MIKE TOWNSEND: On Capitol Hill, the finish line for 2019 is less than three weeks away, as Congress races to complete its work for the year before the annual holiday break.
And this year it seems even more frantic than usual, with a number of high-profile stories dominating the headlines, and news breaking at a dizzying pace.
It can be tough for investors to make sense of it all.
Welcome to the final episode of the year of WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend, and today we’re going do our best to cut through the noise and the nonsense of the nation’s capital and help investors understand what’s really worth paying attention to.
I’m going to focus today’s episode on answering a slew of questions that I’ve been getting during my travels around the country this fall to talk to investors about what’s going on in Washington and how Washington can impact their portfolios. I’ll answer questions big and small and hopefully help give you a better sense of how the markets react to political and policy developments in Washington.
But let’s begin with a look at the stories most important to investors right now.
At the top of the news, Congress has returned to Washington after the Thanksgiving holiday to face a very tricky three-week sprint to the end of the year. It’s tricky because there are four huge issues careening together in this short span of time.
The first, of course, is the impeachment inquiry, which is heading towards its conclusion in the House of Representatives and a possible vote on impeachment later this month, perhaps the week of December 16.
The impeachment inquiry itself has not generated much reaction from the markets so far. But the concern continues to be that it overwhelms everything else in Washington—and potentially makes it impossible to move forward on other important legislative issues.
And the two issues most in danger of getting overwhelmed are the U.S.-Mexico-Canada trade agreement, known as the USMCA, and the risk of a government shutdown.
On the trade agreement, there have been several signs that significant progress has been made on ironing out the final issues and bringing the USMCA to an approval vote in Congress. Last month, House Speaker Nancy Pelosi said that a deal was imminent and that she was optimistic it could be voted on before the end of the year. I expect there would be a strong positive reaction in the markets if that happened.
But could it happen amid a bitter impeachment debate? In her comments a couple weeks ago, Pelosi went out of her way to show that she was serious about bringing the deal to a vote, and I think that’s pretty significant. At the same time, it’s difficult to see the House putting aside its bitter differences on the impeachment process to vote in a bipartisan manner for a trade deal that is a signature issue for the president. In addition, time is running out—there are less than three weeks to go before Congress breaks for the holiday. While it is still possible this vote on the trade agreement could happen this month, I think it’s more likely to slip into 2020.
And the other issue that could be impacted by the impeachment saga is the new deadline for a potential government shutdown—December 20.
The government’s fiscal year begins on October 1, and that’s the deadline for passing the 12 appropriations bills that fund each federal agency and program. When Congress approached that deadline without passing any of the bills, lawmakers agreed to pass a short-term bill that funded government operations through November 21.
The nearly two-month extension didn’t help—Congress still hasn’t passed any of those appropriations bills. So they decided to buy themselves another month, passing an extension through December 20.
But I think that December battle will be tougher. House Democrats have been firm in their refusal to agree to any spending package that includes funding for the southern border wall—and the president has continued to say that he will not sign appropriations bills that don’t provide funds for the wall. While the two sides were able to punt that issue last month, I don’t think either side will be much inclined to compromise if this debate comes up the same week as the impeachment vote.
Finally, there is one other piece of uncertainty to throw into this mix—and that is the growing sense that a “phase one” trade deal with China is not as close as it seemed. The key date to watch is December 15. That’s when the next set of U.S. tariffs on about $150 billion in Chinese imports—including products like laptops, game consoles, and cell phones—are scheduled to go into effect. I think the market is expecting either a deal by then or at least a signal that a deal is close enough at hand that those tariffs could be postponed or canceled. If those tariffs go into effect as scheduled on December 15, it will be a sure sign that the trade war between the two countries is much further from ending than we thought just a couple of weeks ago.
Bottom line: The middle of this month is shaping up to be a very unpredictable one. Market volatility could increase if these issues all come to a head the same week, which is looking like a real possibility.
In the Deeper Dive segment this week, I want to explore questions investors ask at my in-person events throughout the country, because they are indicative of what’s on the mind of most investors. So let’s get right on with it.
Many of the questions surround two of the issues just discussed—the China trade situation and the potential for government shutdowns.
Let’s look at the China trade deal first. Lately, I’m often asked why the market seems to react—and perhaps even over-react—to every tiny bit of news on the China trade talks.
Well, I agree with the premise of the question—it does seem like the market reacts more to China trade news than almost anything else right now, and it’s been that way for most of 2019. I just did a Google search for “stock market reaction to China news,” and here’s a sample from just the first page of results: “Dow jumps 300 points after Trump says U.S. has trade deal with China” … “Trade war escalation with China pummels stock market” … “Five reasons to worry about a China trade deal” … “Stocks climb on U.S.-China trade talk progress.” All of those headlines have just come since August.
In fact, the market reacts to China trade news even if there isn’t any actual news. Think of the number of times the White House has said a deal is “very close”—not just recently, but as far back as February. Every time, the market has consistently reacted positively.
I think the reason for this is because markets crave one thing more than almost anything else—and that’s certainty.
The prolonged trade war with China creates a lack of certainty, particularly for businesses. They don’t know whether their industry is going to see new tariffs, or increased tariffs, or if the tariffs are going to be eliminated. At different times over the past 12 months, all of those outcomes have seemed completely possible, even likely. And it’s that level of uncertainty that makes it hard to plan. So I think the market reactions—positive and negative—are reflective of how much the business world wants this issue to be resolved. Until companies gain some certainty around the environment going forward, we will probably continue to see the market react with each new development.
Now, on the topic of a government shutdown, one of the questions that comes up regularly is, we didn’t used to have such frequent government shutdowns, so what has changed?
Well, one of the most basic responsibilities of Congress each year is to set the total amount of federal spending and then pass those 12 appropriations bills that divvy up that funding among every federal agency and program. Remember, the government’s fiscal year begins on October 1, so that’s the deadline. If Congress hasn’t passed the appropriations bills, they have to pass a short-term funding bill, called a continuing resolution, to keep the government open and operating. If Congress doesn’t pass an extension, then there is a government shutdown.
While this can sometimes seem like a modern development, it has been happening for decades. There have been 21 government shutdowns since 1976, some lasting just a day, while the most recent one, from December of last year into January of this year, lasted a record 34 days.
Even in years when there was not a shutdown, there was almost always the threat of one. In fact, since 1976, there have only been three years in which all the appropriations bills were passed before the October 1 deadline: 1989, 1995, and 1997.
Moreover, since 1977, there have been 186 of these “continuing resolutions,” the short-term funding bills that avert a shutdown—that’s an average of more than four a year. So it’s very commonplace.
Now, the follow-up question to that is whether there’s anything Congress can do to get out of this rut and simplify the budget process so that we don’t have this annual drama over whether the government is going to shut down or not.
The answer to that is: not really. There are annual fights over what the priorities of Congress should be—basically, decisions over whether Program A should get more money or Program B should get more money. But members of the two major political parties in this country have very different priorities—and that produces stalemates.
At the moment, the biggest battle is over funding for the southern border wall. But in other years, it’s been other differences. Our system has always been this way—people with different perspectives and opinions have to hash out a compromise. Compromise has just become more difficult to achieve in Washington.
One idea has been to go to a two-year budget cycle so that Congress would approve a two-year budget instead of an annual budget. That idea has some support—in fact, a Senate subcommittee approved a bill to require two-year budgets earlier this month.
And earlier this year, Congress didn’t even wait for a bill mandating two-year budgets. Last August, Congress approved a two-year budget plan that sets the spending levels for Fiscal Year 2020 and Fiscal Year 2021, which begins next October. Now, this is a one-time agreement that’s only in effect for this budget year and the next—but it could become standard procedure in the future.
Unfortunately, it hasn’t made it any easier to do the appropriations process, allocating those funds to each federal agency—and that’s what leads to shutdowns. Even when the overall budget is in place, if Congress can’t figure out how to divvy up those dollars, a shutdown can take place.
On the topic of government shutdowns, I get a lot of questions about whether they actually impact the markets—and the answer is, historically, not really.
During the shutdown last winter, the markets actually rose by about 7%. And across all the shutdowns since the 1970s, the market reaction has been tiny—on average an increase of less than 1%.
I do think, however, that if shutdowns become even more common in the future, the market will start to react more negatively, if for no other reason than the market tends to get skittish around signs of government dysfunction.
What about elections? Do they affect the market? I’ve been getting a lot of questions recently about how the market fares during an election year. The answer is that, generally, markets have been solid in presidential election years. Since 1928, the average return for the S&P 500® has been 7.1%. In fact, in only four of the presidential election years since 1928 has there been a market decline. One of those was in 1932, the height of the Great Depression. One was in 1940, when the market dropped sharply after Germany invaded France. One was 2000, when the tech bubble burst. And the final one was 2008, during the financial crisis.
Each of these four instances had pretty dramatic extenuating circumstances that didn’t relate to the fact that it was a presidential election year. Outside of these four examples, market performance in election years has been consistently positive.
But that 7.1% average, however, is not the best performing year of the four-year presidential cycle. Indeed, it’s the year we are currently in—the third year of a presidency—that is historically the best-performing year, with an average S&P 500 return of 13.1% since 1928. And this year, at least so far, we are on track to exceed that average.
Of course, it goes without saying—past performance is no guarantee of future results!
Switching topics, another of the most common subjects I’ve been regularly asked about for years is the national debt. Typically, the question goes something like this: “What is the point at which the national debt gets so large that it becomes unsustainable?”
I dove pretty deeply into this issue back in Episode 2, when I talked to Schwab’s chief investment strategist, Liz Ann Sonders, about the impact of the rising debt on the economy and the markets.
As Liz Ann pointed out in that episode, while it’s easy to get focused on the overall amount of debt—which today exceeds $22 trillion—there are a couple of other numbers that are perhaps more important to look at than just the total amount of debt. One is the debt-to-GDP ratio, which measures the size of the debt relative to the size of the economy. That’s at about 78% percent today, but the Congressional Budget Office estimates that, without changes in policy, it would grow to 118% in the next two decades.
And the other number to watch is the percentage of GDP that goes toward just servicing our debt. Last year, we spent about 1.6% of GDP to service the debt, but in the next decade that number is expected to double, and then double again by 2050. And once our cost of servicing the debt is growing faster than our economy is growing, that’s truly unsustainable.
Finally, I want to offer some thoughts on the most common big-picture question I get: How did Congress get so divided where it seems like it is impossible for lawmakers to get anything done? The question is almost always asked with a tone of either frustration or a kind of world-weariness behind it.
Now, the answer is complicated, and I don’t think there is any single factor. One reason, though, is that over the last 10 to 20 years, the middle has slowly disappeared from Washington. When I started my career as a staffer on Capitol Hill in 1993, there was a large group of moderate senators, from both sides of the aisle, perhaps 16 or 18 in all. They had lunch weekly and, in many ways, they negotiated compromises that allowed bills to pass because you really could not move legislation through the Senate without a deal among that group.
Today, there are few moderates left. Both parties have spent more than a decade electing people who are further to the right or left than they are to the center. That contributes to increasing partisanship and an unwillingness to work with members across the aisle.
During campaigns, candidates from both parties all too often say, “Send me to Washington and I won’t compromise.” But our entire system is based on compromise, and if you are coming to Congress with a refusal to compromise as your default position, I think you misunderstand the requirements of the job itself.
A common follow-up question is whether term limits are the answer. Term limits are currently in place in 15 state legislatures—usually limiting legislators in those states to no more than eight or 12 years in office. Six of those states have lifetime term limits, which means that once an individual has served the maximum number of years, he or she can never serve again. The rest allow individuals to run again for the same position after a break, usually of two years.
But there are no term limits at the federal level. There was a big movement in the 1990s toward term limit—in fact, 14 of the 15 states that have state-level term limits enacted those limits in the 1990s, and the 15th state did so in the year 2000. But it never really garnered steam at the federal level, and I don’t think it’s likely to anytime soon.
Next, in my check-in on the 2020 election, I want to keep the theme of common questions going by answering one more. As we head into an election year, I am starting to get asked more frequently how the markets react to different configurations of which party controls the White House and Congress.
The answer may be a little counterintuitive—but if you look at S&P 500 returns going back to the 1930s, the best market performance when a Republican is in the White House has come when Congress has been split, with one chamber controlled by Republicans and one chamber by Democrats.
And the best market performance when a Democrat is in the White House has also come when Congress has been split.
Now, it’s often said that the market loves gridlock—and the statistics seem to bear that out. But I think it is easy to misunderstand the data.
My theory is that gains were strong when Congress was split—but the two parties were working together to find compromise and solve problems. In recent years, that just hasn’t been the case. Nowadays, gridlock is just gridlock.
The market likely still prefers gridlock to one party or the other overreaching, but I think it is growing more concerned that many big problems are not getting resolved by a divided Congress. There are three key things I think the markets would like to see. First, an infrastructure bill that would help address some of the country’s need for improved roads and bridges and ports and rail tracks—something that both parties talk about wanting but can never seem to get done. Second, some real steps taken to rein in the rising cost of health care in the country. And third, a long-term plan for getting the national debt under control.
As we head into an election that includes candidates focused on big policy issues like revamping our tax system and our health care system, we’ll see how the market reacts to the outcome.
In the Why It Matters segment each episode, I look at a story you may have missed and share my thoughts on why it is important for investors. The SEC recently released its regulatory agenda. This is a pretty dry annual list of the issues on which the agency is considering proposing new rules or amending existing rules. One new entry on this list caught my eye: The SEC is considering moving forward with a rule to change the definition of an “accredited investor.”
Accredited investors are those investors who are permitted to purchase shares of non-public securities, or private placements. Current rules set an income and net worth limit for individuals to be eligible to invest in non-public securities: Individuals must have an income over $200,000 and a net worth over $1 million, excluding the value of their primary residence, in order to invest in non-public securities.
What the SEC is at least considering is whether that definition needs to be changed, to open up these types of investments to more investors. Instead of the definition solely being a test based on income and net worth, perhaps it would be rewritten to include education, expertise, and experience as criteria. For instance, a doctor might have the expertise to invest in a health-care start-up, regardless of his or her net worth or income. SEC Chair Jay Clayton has said he thinks the definition needs updating in order to give investors access to a wider variety of investment opportunities. Several bills in Congress are also looking to make these kinds of changes.
Now, nothing is imminent, and both the regulatory and legislative processes can move at a glacial pace. But I think it’s worth keeping an eye on and will be reporting back in 2020 if this idea gathers additional steam.
Well, that’s it for this episode of WashingtonWise Investor. Thanks so much for listening. We’ll be off for the holidays, but we’ll be back on January 14, just after Congress returns from the holiday break. Please make sure you subscribe so that you don’t miss an episode, and please take a moment to leave a rating or a review on Apple Podcasts or whatever app you use for listening. For important disclosures, see the show notes or visit schwab.com/washingtonwise, where you’ll also find transcripts of every episode.
To keep in touch, follow me on Twitter: @MikeTownsendCS.
I’m Mike Townsend, and this has been WashingtonWise Investor. Happy holidays to all, and we’ll see you in January. And keep investing wisely.