Policy, Politics & Portfolios

Updates and analysis from Wells Fargo Investment Institute on what federal budget, regulatory, and trade decisions could mean for investors.

June 25, 2019

Craig Holke, Investment Strategy Analyst
Charlotte Woodhams, Investment Strategy Analyst

Courts, Visas, and Dark Clouds

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Courts

President Trump has appointed judges at a record pace. Federal and Supreme Court judges have an indirect effect on the U.S. economy and markets through their regulatory rulings.

Key takeaways

  • While courts generally have an indirect effect on U.S. markets and the economy, some decisions can have wide-ranging impacts. Regulatory changes and subsequent court decisions can negatively affect corporate revenues, with products or entire lines of business being impacted.
  • According to a study reviewing court of appeals cases, Republican-appointed judges tended to side with businesses when determining the legality of a regulation.1 In this regard, these judges may be viewed as more business friendly and less likely to negatively impact corporate earnings.
  • Should politicians continue to make it easier to place an administration’s judicial nominees on U.S. courts, we could see increasing regulatory uncertainty. This, in turn, could negatively impact companies’ ability to make longer-term investment decisions.

President Trump has made significant court appointments

Open federal judgeships: 131 Pending nominees 60

Judicial appointments are one of a president’s longest-lasting legacies. As U.S. presidents have taken office, they have sought to shape the courts according to their party’s values. In this, President Trump is no different from his predecessors—as he seeks those who share a similar view on how laws should be interpreted and cases decided. Federal regulations are created in response to executive branch actions or laws passed by Congress. When there are challenges to a regulation’s legality or its implementation, federal courts are the final decision-makers. The ability to shape the ideology of U.S. courts lasts significantly longer than any president’s term.

As of 2018, there were 9 Supreme Court, 179 court of appeals, and 663 district court judgeships in the United States.2 Presidents nominate candidates to fill vacant judgeships. Those candidates must then be approved in the Senate through a series of hearings and votes. In recent years, Congress’ partisan nature has led to a longer approval process, and it has limited the filling of open judgeships. In response to Republicans’ blocking of President Obama’s nominees, former Senate Majority Leader Harry Reid changed Senate rules in 2013 to allow a simple majority to approve executive and judicial nominees. (This was known as the “nuclear option,” due to its effect on congressional partisan relations.) However, it did not change the 60-vote threshold for Supreme Court nominees. That 60-vote threshold was changed in 2017 by Republicans to end the Democratic filibuster against the nomination of Neil Gorsuch. Earlier this year, Senate Majority Leader Mitch McConnell led a change to reduce debate time on certain appointments from 30 hours to 2 hours. This does not apply to nominees for the Supreme Court or cabinet secretaries. All of these changes have made it easier for presidents to fill open judgeships.

How successful has President Trump been in his judicial appointments? Chart 1 shows the number of judges appointed by President Trump, President Obama, and President George W. Bush at the same point in their presidency. In total, President Trump has appointed more judges than President Obama but fewer judges than President Bush appointed. As of May 15, 2019, President Trump had appointed 2 Supreme Court, 40 court of appeals, and 60 district court judges. The president’s focus has been on the court of appeals, because these judges essentially act as final arbiters for the majority of cases.

Chart 1. President Trump had more judicial appointments than President Obama did (at this point in his presidency)Chart 1. President Trump had more judicial appointments than President Obama did (at this point in his presidency)Sources: Ballotpedia, Federal Judicial Center, Wells Fargo Investment Institute, June 6, 2019.

President Trump still has plenty of time to appoint more judges. The acceleration of the confirmation process could expedite these appointments. As there are a number of current openings and pending nominees, President Trump’s ability to influence federal courts is likely to significantly outlast his time in office.

The long-term impact of changing Senate rules could lead to faster appointments of judges. It also could result in fewer impediments to reshaping the judiciary in the future, should control of the presidency and the Senate shift to the Democrats. This also could lead to change in the legal interpretation of regulations and leave businesses and consumers with long-term uncertainty on how laws may be interpreted.

Visas and immigration

Legal immigration helps to supply many of the additional workers that businesses need. Major changes that could result from immigration reform could have a significant impact on the agriculture, leisure, and technology areas of the U.S. economy.

Key takeaways

  • Temporary workers fill many roles. From harvesting crops for Consumer Staples companies to research and development for Information Technology companies (via H-1B visas), foreign-born workers contribute to continued U.S. economic growth.
  • A decline in temporary agricultural workers could be negative for the Consumer Staples sector—as higher wages could be needed to attract workers (raising costs) or there may not be enough workers to harvest crops.
  • Immigration and foreign-worker visas can support U.S. economic growth, but social and political pressures often limit both.

Visas and immigration

Percent of H-1B visa applications for jobs requiring some high-level science, technology, engineering, and math (STEM) knowledge:90%; Percent of information technology employees in Silicon Valley that are foreign-born:71%

Immigration has been in the headlines recently. Yet visa programs for foreign workers are also making headlines. U.S. visas for foreign workers are organized into several programs—each seeking to serve a specific purpose. Those allowed entry to the U.S. may be temporary workers, permanent workers, students, or visitors. A key area of importance for the U.S. economy and markets is the need for temporary workers. Temporary workers fill specific needs, which may be seasonal or stemming from particular skills.

At this stage in the business cycle, one of company leaders’ biggest concerns is finding skilled employees. The April NFIB Small Business Optimism Index indicated that the inability to hire qualified workers was the biggest issue for small businesses.5 With the U.S. unemployment rate at a multi-decade low, there may not be enough U.S. workers to meet demand. Temporary workers are a valuable solution for filling this need. Whether it is highly skilled scientists, agricultural workers to harvest in-season crops, or seasonal workers to staff resorts, temporary workers assist in supporting economic activity. These workers also help to increase U.S. economic growth by acting as consumers.

Table 1. Main U.S. temporary worker programs and capsTable 1. Main U.S. temporary worker programs and capsSources: U.S. Citizenship and Immigration Services, Wells Fargo Investment Institute, June 17, 2019.

The U.S. government has many programs in place to enable employers to find additional workers from abroad. Table 1 lists the main programs for temporary workers from abroad. The H-1B program receives the most attention. Companies must handle the paperwork, pay a fee, and sponsor employees for the work visa. As such, large companies, especially in the Information Technology (IT) and Communication Services sectors, are the largest beneficiaries.

While foreign workers offer many benefits to businesses, some have concerns over their effects on U.S. workers. H-1B visa workers often fill needs in the science and technology industries. If they are truly filling additional demand, that is beneficial. Yet, if they are taking jobs from U.S. citizens, that has potential social implications. There also are concerns that H-1B visa employees are paid less than U.S. citizens. This may act to depress overall wages for the industries in which they work. In his 2016 testimony before Congress, Ron Hira of the Economic Policy Institute stated that the salaries for H-1B workers were 40-50% lower than those of comparable U.S. workers (in one specific instance).9

In May, President Trump presented a new immigration plan to Congress that contained significant changes to U.S. legal immigration programs. As these plans rarely become implemented “as is,” this plan is—at the least—a signal of where U.S. immigration policy might be headed. The plan is point-based, with preference given to higher-skilled workers over family-based migration. President Trump’s immigration plan is meant to be “numbers neutral” and increase immigration from higher-skilled workers (rather that lower-skilled workers). Although the administration’s immigration plan does not increase the annual H-1B cap above 65,000, the plan’s focus on higher-skilled workers should benefit H-1B visa holders. In our view, this proposal has little chance of becoming law under a Democratic-controlled House of Representatives. We expect immigration (and the related "work visa" caps) to be a significant issue in the 2020 elections.

Regulatory

U.S. regulators and Congress are showing increased interest in the largest U.S. internet technology firms. These firms have driven advancements and support U.S. industry dominance, yet concerns exist on whether they have become too large and powerful.

Key takeaways

  • Although "big tech" and social media companies are now facing the threat of material U.S. regulation, it is unlikely that Congress will adopt laws that hurt the business models of internet companies directly.
  • Stringent consumer privacy and data protection laws could disrupt advertising-based business models that generate much of social media and internet technology firms’ revenues.
  • We believe that Communication Services companies face more threat of regulation than IT and internet retail companies face. This is consistent with our unfavorable view of the Communication Services sector, relative to our favorable view of IT and Consumer Discretionary/internet retail companies.

Regulatory clouds move toward interactive media and “big tech”

Percent of American adults using social media:69%; Percent of Americans who own a smartphone:; 77%

After years of relatively little attention from government regulators at home, U.S. social media and technology companies are now sitting in the regulatory and antitrust spotlight. Early in June, the stocks of major digital platform companies tumbled on reports that the U.S. Department of Justice and Federal Trade Commission were carving up responsibility for U.S. investigations into four of the largest companies in this space. Concurrently, the House of Representatives’ Judiciary Committee launched its own antitrust investigation into these companies’ business practices and increased concentration within the technology industry.

“Big tech” regulation is a political issue that has gained rare bipartisan support in Congress. Both Democrats and Republicans have expressed their desire to change the landscape for the largest social and interactive media companies, albeit for different reasons. Until significant regulation is defined, antitrust regulation of these technology firms may make a convenient policy opportunity for some candidates to accumulate voter support ahead of the next presidential election. For example, Massachusetts Senator Elizabeth Warren has called for the largest digital platform companies to be broken up if she were elected.

U.S. social media and interactive technology firms have been preparing for a regulatory onslaught from close to home for some time. The largest technology firms have been flexing their muscles by spending record amounts on lobbying in recent years—as antitrust regulatory cases have been built in the European Union (EU) and a new wave of regulatory scrutiny now begins in Washington, D.C.

Annual lobbying by internet-focused companies in 2018:

We do not believe that regulatory changes are an imminent threat to the business models of these firms. First, regulation may develop slowly—as it could potentially take years to complete top-to-bottom investigations and to apply meaningful industry regulation. We foresee that any new rules likely will call for greater transparency and oversight of these firms, rather than mandating stringent regulation that would hurt companies’ advertising- and data-driven revenue models in the long term.

Another reason why extensive regulation and the breakup of firms may not be imminent is that today’s interactive technology firms do not fit the existing mold for U.S. antitrust cases. Today’s interactive technology and social media firms are constantly evolving by adding new platforms and revenue streams. Evolving businesses that are generating new markets and products make it difficult for regulators to implement traditional market share limits.

Splitting up the largest interactive technology companies may not address the root power, privacy, and influence issues within the sector that have drawn legislators’ criticism and ire. It is possible that regulators ultimately may endorse self-regulation that is overseen by a self-governing body. For now—despite the rhetoric—we believe that Congress is unlikely to pass new laws or allow legislation that damages the business models of these firms.

The companies that have come under regulatory scrutiny in Washington, D.C. are in several S&P 500 sectors—Communication Services, IT, Consumer Discretionary, and others.

The S&P 500 sector that we believe faces the most regulatory risk is Communication Services, and our outlook on this sector is unfavorable. This sector faces greater potential to be investigated by the Justice Department’s antitrust division than the traditional IT sector does.

Broadly speaking, we believe that it is less likely that the S&P 500 IT sector will see antitrust investigations. We are most favorable on the IT sector, due to our earnings growth, cash flow, and leverage expectations. The key risks for IT are more trade concerns than they are than regulatory ones.

1 Thomas J. Miles and Cass R. Sunstein, “Do Judges Make Regulatory Policy? An Empirical Investigation of Chevron”, The Law School of the University of Chicago, June, 2006.

2 Excludes temporary judgeships.

3 Ruiz, Neil, “Key facts about the U.S. H-1B visa program”, Pew Research Center, April 27, 2017.

4 Ethan Baron, “H-1B: Foreign citizens make up nearly three-quarters of Silicon Valley tech workforce, report says”, The Mercury News, January 17, 2018.

5 National Federation of Independent Business, May 14, 2019.

6 The H-1B visa is for an individual in an occupation that requires application of highly specialized knowledge and a bachelor’s degree or higher in the specialty area (or its equivalent).

7 The H-2A agricultural program enables agricultural employers that anticipate a U.S. worker shortage to bring nonimmigrant foreign workers to the U.S. to perform agricultural labor or services of a temporary or seasonal nature.

8 The H-2B visa permits U.S. employers to hire foreign workers to perform temporary nonagricultural services or labor on a one-time, seasonal, peak-load or intermittent basis.

9 Testimony before the U.S. Senate Subcommittee on Immigration and the National Interest of the Judiciary Committee by Ron Hira of the Economic Policy Institute, February 25, 2016.

10 Sallomi, Paul, “2019 Technology Industry Outlook”, Deloitte Center for Technology, Media, and Telecommunications, 2018.

11 Smith, Aaron, “Record shares of Americans now own smartphones, have home broadband”, Pew Research Center, January 12, 2017.

12 According to the Center for Responsive Politics, as of June 14, 2019.

Risk Considerations

Forecasts are based on certain assumptions and on views of market and economic conditions which are subject to change.

All investing involves risks including the possible loss of principal. Equity securities are subject to market risk which means their value may fluctuate in response to general economic and market conditions and the perception of individual issuers. Investments in equity securities are generally more volatile than other types of securities.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. Risks associated with the Consumer Discretionary sector include, among others, apparel price deflation due to low-cost entries, high inventory levels and pressure from e-commerce players; reduction in traditional advertising dollars, increasing household debt levels that could limit consumer appetite for discretionary purchases, declining consumer acceptance of new product introductions, and geopolitical uncertainty that could affect consumer sentiment. Consumer Staples industries can be significantly affected by competitive pricing particularly with respect to the growth of low-cost emerging market production, government regulation, the performance of the overall economy, interest rates, and consumer confidence. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks smaller, less-seasoned companies, tend to be more volatile than the overall market.

Investments in fixed-income securities are subject to interest rate, credit/default, liquidity, inflation and other risks. Bond prices fluctuate inversely to changes in interest rates. Therefore, a general rise in interest rates can result in the decline in the bond’s price. Credit risk is the risk that an issuer will default on payments of interest and principal. This risk is higher when investing in high yield bonds, also known as junk bonds, which have lower ratings and are subject to greater volatility. If sold prior to maturity, fixed income securities are subject to market risk. All fixed income investments may be worth less than their original cost upon redemption or maturity.

Definitions

An index is unmanaged and not available for direct investment.

NFIB Small Business Optimism Index is the small business optimism index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members. The index is a composite of ten seasonally adjusted components based on questions on the following: plans to increase employment, plans to make capital outlays, plans to increase inventories, expect economy to improve, expect real sales higher, current inventory, current job opening, expected credit conditions, now a good time to expand, and earnings trend.

S&P 500 Consumer Discretionary Index comprises those companies included in the S&P 500 that are classified as members of the GICS® consumer discretionary sector.

S&P 500 Discretionary Index comprises those companies included in the S&P 500 that are classified as members of the GICS Discretionary sector.

S&P 500 Information Technology Index comprises those companies included in the S&P 500 that are classified as members of the GICS® information technology sector.

Global Investment Strategy (GIS) is a division of Wells Fargo Investment Institute, Inc. (WFII). WFII is a registered investment adviser and wholly owned subsidiary of Wells Fargo Bank, N.A., a bank affiliate of Wells Fargo & Company.

The information in this report was prepared by Global Investment Strategy. Opinions represent GIS’ opinion as of the date of this report and are for general information purposes only and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally. GIS does not undertake to advise you of any change in its opinions or the information contained in this report. Wells Fargo & Company affiliates may issue reports or have opinions that are inconsistent with, and reach different conclusions from, this report.

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