This week’s item is for cryptocurrency fans. The SEC has once again delayed a decision on three applications for the first bitcoin exchange-traded fund.

Three different asset management companies have proposed bitcoin ETFs.

The SEC has moved its deadline for making a decision several times and now says it is delaying decisions until late September for one proposal and mid-October for the other two.

Cryptocurrency proponents are eager to get the SEC’s stamp of approval on these products in order to add a mark of legitimacy for the entire virtual currency space. But thus far, the SEC has been unwilling to do so.

Current SEC Chair Jay Clayton has been skeptical of bitcoin and other cryptocurrencies, particularly about whether they are appropriate for ordinary investors.

Last year, he cited concerns about market surveillance, custody, and investor protection from fraud and theft in the cryptocurrency markets.

And he said he would need to see improvements in these and other areas before he would be “comfortable” with approving an ETF.

Looks like we’ll have to wait a little longer to find out the agency’s decision.

Now a word of caution: Virtual currencies are highly volatile and still lack many of the regulations and consumer protections that legal tender currencies have. My discussion of cryptocurrency developments at the SEC is not meant to be an endorsement of any cryptocurrency as an investment vehicle.

This week I want to take a deeper dive into the increasingly hostile environment Big Tech is facing in Washington.

Not too many years ago, the big tech companies were the darlings of Washington. Politicians loved being associated with groundbreaking companies like Amazon, Apple, Facebook and Google that were constantly changing the way we live, work, and interact with each other.

Fast forward to today. It seems like everyone in Washington is mad at tech companies.

Members of both parties have a long list of concerns, including: 

  • Enabling election interference.
  • Data security.
  • Privacy issues.
  • The spread of misinformation, conspiracy theories, and outright lies. 
  • The squeezing of small businesses, small newspapers, smaller competitors generally.

And the list goes on.

Just this past summer, the Federal Trade Commission settled a 16-month investigation into the privacy practices of Facebook and assessed the company a record $5 billion fine.

Regulators said the company “deceived” its users and “undermined consumers’ choices” about how their personal information would be shared.

Meanwhile, during a set of Congressional hearings, executives from Amazon, Facebook, and Google came under withering criticism from lawmakers on both sides of the aisle about whether they are stifling competition.

And the House of Representatives has launched an anti-trust investigation, as have regulators in Washington. Such investigations could pose an existential threat to these companies.

And some of the candidates in the 2020 presidential race have voiced the ultimate threat: calling for the break-up of the largest tech companies. 

So just how concerned should investors be about all of this? 

Let’s bring in my Schwab colleague Randy Frederick to discuss how investors should be thinking about these issues and their impact on technology stocks.

Randy is vice president of trading and derivatives at the Schwab Center for Financial Research. Thanks for joining me, Randy.

RANDY FREDERICK: You’re welcome, Mike, it’s great to be with you.

MIKE: Technology companies today make up about one-quarter of the value of the U.S. stock markets—their highest level since 2000. And just five companies—Amazon, Apple, Facebook, Google, and Microsoft—represent half of the tech sector’s entire market capitalization.

Investors of all types are invested in them directly—and may not even be aware of the degree to which they are also invested in them through mutual funds, exchange-traded funds, and other products. Are you concerned? 

RANDY: You know, Mike, it really doesn’t concern me too much that the technology sector has gotten so big. I mean what part of our lives is not impacted in some way by technology?

It’s mind boggling to think how technology and the internet have changed our lives over the past 25 years.

I sometimes think back in amazement that when I started working for Schwab in 1993, Schwab.com didn’t even exist; I mean the company didn’t have a website. I dare say a company today with no website would probably be out of business in a week.

And when you consider emerging technologies like autonomous cars, the internet of things, cryptocurrencies, artificial intelligence, robotics, virtual reality, and on, and on, it’s pretty clear this trend is only going to continue.

A key consideration about many tech stocks is that they’re fairly high-beta stocks, and that means they tend to go up faster than the broader market, but they also tend to go down faster than the broader market.

MIKE: But that doesn’t mean that investors don’t have anything to be concerned about when it comes to Big Tech, right?

RANDY: Well, there’s always reason for concern if any investor is overly concentrated in just a few stocks, especially if they don’t even realize it.

It’s important for everyone to check the top holdings of any mutual fund or ETF they own, because if they own some of the most popular ones, they’re probably more concentrated than they think.

I can’t stress enough how important this is, because if you’re overly concentrated, even a small market correction can really crush a portfolio. And when the next bear market comes along, and it eventually will, the impact could be even worse.

These five tech companies make up a sizable portion of the three most actively traded ETFs in the marketplace. And are probably in the top 10 holdings of almost any other large-cap ETF or mutual fund, which investors might own not only in a regular investing account, but also in a 401(k) or other retirement plan account.

Finally, I think it’s important to point out, that while you referred to these five companies as tech companies, and many people also think of them that way, actually only Apple and Microsoft are considered part of the Tech sector according to the Global Industry Classification Standard.

Google and Facebook are both part of the Communications Services sector, and Amazon is actually in the Consumer Discretionary sector.

Now, the reason I point this out is because diversifying your portfolio by market sectors, rather than by market capitalization, is another way to avoid being overly concentrated.

MIKE:  Well, now the list of issues that policymakers in Washington are focusing on with these companies is long—it includes everything from data security, to privacy, to perceived bias, poor policing of online behavior, labor practices, the rise of misinformation, and the stifling of competition, and that’s just to name a few. What should investors be watching for?

RANDY: I think all of these risks are perhaps larger than many investors realize. I do think that many people, especially those in the under-40 crowd, don’t take data security and privacy issues seriously enough.

Perhaps they just haven’t experienced the negative impact of having their information used inappropriately by unethical people or companies.

Now, I’ve seen this first hand with my own two children and their spouses, who are all in their early 30s. They’ve grown up with technology most of their lives and have put a great deal of trust in these companies to safeguard their information.

It’s a fact that technology has greatly changed the news media industry, and I think there’s a real risk that the same level of scrutiny the Federal Communications Commission places on TV, radio, and print media could eventually be applied to much of the content that’s available on the internet.

And frankly, I’m not sure this would be such a bad thing.

False information and fake news is prolific on the internet, and the advent of recent technology that can create videos of people actually saying and doing things that they never said or did, is pretty scary.

Regardless of which side of the political spectrum you sit, I think we should all be concerned that this type of technology could have a big impact on the presidential election coming next year.

MIKE: There’s no question that Washington is scrutinizing the biggest tech companies more closely than ever. There have been hearings, some big fines and multiple ongoing investigations. But it’s one thing to have an executive take a few hits from members of Congress at a hearing, and another thing to talk about breaking some of these companies up, which some politicians have suggested. I suspect we are a long way from that—years, if ever. Should investors in these companies be worried about a government-driven break-up? Or is the Washington scrutiny of these companies just a sideshow, and investors should keep their eyes on the fundamentals?

RANDY: As far as the anti-trust investigations go, I think it could definitely be a big distraction over the near-term, but I seriously doubt if these companies will be forced to break up.

You may know this better than I do, Mike, but if I’m not mistaken, anti-trust law has only been used a handful of times to actually break up a monopoly, and the last time was way back when AT&T was split in the 1980s.

Now, I’m not an attorney, but it doesn’t strike me that most of the things these companies have done would be interpreted as intentionally anti-competitive.

I do think they could do a better job on privacy and security, but in some ways it seems more as if they are simply being scrutinized for being successful.

Even Microsoft, which faced a lot of scrutiny and an anti-trust suit back in the early 2000s for having an alleged monopoly with its computer operating system and web browser, eventually resolved the issue just by sharing its application program interface with other companies, not by breaking the company up.

And now given how much computing is done on smartphones, tablets, and other mobile devices, Microsoft is actually a small player compared to Apple’s iOS and Google’s Android system.

Now, my point here is that from my perspective, the biggest threat to any of these tech behemoths is probably a new upstart company with a great idea. And in the tech sector, upstarts can grow and succeed extremely quickly.

Sometimes it’s better not to be first to market. Among these five companies, while Microsoft and Amazon were pretty much the very first to do what they do, before Google there was Yahoo and Lycos, before Apple there was Blackberry and Palm, and before Facebook there was MySpace and Friendster.

MIKE: You’re right, Randy, we forget how many tech companies have come and gone. Despite everything going on with these companies, they are still among the most popular investments in the world. And the tech sector as a whole, as of mid-August, was the best performing sector of 2019. Yet many of us remember all too well the tech bubble of 1999 and 2000. What’s your confidence level in this sector today—and going forward?

RANDY: It’s important to keep in mind that the tech bubble of 1999 and 2000 was a bubble because many of those new dot-com companies weren’t making any money. These five companies combined generated profits of over $159 billion last year.

And while there are a few examples today where newly public companies with huge losses have had their stock prices driven to astronomical heights, those companies represent a significantly smaller portion of the tech sector today than they did 20 years ago.

Looking forward I think there are two key considerations to keep an eye on.

First, as I mentioned previously, all five of these stocks have a beta greater than 1.00, which means that in a market downturn, they’re likely to drop faster than the S&P 500 does.

And second, the current bull market is about 10½ years old, which makes it the longest bull market in history. That means another bear market is almost certainly coming in the next year or two.

Now, the reason I bring this up is because markets go through cycles that repeat themselves over and over again.

Historically, the Technology, Consumer Discretionary, and Communications Services sectors, which covers all five of these companies, have performed far better in the early stages of a bull market than they have in the later stages of a bull market, or during bear markets. Investors planning for the next couple of years should probably take this into consideration.

MIKE: Thanks, Randy, for that great discussion.

That’s Randy Frederick, vice president of trading and derivatives at the Schwab Center for Financial Research. For more of his insights, follow him on Twitter at @randyafrederick.

With the 2020 election drawing so much interest, we’ll devote a minute or two of each episode of WashingtonWise Investor to the latest developments on the campaign trail. We’ll keep an eye not just on the race to the White House, but also on the key races around the country that will shape the battle for control of the House of Representatives and the Senate.

This week will see the third debate among contenders for the Democratic presidential nomination. But it will be a smaller group that gathers in Houston on September 12 and 13 than the debates that happened over the summer, when 20 of what was then 24 declared candidates participated.

In an attempt to begin winnowing the unwieldy list of candidates, the Democratic National Committee made the standards for participating in the third debate tougher than those for the debates in June and July.

In order to qualify, candidates must have received donations from at least 130,000 donors—twice what the threshold was for the summer debates. And candidates must have received the support of at least 2% of poll respondents in a minimum of four major polls.

So we could be at the front end of seeing a number of changes in the race. But keep this in mind: Not a single vote will be cast until early February, nearly five months from now, when Iowa voters gather for their caucuses. A lot can, and will, change between now and then.

Finally, at the end of each episode, I want to highlight what we’re watching next—things coming up in Washington that could be important for investors.

With Congress having returned only yesterday from the six-week summer recess, things are just getting back up to full speed in the nation’s capital.

The main focus of the next couple of weeks will be passing those appropriations bills as lawmakers look to avert a potential government shutdown at the end of the month.

And the Federal Reserve’s Open Markets Committee meets September 17 and 18 to discuss monetary policy. Is another interest rate cut in the works?  We’ll find out next week.

Thanks for listening. If you like what you’ve heard so far, please consider leaving us a rating or review in Apple Podcasts or your favorite listening app. We hope you’ll subscribe and listen to our next episode, too. You can expect it in two weeks.

For important disclosures and a transcript, see the show notes and schwab.com/washingtonwise.

 

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