MIKE TOWNSEND: All eyes are on the United States Senate, as the third impeachment trial in the nation’s history is underway. That means the legislative agenda has moved, at least temporarily, to the back burner.
But once it gets going again, there is lot on the 2020 agenda for investors to be aware of. Somewhat counter-intuitively, the final year of a presidential term can be a busy one, as lawmakers scramble for accomplishments they can tout on the campaign trail, and regulators push to finish pending rules and regulations before a potential change in the administration resets their priorities. Today, we’re going to look ahead at some of the issues we think investors should be keeping an eye on throughout 2020.
Welcome to WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend, and our goal on this show is to cut through the noise and the nonsense of the national’s capital and help investors understand what’s really worth paying attention to.
At the top of the news this week, of course, is the impeachment trial in the Senate, which began last week. There’s still no definitive timetable for how long it will last.
As I have said before, we don’t anticipate much market impact from the impeachment trial itself, as removing the president from office continues to look virtually impossible. But the trial will overshadow everything else in Washington for however long it lasts, pushing the legislative agenda into the background, probably well into February. While the House of Representatives will continue to have hearings and debate legislation, the non-impeachment work of the Senate has basically ground to a halt during the process.
Elsewhere, I think it could be argued that the week of January 13 was one of the most consequential policy weeks of the entire Trump presidency to date, with two major trade developments. The first, of course, was the signing of the so-called “phase one” trade deal between the United States and China. The formal signing of the deal was the culmination of 18 months of on-again, off-again talks between the countries. And while it left a lot of thorny issues on the table for the next round of negotiations, I continue to think it’s an important first step. In exchange for China’s promise to increase its purchases of U.S. agricultural products and other concessions, the U.S. lowered tariffs on about $120 billion in Chinese imports and cancelled a new set of tariffs that was scheduled to become effective in December.
But even as the president lavished praise on the deal, he threw some cold water on the notion that negotiations on phase two would proceed quickly. The president said last week that the current tariffs, which apply to more than $360 billion in Chinese imports, are likely to stay in place at least through the 2020 election. If that’s the case, it could produce a continued drag on the economy.
The second big trade story was final passage in the Senate of the U.S.-Mexico-Canada trade agreement, better known as the USMCA, on January 16. Senate leaders had been resigned to waiting until after the impeachment trial to take a vote on the trade deal but abruptly shifted gears, getting the trade deal approved in five different Senate committees over the course of 48 hours on January 14 and 15, before passing it by the overwhelming bipartisan margin of 89-10.
The final step for the USMCA is approval by the Canadian legislature, which reconvenes this week and is expected to agree to the deal soon. The USMCA will then go into effect, replacing the 25-year-old North American Free Trade Agreement.
One important takeaway from the USMCA is that it proves that Congress can actually get things done on a bipartisan basis, even amidst the incredibly polarized atmosphere in Congress. Could it be a model for additional bipartisan action in 2020?
To take a deeper dive into the implications of these trade developments, as well as the outlook for action on other legislative items in 2020, I’m pleased to be joined by Dan Clifton, managing partner and head of the Washington office for Strategas, a boutique brokerage and advisory firm based in New York.
Dan, thanks so much for joining me today.
DAN: Thanks for having me, Mike.
MIKE: Well why don’t you start by telling us a little bit about your firm, what it does, and what your role is.
DAN: Yeah. So Strategas is an investment research firm that provides economic investment and policy research to institutional investors. What we try and do is take these different research verticals and overlay them into a comprehensive investment strategy, with the idea that impacts in Washington could have an effect on financial markets, impacts on the global economy can impact financial markets, whatever the issue is, and then we try and put it all together and say, “Here’s where we think the economy is going. Here’s where the markets are going. Here’s where the elections are going.” I have the good fortune of being the head of the Washington office where I get to evaluate public policy decisions that go on here in Washington. Those can be monetary, fiscal, trade, you name it, and then overlay that into our overall investment strategy, and how those policy changes could impact the economy and financial markets.
MIKE: So you’re essentially looking at policy and political developments and then thinking about what investing sectors and even specific companies—how they might be impacted by those developments. Kind of picking winners and losers, right?
DAN: Yeah, that’s correct. I would think about it as a multifaceted approach. We could look at a macro effect. We could look at a sector effect. We could look at an individual company effect. I think a good example of that would be tax reform, which passed in December of 2017. As you know, this was a—probably about a $1½ trillion tax cut over 10 years. We evaluated what the impact of that would be on GDP, on corporate earnings, on overall stocks, and then you could start getting in deeper into some of the components. For example, one provision within tax reform was the repatriation of foreign profits, where companies could bring home their stored foreign cash after paying a one-time tax. We were able to take a look at that and say, “What would be the impact on currencies? Which sectors would be most impacted based on their cash holdings overseas?” And then, ultimately, we build a basket of individual stocks for our clients and say, “Here are the companies that we think will benefit the most from that.” And of course, those are the winners. Those are one component. As you know, Mike, in tax reform, there were some losers. And we’re really trying to handicap political outcomes. And I want to be very clear about this: We cannot be partisan in our approach. We can’t choose for one political party or one team. We really have to get to what the likely outcome is going to be for our clients to make the most informed investment decisions.
MIKE: Well, Dan, a lot of investors that I speak to—and I’m sure you’ve had the same experience—they have had trouble connecting 2019’s incredible market performance with their sense that everything is just out of control, particularly when it comes to the craziness in Washington, issues like climate change, and other issues. But the markets seemed to really rise above it all and keep chugging along. How do you explain that?
DAN: Well, it’s definitely a crazy market in political terms, and I like to tell my colleagues if you’re not having fun in this political environment doing policy research, you’re probably in the wrong business. I mean, this is like the Super Bowl for policy analysts. But what’s good for us as policy analysts, Mike, is really difficult for people who manage money in this … in this environment. You know, there was a time where you just needed to understand what a company balance sheet was, and you were able to make good investments. Now you need to know and understand that Washington component. You know, I … we just finished a study where we found that 52% of S&P 500® companies are now citing the government as their top risk on their SEC forms, which are called 10-Ks. That has doubled over the last 10 years since the end of the financial crisis. And so understanding these policy developments are going to be very important to understanding what’s happening in the market overall.
MIKE: Well, the market’s performance in 2019 was not atypical for the year after a midterm election year, was it?
DAN: That’s absolutely correct. What we like to do is look at the average of how stocks have traded in a four-year presidential cycle. There are four years to a president’s term, and the average return going back to 1948 in years one, years two, and year four of a president’s term is around 6- to 7%. The average return in the third year of a president’s term is 16%. So you see this wide dispersion happen in year three, and we don’t believe that that is a coincidence. You know, presidents are very worried about their own re-election normally, and in most cases, presidents suffer very large midterm election losses. President Trump, he lost about 40 House seats. President Obama before him lost 63 House seats. When that happens, presidents begin to say, “Wow, maybe I could wind up losing my re-election,” and they try and stimulate the economy. In fact, what we see happening is that you get greater monetary policy and greater fiscal policy in that third year, just like what happened in this cycle. And I want to be very clear, Mike, is that what we’re looking at is the average, and that past performance is no guarantee of future results, but you do see this very big similarity coming up.
MIKE: Yeah, it’s amazing the consistency of that third year in the cycle and the stock performance over many, many decades.
MIKE: Well, this month has seen some significant developments with trade, and you’ve mentioned both the China trade and I want to talk you about China and the U.S-Mexico-Canada Agreement. What’s your take on the impact of these two recent trade deals?
DAN: Yeah, so the first one, I think, is what most people call the USMCA. I think it’s very, very significant from a political development of how important this trade agreement is. It got bipartisan support in the Senate. Ninety out of a hundred senators supported that, Mike. And I think the big take-away from that is that the labor protections and the consumer protections that were put in this USMCA, NAFTA 2.0 agreement, are really a path forward for future trade agreements that could gain bipartisan support. So I think people are feeling a lot better about the developments on the USMCA, and that should help capital expenditures in 2020.
China is much more significant economically, as well as politically. I want to first say that the biggest impact from this trade agreement is that you’ve been seeing the Chinese currency strengthen relative to the U.S. dollar. What that is doing is it’s loosening financial conditions, it’s starting to bolster manufacturing here in the United States, which has been in a pretty big slowdown since the trade war began. So before you get into the text, you’re just getting this loosening of financial conditions, which should help the U.S. economy overall. Then you get into the details. I mean, there’s a whole chapter on China liberalizing its financial services industry, where you’re no longer going to require Chinese majority ownership of U.S. companies operating in China. And you take companies that do electronic payment transfers—they were promised that they would have market access in 2006. They still didn’t have it before this trade agreement.
And so you’re going to see a broad range of companies getting on their earnings calls in the next couple of weeks talking about how significant some of these market access reforms are, and I think that’s fairly significant. And then, obviously, China is going to purchase more goods in different areas, such as agriculture, liquefied natural gas, as well as manufacturing goods. And all of them are important, and I think it can add a couple of tenths of a percent to GDP growth in 2020.
MIKE: Well, Dan, in phase one the U.S. really was going it alone. But I’ve heard you talk about possibly seeing a multi-lateral approach to the next phase of negotiations with China. Why do you think that will get China back to the negotiating table?
DAN: I would argue that the one criticism you can make about the U.S.-China Trade Agreement is that it didn’t take on structural reforms, like China’s state owned enterprises, or China’s government subsidizing their own companies, or even the intellectual property protections not being fully hashed out in the phase one trade agreement. The first phase, as you mentioned correctly, Mike, was done as a part of what we call a unilateral push, the U.S. against China. I think the U.S. policymakers have come to the conclusion that to get these reforms on state-owned enterprises, subsidies, and intellectual property, they’re going to need a more multilateral coalition to be able to talk to China about this. One that includes a coalition of Europe, Japan, and the United States to be able to say to China, “If you want to be a big player on the world stage, you got to have much fairer trade rules and how you deal with these issues.” I would expect other countries are going to join in and see if we can get more significant structural reforms. Now, obviously that’s going to take a long time, and that’s why you see the president saying that it’s unlikely that this is going to get done in 2020. It will probably be something that happens after the election. But it feels like the world is coming together and saying, “How can we make the trading process more fairer, more freer, and opener?” I think that’s actually very good for risk assets.
MIKE: Well that’s a great take on the China deal. Maybe more optimistic than a lot of the consensus.
Let’s look further at what you are thinking about for 2020. Despite the highly partisan atmosphere that has dominated Washington really for the past few years, we’ve seen Congress come together recently to get things done—the December agreement to fund government operations comes to mind in addition to the U.S.-Mexico-Canada vote.
Are there issues that you think Congress can come together on in 2020 that investors should be paying attention to?
DAN: It’s a great question, Mike, because we’re moving to the, what I call the accomplishment section of the election cycle. Members of Congress love to go home and tout all the great things that they’ve done while they’ve been in Congress for the last two years if you’re a House member or six years if you’re a Senate member. And completely contrarian to conventional wisdom, election years tend to be more productive for legislative activity than the non-election years, and we have data to back that up. So there is a chance to get a few things done this year, although it’s not guaranteed.
The first is that you could possibly see a deal to end what’s called surprise billing, medical billing. Obviously, there’s a lot of contentions around there, whether we’re going to do this through different methods. Managed care wants one way. Hospitals want another way. Doctors want a third way. It’s hard to reach that agreement, but it feels like there’s a real bipartisan push to get something done on that issue this year.
I also think that there’s going to be a push on prescription drug prices. There will be an effort in Congress to see if we can maybe limit out-of-pocket expenses for senior citizens. The House has a more aggressive plan, which really crams down prices. I’m skeptical that Congress is going to be able to reach a decision on that, and the president is threatening to act on a unilateral basis through something called the International Pricing Index. And what that does is it starts to match up U.S. prices with foreign prices, which could be 30- to 40% lower. And this would be targeted to the Medicare Part B program, a smaller program, one that deals with cancer drugs and other factors, but it would be a test for doing something on the larger drug issue in a second-term Trump administration.
MIKE: Well, as we all know, healthcare is one of the most controversial issues out there, so it’s interesting to think about progress on a couple of these key issues in that sector.
Another issue that is on the top of everyone’s minds is infrastructure. You know, virtually everyone on both sides of the aisle agrees that we need to spend lots of money on roads and bridges and ports and the like. Yet for all the talk, nothing seems to happen. Do you think any progress will be made in 2020?
DAN: Well, that’s another great question, and I actually think there’s going to be some activity around infrastructure over the next year, and in particular in the first half of 2020.
But Mike, you being a veteran of Washington, you know how these games are played. It all comes down to financing. I see very little will to raise the gas tax or come up with some alternative financing. And so the big package, the trillion-dollar package that everyone loves to talk about, seems unlikely, at least until after the election.
Yet this is the year that we have to reauthorize the Highway Trust Fund that usually serves as a catalyst to get something done on highway spending. And in fact, I wouldn’t be surprised if Congress authorizes another $20- or $30 billion on highway spending over the next two years as part of that agreement. I don’t view it as a big macro event. I don’t really think it adds to GDP, particularly in 2020 because there’s a lag in when that money comes out. But it is good for the construction- and infrastructure-related stocks, which will start to see an inflow of funding from that deal.
MIKE: Another sector that I wanted to ask you about—tech stocks—had a great year in 2019. But there is also concern that the continued scrutiny and investigations—not just here in the U.S. but elsewhere in the world as well—these investigations of tech companies when it comes to privacy, data security concerns, anti-trust issues, other potential headaches, that all of this could put pressure on tech stocks in 2020. So what’s your take on the prospects for the sector?
DAN: Yeah, first let me talk about the politics before I get to the stock prospects. But these companies are under attack in a bipartisan manner. This is not just a U.S. phenomenon. It’s going on around the world. You have privacy regulations being developed around the world. You have a digital goods tax being developed, again, not only around the world, but at the state level. California just opened up its privacy rules. And this administration has multiple antitrust cases going on against some of the largest U.S. companies, such as Facebook, Google, and Amazon. It remains to be seen how those antitrust cases are going to be resolved. And the punchline here is that despite all of our polarization, there seems to be a widespread agreement amongst Democrats and Republicans on doing something on the tech platforms. We just haven’t figured out what that is here in the U.S., but there’s going to be continued activity around the world. And if that’s the case, I would favor some of the non-tech-platform tech companies rather than the tech platforms, where I think there’s significant policy risk creeping into those stocks ahead of the 2020 election.
MIKE: Well, Dan, lots of great information here. Thanks so much for joining me here today.
DAN: Thank you for having me, Mike. It’s been great to speak with you about all these pressing issues. It’s going to be a great election cycle.
MIKE: If you’d like to keep up with Dan’s latest thoughts, you can follow him on Twitter @DanCliftonStrat.
Now turning to our Election 2020 check-in, it’s less than a week before the Iowa caucuses on Monday, February 3. And to me, the most interesting and unpredictable element of the run up to the first actual votes of this primary season is the fact that three of the five leading candidates are pretty much off the campaign trail. Senators Amy Klobuchar, Bernie Sanders, and Elizabeth Warren are in Washington for the impeachment trial, which requires them to be seated in the Senate chamber for as many as six days a week during the duration of the trial.
Of course, it’s a big advantage for candidates like former Vice President Joe Biden and former South Bend, Indiana, Mayor Pete Buttigieg, who can barnstorm around Iowa and the other early states as much as they want. We’ll see how this unusual dynamic plays out next week.
The other thing about the election that I continue to find fascinating is the candidacy of former New York City Mayor Mike Bloomberg. Now Bloomberg is trying to upend the traditional model for winning the presidency in many ways, most notably by essentially skipping the first four states and concentrating instead on Super Tuesday. That comes on March 3, when voters in 14 states go to the polls, including the two largest prizes in terms of delegates at stake, California and Texas. Nearly 40 percent of all the delegates available during the Democrats’ primary process will be awarded that day.
Now, no candidate in modern times has successfully won the nomination while skipping the early states. But no candidate ever has vowed to spend more than a billion dollars of his or her own money on the presidential race, as Bloomberg has done. In fact, he has reportedly already spent more than $250 million just on television advertising.
Bloomberg’s strategy may be to deny the ability of whoever emerges from the early states as the frontrunner to gather the necessary number of delegates to win the nomination. If no candidate has reached the 1,990 delegates needed to win the nomination outright, then there will be a contested convention—and Bloomberg may be thinking that he could be the last one standing if it comes to that.
Now, I have no idea at this point whether such a path is realistic for Bloomberg. But it sure makes Bloomberg a candidate to watch in the weeks ahead.
In our Why It Matters segment each episode, I try to highlight something you may have missed and explain why I think it’s important. This week, I want to mention two announcements that will have significant impact on the financial services sector for years to come.
First, Robert Jackson, one of the five commissioners at the Securities and Exchange Commission, or SEC, announced last week that he will step down from his post on February 14, to return to teaching at the New York University School of Law, where he has been on a public service leave. Jackson, one of two Democrats on the commission, joined the SEC in January 2018. In a relatively short tenure at the agency, he’s established himself as a thoughtful overseer of the markets—someone interested in making sure the markets are a level playing field for all investors. His voice will be missed. No word on who might replace him, though one of his staff attorneys, Caroline Crenshaw, has been tapped by at least one media outlet as a potential successor. But there’s no timeline for when a nomination will be made, and the confirmation process can take months. So don’t be surprised if the SEC has a vacancy through at least this fall’s elections.
And second, the president last week formally nominated two economists, Judy Shelton and Christopher Waller, to fill the two open seats at the Federal Reserve Board of Governors. The Fed is supposed to have seven members, but it has had five or fewer for several years. In fact, if Shelton and Waller are confirmed, it would be the first time the Fed had a full slate of governors in more than six years. Shelton, who most recently was the U.S. executive director for the European Bank for Reconstruction and Development in London, has expressed some controversial views in her past that could make her confirmation a bit tricky. Waller, who has been a senior economist at the St. Louis Fed for more than a decade, is seen as something of a slam-dunk for confirmation. Now, it could still be a few months before those confirmation votes happen, but if they are confirmed, it would add two new voices to the Fed’s decision-making process on monetary policy and bank regulation for years to come.
That’s all for this episode of WashingtonWise Investor. Please take a moment to leave us a review or a rating on Apple Podcasts or whatever app you use for listening—those really do matter. And be sure you subscribe so you don’t miss an episode. For important disclosures, see the show notes or visit schwab.com/washingtonwise, where you can 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. Thanks for listening and keep investing wisely.