- The proposed hike in the corporate tax rate potentially affects almost all businesses except utilities, which usually can pass the cost on to consumers, and REITs, which don’t pay taxes.
- A big infrastructure bill, a multibillion-dollar commitment to boost research and development (R&D) spending, and the ability to source more highly skilled workers from abroad could take the sting out of higher tax rates for some sectors.
- Very low interest rates, tighter regulation, and higher tax rates are likely to challenge much of the Financials sector, including banks.
With U.S. elections rapidly approaching, all plausible presidential/congressional configurations remain on the table. Among these, the biggest potential for government policy changes comes from the scenario in which Joe Biden captures the White House and the Democratic Party wins control of both chambers of Congress. This article, the third in our “U.S. elections & market matters” series, outlines what RBC Capital Markets’ analysts have determined these policy shifts might mean for each of the 11 U.S. market sectors as well as for the major industry subsectors within each.
The Biden/Democratic platform proposes to unwind about half the Trump corporate tax cuts, increase taxes on high-income earners and investors, and expand health care coverage while lowering costs. It prioritizes addressing climate change, reducing the use of fossil fuels, and increasing development of renewable energy. The platform also calls for a revamp and modernization of the nation’s infrastructure, a more active regulatory approach, and an expansion of immigration. Were Democrats to gain full control of Congress, we would expect few barriers to implementing these policies.
Survey says: Winners and losers
To assess the impact of the Biden platform on various sectors, Lori Calvasina, head of U.S. Equity Strategy for RBC Capital Markets, LLC, surveyed RBC Capital Markets’ U.S. equity research industry analysts, asking them to evaluate the outlook for the subsectors under their coverage. She tallied the results in her comprehensive report Eye on the Election published in July.
Outlook by sector
Bearish outlook for sectors representing close to 60 percent of the S&P 500
|S&P 500 sector (weighting)||Overall sector outlook||Number of subsectors whose outlook is:|
|Very bullish||Bullish||Neutral||Bearish||Very bearish|
|Communication Svcs. (11%)||Neutral||3|
|Consumer Staples (7%)||Neutral||1|
|Health Care (15%)||Mixed||3||1||3|
|Technology (27%)||Slightly bearish||2||2|
|Consumer Discretionary (11%)||Bearish||5|
Source - RBC Capital Markets, RBC Wealth Management; S&P 500 weightings as of 6/30/20
What are the key drivers?
The factor most often cited in Calvasina’s survey as a negative for sector outlooks is higher corporate taxes. This isn’t surprising. According to our national research correspondent and RBC Capital Markets, if half of the Trump corporate tax cuts were reversed and the top individual rate raised—as Biden has promised to do—S&P 500 profits could be 5.5 percent to 9.0 percent lower than they otherwise would be during the first year of implementation. Calvasina suggests the effect could be somewhat greater due to secondary impacts. For example, demand for some products could fall as companies hike their prices in an attempt to pass on some of this additional burden to customers.
Another corporate concern is the prospect for stricter regulation. “Too much regulation” has been a longstanding beef that has shown up perennially in surveys of small and medium-sized businesses. The concerns center mostly on the perceived high costs of compliance rather than on the goal of the regulation in question. Large businesses too—notably banking, pharmaceuticals, energy, and now large tech—are all wary of new constraints on business.
There are also positive drivers in the Democratic platform, which has committed to additional investment in scientific research and development (R&D), as well as higher, targeted immigration. The latter could result in higher demand for some products and services as well as improve the supply of highly skilled workers—the lack of which is often cited by several industries as a major growth limitation.
Under a blue wave scenario an infrastructure bill would almost certainly be introduced and have a strong likelihood of being passed. The platform, among other things, proposes improvements to roads, bridges, ports, airports, and high-speed rail, as well as the extension of high-speed internet to underserved rural areas.
We have a winner
Utilities: Bullish (subsectors – one very bullish; one bullish; one bearish)
The utilities companies that are stable dividend payers should continue to stand out as bond alternatives in an environment where the Fed is committed to an extended period of ultralow interest rates. RBC Capital Markets’ analysts see very bullish prospects in particular for the alternative energy companies as they should benefit from significant government support under a blue wave scenario.
The outlook would also be bullish for electric and water utilities due to the Democratic platform’s focus on infrastructure investment. As well, utility regulators typically permit any higher corporate taxes to be passed on to consumers. The outlook is more cautious for independent power producers as they are most exposed to fossil fuel generation. Any mandated accelerated retirement of coal-fired plants would fall more heavily on this group.
Net neutral (three sectors)
Real estate investment trusts (REITs): Neutral (subsectors – two neutral)
Biden’s policies would not alter the business model or environment for REITs in a meaningful way, as they are not taxpayers.
Communication Services: Neutral (subsectors – three neutral)
The potential negative impact of some policies could be offset by the positive impact of others. For instance, the sector would have to grapple with higher taxes, a more restrictive view on future mergers and acquisitions, and an anti-stock buyback stance. On the other hand, it would benefit from proposed higher government investments in R&D, support for new technologies including 5G, policies supportive of greater access to broadband for underserved regions, and a more expansive immigration policy.
Consumer Staples: Neutral (subsector – one neutral)
Worker-friendly policies like support for a higher minimum wage; tighter rules on what can be designated “Made in America”; child care initiatives; student debt relief; tuition assistance; teacher pay; and a renter’s tax credit could boost wages and household spending on consumer staples goods, partially offsetting the impact of higher corporate taxes.
Mixed outlook (two sectors)
A Biden presidency and Democratic-controlled Congress would be “mixed” (i.e., equal number of subsectors with bearish and bullish outlooks) for Health Care and Materials.
Health Care: Mixed (subsectors – three bullish; one neutral; three bearish)
The sector encompasses seven subsectors; a Democratic sweep would be bullish for three, neutral for one, and bearish for three. Higher corporate taxes are the principal headwind facing the sector.
The three subsectors with a bullish outlook (equipment & services; service providers; services & distribution) would all benefit from an expansion of health insurance coverage (i.e., the Affordable Care Act), which would reduce uninsured volumes for providers. The three subsectors with a bearish outlook (biotech; large pharma; specialty pharma) would all suffer from drug pricing reform. The outlook for the managed care subsector is neutral as the policies put forward by Biden would not have an obvious negative effect.
Materials: Mixed (subsectors – two bullish; one neutral; two bearish)
While higher corporate taxes would be an added burden across all subsectors here, the Democratic plan to spend $640 billion over 10 years to build affordable housing would benefit forest products. Infrastructure investment would be supportive of them, as well as the coatings group. Tax increases would fall hardest on domestic producers while trade frictions cloud the outlook for both exporters and importers within the sector.
Finally, the outlook is slightly bearish for one sector (Technology), and bearish for the remaining four (Energy, Consumer Discretionary, Industrials, and Financials). Digging deeper into each sector reveals disparities at the subsector level.
Technology: Slightly bearish (subsectors – two neutral; two bearish)
Higher corporate taxes are the principal headwind facing this sector. A related issue would be reduced offshoring, which would simultaneously raise operating costs and expose a greater proportion of profits to higher domestic taxes. More intrusive regulation is very much a headline topic, although the momentum behind this seems to be bipartisan. However, regulation is likely to be targeted and not affect the majority of the sector’s constituents.
Positives include: a more relaxed immigration stance for higher-skilled IT workers; the proposed $300 billion investment on R&D; and the anticipated push for accelerated 5G development.
A Biden/Democratic Congress would have a neutral impact for payments, processors & IT services, and software. At the same time, this outcome would be bearish for enterprise/IT hardware, and semiconductors and semi-capital equipment.
Energy: Bearish (subsectors – one neutral; three bearish; one very bearish)
The Democratic proposal to achieve a 100 percent clean energy economy and net-zero emissions no later than 2050 means almost all subsectors within the energy complex would face the prospect of a challenging operating environment, according to RBC Capital Markets’ analysts. Moreover, higher corporate taxes, greater federal royaties, and lower tax credits would substantially add to the burden already confronting the sector. Oil services companies are the exception, with a neutral outlook, as they have an opportunity to pivot toward providing services for carbon capture, offshore wind installations, and new energy technologies.
Integated oil and gas companies could potentially transform themselves by becoming major owners and developers of renewable energy. But the headwinds facing their fossil fuel operations would likely dominate the group’s earnings outlook for some time. Midstream pipelines/processors as well as non-integrated refiners are looking at many years of stagnant/declining end markets.
The outlook for exploration and production companies would be very bearish as the proposed goal for net-zero emissions by 2050 could accelerate demand destruction for oil and gas, while the prospect of higher royalties and reduced tax credits would be painful.
Consumer Discretionary: Bearish (subsectors – five bearish)
Higher corporate taxes and rising wages are the biggest negative factors for the sector, especially for those companies and subsectors with largely domestically driven operations like homebuilders. While the clean energy push is an opportunity for some automakers, it’s a costly conversion exercise for most. Retailers without a viable online presence will continue to be marginalized by those who do while also contending with higher wages. RBC Capital Markets’ analysts view the prospects for all subsectors in the Consumer Discretionary space as bearish under a Democratic sweep.
Industrials: Bearish (subsectors – six bearish)
Higher taxes, rising wages, as well as the higher costs and disruption caused by onshoring would be headwinds for a swath of subsectors including rails, waste, machinery/capital goods, and multi-industry & electrical equipment. Aerospace and defense will also have to contend with tighter government budgets. Onshoring may offer some positive offsets, such as lower transportation costs, for certain companies, but the overall balance of the proposed new policies of the Democratic platform is likely to be negative.
Financials: Bearish (subsectors – one neutral; four bearish; one very bearish)
The Financials sector has the most broadly bearish outlook. It has only one subsector with a neutral outlook, four considered bearish, and one—national and money center banks—seen as very bearish.
The outlook for property & casualty (P&C) insurance is neutral as most companies in the group are state-regulated, so a Biden presidency would have little impact. In contrast, national and money center banks would struggle not only with higher taxes but also with the re-regulation of certain industries, such as oil, which would lead to fewer loan opportunities. Life insurers, regional banks, asset managers, and specialty/consumer finance companies have a bearish outlook as higher taxes and the prospect for tighter regulation would likely weigh on earnings.
Much can change between now and Election Day. Undoubtedly, a great deal of ink will be spilled about where things may be headed, both in terms of the eventual election outcomes and what that all may mean for the U.S. and global economies as well as financial markets.
We would offer three considerations to keep in mind moving forward:
- History strongly suggests that while political change can have an effect on the economy in the long run, over a span of a year or two it’s the business cycle and the credit cycle that have the most influence on the direction of the economy.
- Of the three plausible outcomes—Trump/divided Congress; Biden/divided Congress; Biden/Democratic Congress—it is the last, in our opinion, that would likely see the biggest policy shift away from the status quo.
- The economy and markets have shown they can adapt to new policy directions. By drilling down deeper into the levels of sectors, industry groups, and individual companies, we can see what may emerge as the winners and losers.