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Policy, Politics & Portfolios

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

 

The Biden administration targets anti-competition

The White House has pledged to take a tougher approach to anticompetitive practices. Earlier this month, President Joe Biden signed an executive order directing regulators to review rule-making processes across sectors.

Key takeaways

  • The White House has pledged a tougher approach to regulating anticompetitive practices.
  • Earlier this month, President Joe Biden signed an executive order directing regulators to review rule-making processes across sectors.
  • We believe headline risk could pose short-lived headwinds for the Communications Services and Information Technology sectors (we are favorable and neutral, respectively) with little effect on valuations.

A tougher stance

The White House has pledged to take a tougher approach to regulating anticompetitive practices. The dominance of Big Tech (major U.S. technology companies) also has lawmakers and regulators calling for more oversight. As Big Tech expands its influence, public concern over the concentration of power held by a handful of internet and social media firms is growing. As illustrated in the chart below, industry concentration across many sectors has increased since the 1990s, driven largely by mergers and acquisitions.

Chart 1. Industry concentration has increasedThe chart shows the top four firms in the software, pharmaceutical, and media and entertainment industries as a percent of total revenues of the S&P 500 Index. Based on this measure, these industries are more concentrated today compared to 1995.Sources: Wells Fargo Investment Institute and Bloomberg, July 12, 2021.

The Biden administration aims to broaden its regulatory approach to corporate concentration by going beyond typical antitrust enforcement of blocking mergers and developing new rules that promote competition across the U.S. economy.

What are antitrust laws?

U.S. antitrust law was fashioned by three pieces of legislation: the Sherman Anti-Trust Act (1890), the Federal Trade Commission Act, and the Clayton Anti-Trust Act.; The Executive Order calls on the Department of Health and Human Services to tackle drug pricing and encourages the Federal Maritime Commission to address allegations of consolidation and aggressive pricing; 57% of Americans think the government should increase regulation of technology firms, up from 48% in August 2019. Source: Gallup, February 18, 2021.

Antitrust laws are intended to help protect consumers from predatory corporate activity and promote fair competition in the open market. The intention of these laws and associated regulations is to help curb a range of business practices, including price fixing and monopolies. Without regulatory oversight, lawmakers' concern is that consumers would likely pay higher prices and have access to fewer choices of products and services.

Antitrust laws are comprised of three pieces of legislation enacted by Congress (see Sidebar 1). U.S. antitrust regulations are enforced by two federal agencies: the Federal Trade Commission (FTC) and the Department of Justice (DOJ). Yet, there are limits and potential delays to antitrust policy under current laws. At times, U.S. courts have struggled to interpret vague language and make rulings.

Biden acts

Earlier this month, President Biden signed an executive order (EO) initiating a broad-based approach to spur competition across sectors including Information Technology, Health Care, and agriculture. The EO includes 72 actions and recommendations across 12 federal agencies (see Sidebar 2).1 President Barack Obama issued a similar EO late in his second term, but few agencies responded to it. Recently appointed FTC Chair Lina Kahn appears poised to broaden oversight and enforcement of anti-competition laws. Yet, there are questions about the president’s authority over the FTC and the agency’s reach; certain measures will likely be blocked by courts.

In Congress, regulating Big Tech has garnered bipartisan support, but for different reasons. Democrats are focused on alleged anticompetitive practices while Republicans are concerned about the limitations on commentary and content on social media websites. Last September, Congress held hearings to investigate these allegations. In June, the House Judiciary Committee approved five of six proposed bills, mainly aimed at Big Tech platforms favoring proprietary products and services. Yet, even with bipartisan support, we believe the odds of passing meaningful antitrust legislation in the near term are slim as proposals for physical infrastructure and social spending take precedence. That said, we expect antitrust legislation to remain a priority for lawmakers ahead of midterms.

Investment implications

With the signing of the EO, we believe changes in regulatory oversight are likely. Successful antitrust litigation from lawmakers is a growing possibility, yet likely slow in coming. The DOJ suit filed last year is still scheduled for September 2023, demonstrating the snail-like pace of litigating antitrust cases.

We currently have a neutral tactical position on the Information Technology sector. This outlook aligns with our view that the path of regulation is unclear and will likely be delayed by court challenges. This trajectory may not affect the earnings of large firms with component businesses that could be flexible enough to maintain earnings growth as individual or spun-off companies. Thus, the cross-currents of regulation add uncertainty that balances against our view that the sector’s earnings will grow over the next 6 to 18 months.

 

Recharging transatlantic ties at the G-7 meeting

The G-72 meeting showed some renewed international interest in U.S. leadership. We believe U.S. initiatives on trade issues were well-received. Separately, the U.S. remains a leading destination for global direct investment.3 These positives for the U.S. reinforce the favorable equity market momentum we expect from the U.S. relative to the European and Japanese markets.

Key takeaways

  • The G-7 made significant progress on U.S.-European trade issues, although more details remain to be agreed on regarding global taxation and China’s economic and political challenges.
  • Notwithstanding the unsettled details, U.S. leadership among advanced democracies, its leading-edge economic growth, and its number-one ranking as a foreign investment destination all support our view that U.S. equities will continue to outperform markets abroad.

Weighing the new roadmap for investors

The Federal Reserve’s response to stubbornly low inflation has resulted in persistently negative real, or inflation-adjusted, interest rates in the past decade.; Inflation may not return soon to the sub-2% pace of the past decade, encouraging the Federal Reserve to shift away from aggressive monetary stimulus.

A glass half full or half empty?

The G-7 meeting in June was an important first step toward reestablishing a united front among advanced democracies. Common challenges and a new U.S. president both set a constructive tone at this G-7 meeting. The meeting confirmed the Biden administration’s desire to restore traditional multilateral ties with U.S. allies. For example, the president agreed to allow European countries to tax profits large U.S. multinationals earn on sales within their countries. Another sign of cooperation is that the U.S. and its European partners reduced tensions on the commercial aircraft subsidy dispute and developed a common response to Russian challenges. The G-7 also pledged to develop an infrastructure aid program called Build Back Better for the world to counter China’s Belt and Road Initiative.4

Even with this progress, some distance remains among the G-7 partners on other issues, including those where there is general agreement on ultimate goals. Climate was one such example, where the group failed to announce a specific end date for the use of coal. The final communique also called on China to honor human rights, particularly in the western province of Xinjiang, and to respect its agreement with the U.K. on Hong Kong. However, a lack of specific consequences for Beijing pointed up the differing attitudes toward China — the U.S. sees China as a rising competitive challenge to the G-7, while Europe has a softer view of China as more of a competitor and an important market for European exports.

On the issue of a global minimum corporate tax, the hurdles to passage are high. Individual countries would have to approve additional taxes, a task that varies in difficulty across countries. In the U.S., for example, the measure represents a tax treaty, which would require approval by a two-thirds majority in Congress. In our view, that is a hurdle too high for the U.S. Congress until at least a new session in Congress begins in 2023, and likely longer.

On balance, for investors, we see the U.S.-European trade concessions as a significant and positive bird in hand — that is, a concrete action that demonstrates U.S. leadership. By contrast, we believe the issues of China's competitive challenge and the global minimum tax seem more like birds in the bush, likely requiring much more negotiation among the G-7.

The U.S. remains among our favored top investment destinations

Perhaps equally important, U.S. economic leadership remains strong and seems set to continue. A review of foreign direct investment (FDI) flows over the past five years offers an added dimension of U.S. leadership and strengthens our conviction that the U.S. market continues to be more attractive than those abroad.

According to the United Nations Conference on Trade and Development (UNCTAD), global foreign direct investment during the 2020 pandemic year dropped by 35% to slightly below one trillion dollars. Much of the decline occurred in developed economies. Pre-pandemic, the U.S. was already a significant investment destination for FDI in the developed world. Given the size and strength of the U.S. economy, pandemic fears have strengthened the U.S. role as a perceived “safe haven” during times of uncertainty. By year-end 2020, the U.S. captured 50% of all developed-country FDI inflows, compared to an average of 34% in the five years leading up to the pandemic. This is consistent with a longer-term historical trend. Based on our analysis using UNCTAD historical data, the U.S. captured on average 35% of developed countries’ inflows from 1988–1999. The sharp rise in 2020 resembles the 1980s, when the U.S. was an even more dominating destination for investment flows at an average of 49% from 1981–1988.5

Chart 2. FDI inflows, U.S. versus other G-7 countries (as a % of developed countries’ total inflows)The chart compares the U.S. and G-7 countries, excluding U.S. investment flows as a percent of total developed world investment flows. The solid bar shows that the U.S. is a significant investment destination, taking over on average 34% of developed world investment flows from 2015 to 2019. In 2020, the U.S. proportion increased to 50%. The dashed bar shows that the other G-7 countries combined have seen growing shares during the past five years preceding the pandemic. In 2020, these countries captured 34% of investment inflows into the developed countries.Sources: World Investment Report 2021 UNCTAD and Wells Fargo Investment Institute. Data as of 2020.

The growth in FDI shows confidence in the U.S. policies resolving economic challenges posed by the pandemic. As global economies recover, UNCTAD forecasts that FDI will increase by 15%–20% in 2022, recovering to pre-pandemic levels.6 We expect the historical dominance of the U.S. in capturing developed countries’ investment inflows to continue at a pace following the trajectory shown by the past five years’ average. With a net-positive tone at the G-7 meeting, we also expect to see a boost to U.S. leadership in trade and, potentially, diplomatic questions. These expectations reinforce our preference for U.S. equities over Developed Market ex-U.S. Equities.

 

Security spotlight

Cybersecurity has been a key talking point for the Biden administration following several high-profile cases. In this article, we discuss some questions investors may have on the economic impacts.

Key takeaways

  • The prevalence of cyberattacks targeting the private sector has risen drastically since 2019. Some attacks have state sponsors while others are purely private groups.
  • Cyberattacks carry the potential for significant economic harm and, as such, both the private and public sectors are likely to work to lessen the risk.
  • We believe that the primary benefits from tackling cybersecurity will be felt across the economy through added stability and public trust.

A ransomware Q&A

Roughly $350 million was paid in ransom as a result of cyberattacks in 2020, an increase of over 300% year-over-year.  Source: Nathaniel Lee, “As the US faces a flurry of ransomware attacks, experts warn the peak is still likely to come,” CNBC, June 10, 2021.; Following the Colonial Pipeline shutdown, national average gasoline prices rose to the highest levels since 2014, with some consumers seeing a $0.11 per gallon rise in a single day.  Source: Joan Greve and Victoria Bekiempis, “Colonial Pipeline reaching full capacity after cyberattack, Biden says,” The Guardian, May 13, 2021.

Ransomware attacks, whereby an outside party may gain access to a company’s or government’s computer systems and hold them hostage, have become a concern following a series of attacks in 2020 and 2021. The Biden administration has taken steps to address this, but some investors may wonder about the potential economic impacts.

What risks might cybersecurity pose for the economy?

The costs of cyberattacks go beyond the simple dollar values of ransoms. Companies may see significant delays, even after the ransom payment. In the case of the Colonial pipeline, operations took 10 days to return to normal levels, even with the relatively quick decision to pay the ransom.7 In the case of infrastructure or software where a variety of businesses depend on a single service for normal operations, even a short delay may have ripple effects across their businesses.

The shape of current policies

In 2013, the Department of Defense (DoD) implemented a rule imposing requirements on government contractors, including compliance with certain information technology (IT) standards and mandating the report of cybersecurity incidents to the DoD. In 2013, President Barack Obama also directed the National Institute of Standards and Technology (NIST) to develop a cybersecurity framework for critical infrastructure and to work with industry leaders to implement this.8

However, these requirements only applied to businesses contracting with the government. As a result, businesses in the software supply chain that were not government contractors were not held to such strict standards, even though their software may have been widely used. Any potential security flaws in that software would therefore pose a threat to the end users.

President Joe Biden’s recent executive order (EO) seeks to address some of these shortfalls. IT providers are now required to disclose breaches which may potentially impact government networks. Additionally, the EO creates security standards for software development and intends to make the results of these standards available to consumers. Increasing the security of the IT supply chain may be a necessary step to soften further cyberattacks as many end users may be unaware of security flaws in software.

What could this mean for the private sector?

While the majority of the recent action surrounding cybersecurity has been targeted at businesses dealing directly with the government, we believe that the response will benefit both the public and private sectors. While the recent EO has imposed legal cybersecurity requirements primarily on businesses involved in the government IT supply chain, we believe it is likely that these standards will carry over to consumers as well. The public and private sectors typically use similar software, so we believe that there will be only small cost increases to developers as a result. We believe these small cost increases are likely to be passed along to consumers and are unlikely to impact developer profit margins. Additionally, Biden’s aim to have the results of these software standards made available to consumers may incentivize private businesses to focus on security in the IT supply chain.

We believe that this potential for added focus on IT and cybersecurity will continue to increase the importance of the Information Technology sector in the economy, and we favor a long-term allocation to this sector.

1 Evercore ISI, July 9, 2021.

2 Group of Seven, an intergovernmental organization composed of France, Germany, Italy, Japan, the United States, the United Kingdom, and Canada.

3 “World Investment Report 2021,” United Nations Conference on Trade and Development, June 21, 2021.

4 Carbis Bay G7 Summit Communique, The White House, June 13, 2021.

5 Edward Graham and Paul Krugman, “The surge in foreign direct investment in the 1980s,” January 1993.

6 “World Investment Report 2021,” United Nations Conference on Trade and Development.

7 “The Partnership between NIST and the Private Sector: Improving Cybersecurity,” testimony provided by NIST to U.S. Senate Committee on Commerce, Science, and Transportation, July 25, 2013.

8 “Fact sheet: president signs EO charting new course to improve nation’s cybersecurity and protect federal government networks,” The White House, May 12, 2021.

Risk considerations

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

Different investments offer different levels of potential return and market risk. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. These risks are heightened in emerging markets. 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. This can result in greater price volatility.

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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