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Political Influence

Wells Fargo Investment Institute - February 2020

Policy and investor portfolios

by Gary Schlossberg, Global Strategist

We believe that any market fallout from the clash between Democratic redistributive policies and evolving Republican populism likely will be muted by prospects for a split government after the 2020 elections. 

Key takeaways

  • The increased importance of politics and policy in the U.S. economic and investment outlook has stemmed from economic stress that originated in the Great Recession and the moderate growth and structural changes that followed it.
  • Political polarization has exposed the U.S. to widening tax and other fiscal policy swings—with changes in party control of the White House and Congress coinciding with lower business confidence and investment spending as policy has become more “protectionist” in nature.
  • We believe that investors should look past unlikely political developments to a still-supportive economic and financial backdrop. We continue to favor a late-cycle strategy keyed to higher-quality U.S. stocks and bonds and more liquid, large-cap equity sectors within a well-diversified portfolio that incorporates all major asset groups.  

‘Tis the season

The presidential primary season is revving up as the candidates move to the “Super Tuesday” primaries just weeks away. At stake in this important election year is a potential sea change in the federal government’s relationship with business, high-net-worth individuals, and the financial markets. Beyond the U.S. elections lurk added policy flashpoints, ranging from the threat of ongoing U.S. protectionism to Brexit’s uncertain end and—possibly—a populist resurgence in Italy that could threaten EU cohesion.

For now, presidential candidates are competing for the market’s attention with the spreading coronavirus. The outbreak, a human tragedy in the world’s second largest economy, could shape the economic environment that underpins market performance this year.

Common cause?

Since the deep global economic recession of 2007-2009 and the modest economic growth that followed, policies have had an elevated impact on global market performance. These developments, plus ongoing structural changes, have created economic stress across a wide swath of the workforce in the U.S. and overseas. This, in turn, has encouraged leaders in many countries to embrace protectionism and “deglobalization.” In the wake of this economic stress, the resulting U.S. political polarization has led to a collision between Democratic redistributive policies and Republican populism that has sought to expand the economic “pie” by ring-fencing the U.S. economy from foreign competition and immigrant labor. 

Chart 1. Gyrating policy uncertainties have weighed on CEO confidence

Chart 1. Gyrating policy uncertainties have weighed on CEO confidence

Sources: Scott R. Baker, Nicholas Bloom, and Stephen J. Davis; National Bureau of Economic Research; Chief Executive Magazine. The Policy Uncertainty Index consists of three broad components designed to measure policy-related economic uncertainty. December 2013 = 100. The CEO Confidence Index is a rating from 1 to 10 of CEOs’ expectations for overall business conditions, as a measure of CEO confidence in the economy and prospects for business in the coming year. Ratings range from poor (1 and 2) to excellent (9 and 10). 

A hollowed political center has exposed the U.S. to widening policy swings with changes in party control of the White House and Congress—which has coincided with falling CEO confidence and investment spending (Chart 1). U.S. economic and corporate earnings growth, which had been on track for respectable 2020 gains, ultimately risk becoming a casualty of those uncertainties if the policy uncertainties intensify enough to affect business and consumer confidence and spending. 

Turning to the financial markets, Democratic plans for greater tax progressivity could affect investment strategy as significantly as the response to Republican-led tax changes in 2017-2018 did (but with a less positive market reaction). Also at issue is the lack of federal spending discipline that has coincided with the decoupling of rising late-cycle deficits from interest rates and financial stability. The enthusiasm for added spending stimulus has included proposed financing schemes—embodied in Modern Monetary Theory—that effectively subordinate monetary policy to fiscal policy in order to finance federal budget deficits.

An investor road map for 2020

While U.S. presidential and congressional election results are uncertain, we believe that they likely will be diverse enough to limit the chances for one-party control of the White House and Congress that would be needed for major federal tax and spending reforms. We see the risk of a seismic political shift as low enough that we favor portfolio allocations that are based on a still-supportive U.S. economic backdrop, featuring late-cycle growth with the potential to kindle a U.S. corporate profit recovery this year. Ample market liquidity is suppressing interest rates enough to support elevated equity and fixed-income valuations, underwritten by central-bank bias toward monetary accommodation here and abroad. Positive fundamentals, combined with the usual late-cycle risks, are consistent with our strategy generally favoring U.S. markets over international markets, emphasizing higher-quality holdings in equity and fixed-income markets, and preferring the added liquidity (or “tradability”) of the Information Technology, Consumer Discretionary, and Financials sectors of the U.S. large-cap equity market. 

A family feud? U.S.-EU trade

by Charlotte Woodhams, Investment Strategy Analyst

The European Union (EU) is attempting to avert a trade war following tariff-related warnings from the Trump administration. Multiple “sticking points” may make it difficult for transatlantic allies to arrive at a broad U.S.-EU trade agreement quickly.  

Key takeaways

  • The U.S. and the EU are negotiating a broad new trade deal that also would cover technology and energy.
  • Trade tensions have arisen around the openness of the EU’s agricultural markets and a proposed digital tax on web-based revenues.
  • U.S.-imposed tariffs already have hit important EU products, such as civilian aircraft, aluminum, and steel. 

U.S.-EU trade talks continue

With a win in hand following the U.S.-China Phase I trade agreement, President Donald Trump now can set his sights on reaching a trade deal with the European Union (EU). Business leaders may be concerned that President Trump might become more aggressive toward some of the United States’ closest allies within the EU, following a trade-dispute pause with China and the passage of the USMCA (United States-Mexico-Canada Agreement) by Congress.

U.S.-EU trade escalation began in mid-2018—when the Trump administration imposed tariffs of 10% and 25% on EU-made aluminum and steel, respectively—citing national security concerns. The EU quickly retaliated, countering with tariffs on $3.2 billion of U.S. goods. In October 2019, the U.S. implemented tariffs on $7.5 billion of EU goods imported annually after winning a World Trade Organization case regarding EU aircraft subsidies. The U.S. has threatened that it could expand those tariffs to other goods. In January 2020, the Trump administration threatened to impose tariffs on $60 billion worth of European automobiles and car parts if a deal couldn’t be struck with the EU. The EU has stated that it will respond with tariffs on $100 billion worth of U.S. goods. President Trump also has raised tensions with individual EU members, specifically France and the U.K., following a proposed digital services tax that would primarily affect U.S. technology companies—as he threatens to place levies on British car exports (to the U.S.) and $2.4 billion worth of French goods. 

Chart 2. The U.S. trade deficit with the European Union continues to rise

Chart 2. The U.S. trade deficit with the European Union continues to rise

Sources: Bloomberg, Wells Fargo Investment Institute, February 11, 2020. Monthly data from 1999 through 2019.

At the World Economic Forum in Davos, Switzerland in late January, President Trump and European Commission President Ursula von der Leyen met to discuss a possible trade deal and the easing of political pressure between the two sides. The talks between the two leaders seemed to alleviate tensions and provide some clarity on the scope and timeline of a possible transatlantic trade agreement. European Commission President von der Leyen stated that she wanted to reach an agreement with the U.S. “in a few weeks” in order to find a conclusion to the trade, technology, and energy-related issues between the two sides.1

Negotiations between the U.S. and the EU have faltered on several fronts, most notably regarding the proposal of a digital tax on web-based companies, lack of accessibility to European agriculture markets, and fifth-generation (5G) technology infrastructure. By one economic indicator, Europe is less vulnerable to a trade war with the U.S. than China is. That is, the U.S. exported more than three times as many goods to the EU in 2019 as it did to China each month (on average). This would allow the EU to have plenty of options when targeting retaliatory tariffs on U.S.-made goods, if it were to decide to respond to levies placed by the Trump administration on European goods. Yet, we do not believe that a protracted trade dispute would benefit either side. President Trump may seek to avoid further escalation with the United States’ transatlantic allies as he campaigns in the run-up to November’s general election, while the eurozone faces slowing economic growth, leaving the currency bloc susceptible to more U.S. tariffs.2

Investment implications

Further tariff escalation by the U.S. or EU likely would be damaging, as trade between the two is the biggest bilateral trade flow globally. Given that both economies are slowing, the cyclical effect of further (or increased) tariffs could be significant. Consumers also may feel the tariffs through increased prices, as the complex supply chains of various goods often include both the U.S. and EU. We would expect automobile engines and motors, aircraft, machinery, and pharmaceuticals to be the most affected industries as these are the most-traded types of goods between the U.S. and EU (according to Eurostat).3

Prescription renewal?

by Charlotte Woodhams, Investment Strategy Analyst

No obvious winner has emerged to date in the legislative battle between drug makers, Congress, health insurers, and patients.  

Key takeaways

  • Pressure from patients and Congress to limit annual drug-price increases remains strong. Drug prices could be a top priority for voters in the 2020 election.
  • Rhetoric in Washington D.C. continues to impact drug-pricing decisions and possibly annual increases as well.
  • With increased political attention on the sector, drug makers may choose to limit big ticket spending on innovation and research and development (R&D) on new drugs. 

A chill pill—prescription drug price legislation cools off

History would suggest that, during an election year, it is unlikely that Congress will pass impactful legislation. In 2020, U.S. lawmakers continue to face pressure to move past an impasse on limiting (and reducing) drug prices. This is a key issue for voters as they look ahead to November. We believe the most likely outcome in the near term is that a small deal could be reached to cap out-of-pocket drug costs for Medicare users—or legislation could be passed that allows prescription drug imports from Canada—leaving the more consequential government intervention questions for debate after Election Day.

Democratic presidential debate

Candidates vying for the Democratic presidential nomination have proposed several ideas to tackle prescription-drug pricing challenges. These include authorizing Medicare to negotiate drug prices, allowing citizens to buy prescription medicines from other countries that have adequate quality controls (such as Canada), capping out-of-pocket drug spending for Medicare beneficiaries, and limiting the practice of “evergreening” in the pharmaceutical industry (whereby pharmaceutical companies obtain multiple patents in order to extend drug exclusivity and stanch the introduction of generic pills to the market). 

Chart 3. Drug stocks push higher

Chart 3. Drug stocks push higher

Sources: Bloomberg, Wells Fargo Investment Institute, February 12, 2020. S&P 500 Pharmaceutical Biotechnology and Life Sciences Industry Group Index is capitalized weighted index designed to measure the performance of narrow GICS® industry group. The Index comprises stocks in the S&P 500 Index that are classified in the GICS pharmaceutical biotechnology and life sciences sub-industry. An index is unmanaged and not available for direct investment. Past performance is no guarantee of future results.

President Trump’s proposals 

Despite the fact that drug prices have been a key piece of President Trump’s health care agenda, he has not yet found legislative success in lowering them. Legislative items that address high prescription drug prices stalled in Congress late last year. In mid-December, President Trump announced a plan that would—if finalized—allow the importing of some prescription drugs from Canada, in an effort to reduce the costs of prescription drugs in the U.S.4 However, the most recent Kaiser Family Foundation poll found that the net approval rating on President Trump’s handling of prescription drug pricing was the lowest among all health issues surveyed.5

Prescription-drug price legislation sits in Congress

In late December 2019, the House of Representatives passed a first-ever bill that would require the government to annually negotiate the prices of at least 25 Medicare Part D drugs and cap out-of-pocket prescription costs for those with Medicare coverage. The passage of the H.R. 3 legislation was considered to be a win for Democrats—with opposition from across the aisle and pharmaceutical industry interests. During President Trump’s State of the Union address, he urged Washington D.C. lawmakers to pass drug-pricing legislation so that he could sign a bill into law. Yet, Senate Majority Leader Mitch McConnell already has announced that he would not take up the bill in the Senate.

Democrats remain somewhat skeptical of President Trump’s call for unity and whether he would indeed sign bipartisan legislation. We believe that the debate around reducing drug prices will, therefore, continue to be fractured.

Investment implications

Health Care sector valuations are favorable, but we remain cautious given the uncertain legislative outlook. Companies within this sector are awaiting clear direction and comprehensive legislation to pass in Washington D.C., in order to determine their growth path forward. Therefore, we remain neutral on the Health Care sector.

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1Jacob Hanke Vela, “Von der Leyen: Trade deal with America ‘in a few weeks,’” Politico EU, January 22, 2020.

2Wells Fargo Securities forecasts eurozone economic growth of 1.0% in 2020.

3Eurostat, “USA-EU—international trade in goods statistics,” European Commission, updated on November 7, 2019.

4Katie Thomas, “Trump Administration Takes First Step to Allow Drug Imports from Canada,” New York Times, December 18, 2019.

5Lunna Lopes, Liz Hamel, Audrey Kearney, and Mollyann Brodie, “KFF Health Tracking Poll—January 2020,” Kaiser Family Foundation, January 30, 2020.