MIKE TOWNSEND: It's kind of amazing to think about everything that happened in the first quarter of 2021.
Just days into the new year, we saw the riots at the U.S. Capitol, disrupting the certification of the presidential election results. We saw two Democrats win January runoff elections in Georgia, flipping control of the Senate to the Democrats by the narrowest of margins.
We saw the outgoing president impeached by the House of Representatives, and then be acquitted, after he was out of office, at a trial in the Senate.
We saw a new president inaugurated, the most diverse Cabinet in history confirmed, and a $1.9 trillion economic stimulus bill signed into law just seven weeks after President Biden took office.
We saw more than 50 million Americans get fully vaccinated against COVID-19—barely a year after the term “COVID-19” first entered the mainstream.
And on Wall Street, we saw new terms become part of the lexicon. “Meme stocks.” “Non-fungible tokens.” “Celebrity SPACs.”
So the question is, “Will the drama continue in the second quarter?”
Welcome to WashingtonWise Investor, an original podcast 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.
This week, I’m sitting down with Randy Frederick, Schwab’s vice president of trading and derivatives. We’re going to look back at that crazy first quarter of 2021 for investors and look ahead to what investors can expect in the coming months. That conversation is coming up in a just a few minutes.
But first, let’s take a look at the big story making news right now.
The last couple of weeks have been relatively quiet here in the nation’s capital. Congress is at the tail end of the annual two-week recess on either side of Easter and will return next week.
But the White House stayed busy, with President Biden traveling last week to Pittsburgh, Pennsylvania, to outline his much-anticipated infrastructure plan—the next big legislative push by this administration.
So here are five things to know about the infrastructure plan and its prospects for moving through a narrowly divided Congress.
Number one: This is a big plan, with a big number attached to it—about $2.25 trillion. The president called for more than $620 billion for repairing and rebuilding the nation’s roads and bridges; $85 billion for public transit; and $80 billion to help Amtrak expand nationwide train service. The plan calls for more than $200 billion to build affordable housing and repair and rebuild schools, childcare centers, veterans’ hospitals, and federal buildings. And it includes $100 billion each for upgrading the nation’s electrical grid and for expanding access to high-speed broadband, mostly in rural and remote areas.
Now, these are all ideas for which there is broad support, both on Capitol Hill and among the public, at least in the generic sense. Republicans and Democrats in Congress have long recognized the need for significant investment in the nation’s roads and bridges and the like. They know that this kind of spending creates jobs, and it tends to be popular with the public because it has tangible benefits that every constituent can actually see in their community. Indeed, a new poll taken last week found that 79% of Americans supported an overhaul to the nation’s roads, bridges, railways, and ports. And 71% support the expansion of broadband access.
Not surprisingly, however, those numbers dropped significantly when the question was about the specific proposal put forward by the Biden administration. When asked that question, support for the plan fell to 45% and split starkly across party lines.
Thought number two: This proposal is about much more than roads and bridges—some have called it the most sweeping climate change legislation ever. It contains a heavy dose of green initiatives, which are likely to be very controversial. It calls for 500,000 charging stations for electric vehicles, the electrification of 20% of the nation’s school buses and 100 percent of federal vehicles, including the Postal Service. It creates a Civilian Climate Corps to create jobs preserving the nation’s forests, waterways, and wetlands. And it calls for the nation to be powered by 100% clean energy by 2035.
Thought number three: As expected, this will be the bill that brings tax increases squarely on to the front burner in Washington. But what was somewhat unexpected is that the bill as outlined by the White House does not include any tax increases on individual taxpayers. Instead, the administration will pay for the infrastructure spending package by increasing the corporate tax rate from its current level of 21% to 28% and closing a number of loopholes that corporations use to keep their money overseas and avoid taxes. The White House said that would raise enough revenue in 15 years to cover the entire cost of the infrastructure plan, although the spending would come in just eight years.
President Biden said throughout the presidential campaign that he wanted to raise the corporate tax rate to 28%. But that level could get some pushback on Capitol Hill, where some Democrats have already indicated they would be more comfortable supporting a rate of 25% or 26%.
In the weeks leading up to the White House announcement of the package, there had been reports that the president was considering tax increases on wealthy individuals, perhaps by taxing capital gains and dividends as ordinary income for the wealthiest filers. But that and other individual tax increases were dropped from the proposal. Expect those ideas to be attached to other upcoming legislative proposals.
My fourth point: Given tax increases, the push toward clean energy, and what is either way too much money or way too little money, depending on your perspective, this is going to be a lot harder to get through Congress than the stimulus bill that was approved last month. At this point, President Biden’s plan is just a set of talking points, a broad outline of priorities. It’s Congress that is going to have to turn those bullet points into an actual piece of legislation, and that’s going to be a difficult process. Every Member of Congress is eyeing this package as the vehicle to which they can attach their own priority projects.
And even the basic premise is in dispute among Democrats. Moderate Senator Joe Manchin from West Virginia has already said that the plan is too big and the corporate tax hike too high. Progressives like Rep. Alexandria Ocasio-Cortez think the plan is way too small—she called for spending $10 trillion over the next decade on infrastructure. So getting all Democrats on board with this plan is not going to be easy.
At this point, there seems little chance that there will be any bipartisan infrastructure deal. Expect this legislation to be considered under the budget reconciliation process, that special set of rules that was used to pass the economic stimulus bill last month without any Republican support. Those rules prohibit a filibuster in the Senate and allow the bill to be passed through the Senate with just a simple majority. But all 50 Democrats would have to support the bill to make that happen—and clearly that’s not the case yet.
Which brings me to my fifth and final point: This is going to take a long time. I mean months and months. The economic stimulus bill was passed through Congress in just seven weeks. That won’t happen this time.
Just turning this proposal into an actual bill is likely to involve more than a dozen committees on Capitol Hill, with untold cooks in the kitchen. It’s going to change and change and change again, until we may not even remember what the president’s original proposal looked like. The White House would like the bill to get moving this spring and hopes to have it passed by mid-summer. Given the complexity and the political dynamics, I’d say September or October is a more realistic goal.
Not much is certain about how this process will unfold in the months ahead—but expect it to be messy.
On my Deeper Dive this week, I want to look back at an unusual first quarter for investors and look forward to what to expect in the months ahead. The first quarter of 2021 saw enormous overall trading volume, unprecedented market volatility in certain stocks, a record volume of deals for companies to go public—but not via IPOs—and the infusion of nearly $2 trillion into the economy in the form of economic stimulus. Now, the huge infrastructure push could send another $2 trillion into the economy. So what does all of this mean for investors? Here to help us sort through it all is Randy Frederick, Schwab’s vice president of trading and derivatives. Randy, welcome back to the podcast.
RANDY: Thanks. It’s great to be here, Mike.
MIKE: Well, Randy, let’s start by looking at some of the overall trends in the markets that you saw in the first quarter. Trading volume continues to be way up. Is that increase driven by retail investors? Is that just pandemic boredom resulting in more people trading?
RANDY: You know, Mike, I think it’s a combination of several factors. And what’s fascinating to me about it is that it’s been contrary to historical trends. To understand this, we have to look back at how volume trends typically occur and how that has changed since the coronavirus hit.
Normally volumes spike higher when the market pulls back. This is usually because of three specific activities.
Some investors will scramble to sell profitable positions before those profits disappear.
Other investors will scramble to put on hedges to protect those profits on positions they don’t yet want to sell.
And finally, some investors will start bargain hunting to add positions at a lower price.
For these three reasons, trading volume and market performance tend to be very inversely correlated. Eventually though, if the downturn lasts long enough, all three of these activities will subside, and volume will revert to normal levels. However, if the downturn eventually becomes a bear market, then trading volume will decline even further, and it’ll stay low, until it’s very clear that the bear market is over.
MIKE: But clearly that’s not what has happened over the past year—trading volumes didn’t decline, right?
RANDY: Right. When the coronavirus hit back in March of last year, initially the volume patterns seemed fairly typical. There was a huge spike in volume when the downturn started, but even though the downturn exceeded 33%—which is clearly bear market territory—it was so quick and so sharp, that the usual volume trough that occurs during bear markets never really appeared. And even more interesting was the fact that once the initial volume spike subsided, the new normal levels were about 25% higher than they had been previously.
Now this elevated volume continued throughout the summer months as the market recovered, and I would attribute it mostly to the factors that you mentioned. Pandemic boredom, as you called it, exacerbated by a lack of sports, casinos, dining out, as well as people working at home, or in some cases even unemployment, all led to a surge in trading activity in the markets. And most people had more expendable cash too, partially due to the economic stimulus checks which were issued in April of last year. Trading was one of those solitary activities that was just easy to do when you were cooped up at home.
And trading volumes continued to climb into the fall as the economy remained mostly shut down, finally reaching historically high levels in December, even as the market continued to climb. Now I know it seems somewhat counter-intuitive, but rising volume in a rising market virtually never happens. Usually when the market is rising, investors just hold on to their positions and watch them go up—they aren’t trading, and that results in lower overall volumes.
Now, as the new year got underway, those historically high volumes climbed even further, finally peaking in about the late January, early February timeframe. But by then we knew why it was happening. It wasn’t your average investors. These historically high volumes, literally twice the pre-pandemic levels, were being driven by a whole new group of young speculators trading mostly low-priced, low-quality—or what we now call “meme stocks”—driven by a chatroom induced frenzy.
MIKE: Well, Randy, as we think about how sustainable this momentum is, we have to look to the launch of the huge infrastructure push by the White House. Yes, Congress is likely to make a lot of changes to what was proposed by President Biden last week, and the expectation is that it will take several months to get a bill drafted and get a majority of the House and Senate on board, but I think there’s a really good chance that a major infrastructure plan eventually does get approved by Congress this year. So what opportunities do you see if that comes to pass?
RANDY: Well, when it comes to infrastructure, the two sectors where most investors will likely look for opportunities is in Industrials and Materials. Infrastructure projects tend to take a really long time to get going because projects must first be identified, then they have to be prioritized, and then the financial, human, and material resources have to be obtained before the work can begin.
However, as usual, the market doesn’t move based on what is happening; the market moves based on what will, or even what might, happen in the future, and even the potential for an infrastructure bill has already pushed these two sectors higher. Industrials are the third-best-performing sector—up 13% year to date—and Materials are the fifth-best-performing sector—up 11% YTD.
But Biden’s infrastructure plan is a bit of a misnomer from my perspective, as it goes far beyond traditional projects like roads, bridges, and airports that people often think of. It also includes plans to update water and electric utilities, expand high-speed internet, enhance public education assistance, improve care for the elderly and disabled, expand job training, fight climate change, and on and on.
In fact, it’s so all-encompassing there’s probably something in there for almost everyone, and that means there are probably investing opportunities in other sectors as well. The big caveat of course—and this is something we both agree on, Mike—is that when the bill finally becomes a law, it’s will likely look a lot different than the big wish list in the initial proposal. Still, I would encourage investors to look to those items that are most likely to have support from the Republican side of the aisle, and that would be expanding high-speed internet, repairing roads and bridges, modernizing airports, and expanding job training.
MIKE: Randy, you mentioned a minute ago the retail trading frenzy from earlier this year, and I want to go back to that. As you know, that has drawn a lot of attention here in Washington. There’ve been three hearings on Capitol Hill in the last several weeks, and the SEC has undertaken a study of all the market volatility to better understand what happened. One of the issues that’s received a lot of attention is what’s being referred to as the “gamification” of stock trading—basically, that it has become too easy for inexperienced investors to make risky trades without really understanding what they are doing. How concerned are you about this and the impact on the markets? Do you think there needs to be more regulation?
RANDY: I’m actually not too terribly concerned about it. The impact this activity had on the markets has completely passed now, and, frankly, no rules have been changed. The associated volatility that occurred when it was at its peak back in late January resulted in an overall downturn in the S&P 500® of less than 4%, and the market fully recovered in less than a week. As I mentioned previously, volumes reached their peak in February, and they’ve been coming back down closer to normal levels in March. The S&P 500 is up over 8% year to date, and it’s sitting right at an all-time high at this moment.
You know, whenever something unusual occurs in the markets, there always seems to be this rush to try to change the rules to keep it from happening again. But there are plenty of regulations on the books to protect investors already. Not only did the investors not understand the rules, they were also being misled, to some extent, by these so-called “experts” who didn’t understand the rules either, and some of these rules were not being very well enforced. Enforcing existing rules doesn’t require Congressional involvement. Firms that have been viewed as promoting gamification have already been hit with SEC fines, and they’ve already made appropriate changes to their trading applications.
You know, I’ve been in this business over 30 years, and well before I started, brokers were required to present the risk and reward of any investment or strategy, with equal emphasis. When an investor signs a margin agreement, he or she is agreeing to let the broker change the margin requirements on any particular stock to effectively manage risk to the customer and the firm.
And sometimes that means declaring certain stocks non-marginable. And if the risk gets too high, the broker can prevent the customer from buying more or even liquidate positions to cover a margin call. These practices have been around longer than some of these traders have been alive.
MIKE: And the idea that investors are sharing information with each other, that’s not exactly new, either, right?
RANDY: That’s right. Day trading among groups of speculators communicating with each other in chat rooms is not new at all. Those of us who remember the dot-com bubble back between about 1995 and 2000 can see all kinds of similarities. In those days, day trading kind of began in these physical trading rooms of about 50 to 100 participants. Some pundits called those rooms trading arcades, which does kind of bring to mind the idea of “gamification.”
Later, a handful of day-trading firms sprouted up that allowed these traders to trade from home but communicate via proprietary chat rooms that were actually provided by the brokers themselves. And now that same community exists on Reddit, on Twitter, and on many other social media outlets. The game really hasn’t changed much—there’s just a lot more participants, they have a lot more capital, and many of them are trading at zero commission costs.
MIKE: How do you think these investors will react to their recent experience trading in some of these volatile stocks? Are they just going to go back to betting on basketball games, or will they take a longer view about staying invested?
RANDY: I actually think there’s a potentially very positive outcome from all of this. I’m sure some of them are going to go back to their old habits, and that’s OK if they’re betting with money that they can afford to lose. Day trading and speculating on penny stocks—well, that can be a lot like gambling— it’s not the same as investing. As you know, in all aspects of life, we learn far more from our mistakes than from our successes. Everyone loves to hear to the stories about the 22-year-old who turned $5,000 into $5 million, but the reality is there were many, many more of these traders who lost money. I suspect many of them learned something about the stock market, even if they learned it the hard way. And I’m hopeful that experience will spark an interest in investing, a desire to learn more, and a wakeup call that investing is a life-long pursuit, not just a summer job.
As I have said so many times, investing is not about getting rich quickly—that’s something very few people are lucky enough to do. It’s about getting rich slowly, and that’s something many more people have the ability to do.
MIKE: Well, another phenomenon of the first quarter of 2021 was the explosion of special purpose acquisition companies (or SPACs), which is a way for companies to go public without doing a traditional IPO. I read this week that there were more than $165 billion in SPAC deals in the first quarter of 2021, which is more than were done in the entire year of 2020. So what exactly is a SPAC, and why are they suddenly exploding in popularity?
RANDY: Yeah, so a SPAC is a publicly traded company comprised solely of cash, and it exists for the sole purpose of acquiring a privately held company. Now when a publicly traded company buys a privately held company, the privately held company effectively becomes public—thereby avoiding an initial public offering, or an IPO.
Now I can’t really say for sure why SPACs, which have existed for many years, have suddenly become so popular. Perhaps it’s just that investors’ risk appetite for IPOs is seemingly very high, and in an economy that is awash in liquidity, there’s just plenty of venture capital available.
As a new company wishing to go public, however, I think the appeal of a SPAC merger is more about clarity on the valuation of the company. The acquisition price is determined between the two parties, rather than by the market on the day that it goes public.
MIKE: Well, all of this has caught the eye of the SEC, which recently issued two investor alerts related to SPACs, and it’s expected to look into whether more regulation is needed in this space. So, if the SEC is concerned, what does the individual investor need to be paying attention to when it comes to SPACs, and what do you think the SEC is so concerned about?
RANDY: Well, as you mentioned, this is one of those trends that has caught the attention of regulators because many high-profile celebrities, entertainers, athletes, and entrepreneurs have been either endorsing or participating in them. I, for one, am happy to see the SEC proactively issue alerts before uninformed investors have incurred losses, rather than after.
So SPACs are typically issued at $10 per share, and then they have a period of two years to make a deal. Now, some SPACs will actually start trading higher based on rumors or which company or industry they are targeting. After a merger the SPAC could trade higher or lower, depending upon whether the terms are perceived as favorable or unfavorable and whether the investor optimism in the company is strong or weak. Now, I can’t say whether or not more regulation is needed, but before investing in a SPAC, I do think it is important to understand that there is no guarantee what company, if any, that a SPAC will merge with.
So, if no acquisition occurs, that doesn’t mean that investing in the SPAC results in a loss. If no deal is completed within the two-year window, the SPAC is liquidated, and investors get back their money, with interest—or, essentially, a break-even trade.
Because some SPACs rise in price on just the anticipation of a merger, they can often be sold in the market at a profit, just like any other stock. But this is where retail investors need to be especially cautious. Because if they buy a SPAC that has already risen in price due to an expected acquisition, it could sharply decline if that acquisition never materializes. And these investors will experience a loss because at the end of the two-year window, they’ll only be compensated at the $10 opening price, plus interest—not at the increased price they paid.
MIKE: Well, Randy, we’ve covered meme stocks, and we’ve covered SPACs—I want to get your thoughts on another issue that I think will be getting a lot of attention at the SEC this year, and that’s cryptocurrency. As you know, the SEC has been pretty hostile to cryptocurrency in recent years. But the incoming SEC chair, Gary Gensler, is something of an expert in this space. Do you think that means the SEC will get more engaged in trying to regulate cryptocurrencies? Do you think cryptocurrency trading will ever “go mainstream”?
RANDY: Cryptocurrencies have been around for close to a decade now, and since they continue to grow not only in popularity, but also in price, especially Bitcoin, I think it’s safe to say they aren’t going away any time soon.
Supporters of Bitcoin believe that it could eventually decouple currencies and monetary value from governmental control, but frankly, I find this highly unlikely. While the concept of a single global currency could make global travel and commerce a lot simpler—it could eliminate the need for currency exchange, and the associated fluctuations—but there are far too many reasons that I think it probably won’t happen.
Bitcoin, in particular, is just way too volatile. Year-to-date it’s risen about 100% in price, but in that time, it has experienced weekly price swings exceeding 20% on several occasions. Now, there are other cryptocurrencies, like Tether for example, that are intended to maintain a stable relationship with the dollar, which would likely be a better choice as a currency. But there have been many instances in which cryptocurrency exchanges have been hacked, and Bitcoin has been used for all sorts of crime and money laundering. It also has very high transaction costs and relatively slow transaction processing speeds.
Another big problem facing cryptocurrencies, and Bitcoin in particular, is that despite being nothing more than computer code, it is environmentally very unfriendly. In fact, Bank of America put out a report a few weeks ago saying that the energy consumption of the servers around the world that are currently mining for Bitcoin is on par with the entire amount of energy used by American Airlines, by the U.S. government, or by the entire country of Greece.
But you know, probably the biggest threat to cryptocurrencies is governments themselves, who are highly unlikely to ever willingly relinquish control of their currency or central banks. I mean, central banks could not control inflation or inflate themselves out of a recession if they couldn’t control their own currency. If cryptocurrencies ever become a true threat to the almighty dollar, you can bet they would be quickly restricted or outlawed.
As Chair of the SEC, Gary Gensler is probably a mixed blessing for crypto fans because, while, as you said, he is an expert on the topic—and therefore less likely to be hostile than previous regulators—he’s also more likely to exert more regulatory oversight on the industry, which, ironically, goes completely against the whole philosophy and purpose of cryptocurrencies in the first place.
MIKE: Randy, let me wrap up by asking you to give us your overall sense of where you think the market is headed. Over the past 13 months, we’ve seen astonishing gains. Is that sustainable? Or are you anticipating that the adage of “sell in May and go away” might ring true this spring?
RANDY: You know, since May of last year, I’ve been watching very closely the S&P 500 and how it’s tracked the trend that it made coming out of the financial recession of 2009 and into 2010. At the end of 2020, the percent change in the S&P 500 from the bottom of the March bear market was literally within one half of 1% different from the percent change at the end of 2009 coming out of the bottom of the March bear market from that year. During these nine months, the two lines followed a very similar trajectory. That alignment has continued, even into the first three months of 2021, and now the current trend is running about five percentage points ahead of where it was in 2010.
There have been a few brief divergences, primarily in September of last year and in February of this year, but in both cases, they quickly realigned themselves. Now at the end of April in 2010, the market went into about a 16% correction, and it really didn’t recover until early November, after which it then had a pretty solid finish into year-end. Now many of my Twitter followers actually pointed out that this looks like, as you mentioned earlier, this classic “sell in May and go away” pattern. And indeed it does.
Now, for those you who aren’t familiar with that, let me explain. “Sell in May and go away” is based on a long history which shows that the market often has a tendency to wind down around Memorial Day, and then it doesn’t really pick back up again until after Labor Day. So that period of time represents about 27% of the trading days in each year, but historically, it has only accounted for about 15% of the total annual returns. Now, one caveat I will mention is that over the past five years, specifically, this period has actually performed far better than the historical average.
Certainly, the economic and political environment is very different this time, and the catalyst, of course, that caused the bear market in 2008 is completely different than the one that caused the bear market in 2020. And we all know past performance is no guarantee of future results, but I do think anything that has worked and has followed so closely for 14 months deserves our attention.
Now one other factor that could weigh on the markets is earnings. Earnings expectations uncharacteristically rose throughout Q1, and when that happens it can sometimes have negative ramifications. Yes, it does mean that the outlook is improving, and it also means that earnings are likely to be strong, but it also may mean lower earnings and lower revenue beat rates. In other words, fewer upside surprises, which tend to be a big driver of the market. Earnings season will begin towards the end of April, which is just about the same point where the roadmap shows a potential downturn. So the combination of those two factors makes me a little bit cautious that we may be in for some sort of a pullback or even a correction sometime in Q2—just about the time earnings season gets underway.
MIKE: Randy, as always, you’ve given us great perspective today. Thanks so much for joining me.
RANDY: Thank you, Mike.
MIKE: That’s Randy Frederick, vice president of trading and derivatives here at Charles Schwab. You can follow him on Twitter @RandyAFrederick.
Finally, on my Why It Matters segment, the Federal Trade Commission, better known as the FTC, is not an agency that investors typically spend a lot of time paying attention to—but they should probably start.
The escalating battle between Washington and Big Tech is one of my issues to watch this year. We’ve seen skirmishes already on Capitol Hill, like when the CEOs of Facebook, Google and Twitter clashed with lawmakers from both parties at a virtual hearing late last month. And we’ve seen the Justice Department get involved, as when they sued Google last fall for its anti-competitive behavior in its ad and search businesses.
But it may be that the most consequential battles will be fought at the FTC this year. The Washington media group Axios reported earlier this week that the acting chair of the FTC, Rebecca Slaughter, recently created a “rulemaking group” within the agency’s general counsel’s office. Why does that matter? Because it’s a signal that the FTC is gearing up for a major regulatory challenge to the Big Tech companies, and that it may use its authority to go after the “unfair and deceptive” practices that are at the heart of the agency’s mandate to protect consumers.
I’ve been saying for months that Washington is at the front end of what I expect to be a long battle with the Big Tech and social media companies on several fronts, from anti-trust issues to the spread of misinformation to content management to the security of data and personal information. The Federal Trade Commission may become ground zero for some of these key battles as it stakes out its regulatory authority in a very public way. Stay tuned—I’ll be covering this much more in the months ahead.
Well, that’s all for this week’s episode of WashingtonWise Investor. I’ll be back in two weeks, so please 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—that’s what helps 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 Investor. Wherever you are, stay safe, stay healthy, and keep investing wisely.