Using Sectors to Capture Opportunities from Performance Dispersion
Sector investing has historically been an effective way to express market views around US elections (see our recent article), taking advantage of sizeable return dispersion. Indeed, sector ETFs proved a popular tool during the last election cycle, and we expect high interest this time as well.
The following are the 5 sectors we believe could be most affected by the upcoming election and thus provide some of the greatest upside potential or downside risk. We conclude the article with an overview of policy considerations for sector performance and a summary of potential outcomes and their impact across the full range of sectors.
Health Care: Protected by the Pandemic
The scenarios for US Health Care are complicated but not as negative as the underweight postioning by institutional investors and current modest rating would suggest.
With a split Congress, Biden’s policies (not as aggressive as some in the Democrat camp) may not have a huge impact on the sector. In spite of the Affordable Care Act, 20% of the US population remains uninsured. Biden’s public option for insurance could allow Americans to buy health insurance (most likely through Medicare) from the government, but using the health care insurers. This could lead to a beneficial outcome for the sector. In the less likely scenario of a full Democratic sweep, the public option could be larger and there would be attempts at controlling drug pricing, which could unnerve the market.
By contrast, if Trump retains the presidency, he may seek further repeals against parts, or all, of the Affordable Care Act. Staying with the status quo may be seen as beneficial for the Health Care sector, with lower headline risk from drastic policy changes. However, the need for either man to manage the country through a pandemic, reliant on health care provision and supplies, with the full opening up of economic activity only possible with an effective vaccine, suggests that the sector may not be hit too heavily for some time.
Utilities: A Play on Green Policies
Biden has a significant green policy with a pledge to spend more than $2 trillion to achieve carbon neutrality within the US power sector by 2035. His “Build Back Better” plan will focus on investing in modern and sustainable infrastructure to encourage clean energy. Businesses focused on renewables may benefit, giving a big option to Utilities companies should they embrace cleaner electricity generation as their European peers have done.
The Utilities sector also stands to benefit from its low correlation and low beta to equity markets, along with its relatively low volatility characteristics, which could help in the event of a negative market reaction to a contested election result.
Energy: A Challenged Outlook with Downside Risks
The much-maligned Energy sector could see more pressure from fiscal policies under a Biden presidency. Biden’s revamped clean energy plan includes aggressive methane pollution limits for oil and gas operations and restriction of production on federal lands. A Democratic sweep of Congress and the presidency would increase support among lawmakers for additional carbon taxes.
This inhospitable outlook for Energy is reinforced by potential Vice President Kamala Harris’s background in environmental justice and could be given structure by re-signing to the Paris Agreement on Climate Change. This would come at a time when the low oil price offers no relief to P&L accounts or cashflow, putting further pressure on dividends and the once attractive yields of the sector.
By contrast, a Trump administration may struggle to further loosen environmental regulations beyond the actions of the past four years. At the same time, without control of the House of Representatives, state environmental restrictions may become tougher.
Financials: Rates Could Be More Important than Regulation
Banks were in the cross-fire in 2016 but then, early in the Trump presidency, they benefited significantly from deregulation and moves by the Federal Reserve. Expectations are muted this time, and it could be that any change in interest rates or the Treasury yield curve is much more important to profitability than legislative changes.
We expect that regulatory oversight would intensify under a Democratic administration, with a review of the reforms imposed by Trump and support for the consumer over corporations. Most far reaching would be a reimposition of the Glass-Steagall Act, although this would take time and require a sizeable Democrat majority in the House. Either way, a retention of the status quo would likely suit this sector better.
Consumer Discretionary: A Mixed Picture
The probable impact is mixed-difficult for Consumer Discretionary businesses. Any boost to the consumer balance sheet under Biden could drive consumer spending, thus helping retailers and restaurants. However, labour-dependent leisure and entertainment industries could be hit by an increase in minimum wages.
Amazon*, which dominates the sector weight and performance, could also be the subject of anti-trust legisation that targets monopolistic behaviour.
On the other side, if Trump were to cut personal tax rates, this could also spur consumer spending. Nevertheless, in all scenarios, we should remember the backdrop of higher unemployment that has arisen due to COVID-19.
Policy implications for sector performance
Relative sector performance around elections does not neatly fit cyclical/defensive or growth/value themes; other factors tend to provide the headwinds or tailwinds. Consider the experience during the immediate aftermath in 2016, when expectations of lighter regulation helped the performance of Financials and Energy. Winners were also found among sectors with high corporate tax rates given the anticipation of cuts.
Tax will feature again in 2020. As an important revenue raiser for Biden, he has proposed increasing the corporate tax rate from 21% back to 28%, whereas Trump hopes to lower taxes further. Higher taxes imposed by a Democratic House and Presidency could curtail earnings growth and reduce cash flow across the equity markets, albeit with a greater headwind depending on tax rates.
The location of a sector’s main customer bases will also be a factor, with international markets more sensitive to trade relations and/or moves in the dollar, as will employment bases, depending on any minimum wage plans. It is also worth thinking about beneficiaries of infrastructure spending and new green policies.
The table below summarises the impact for each sector in four potential election scenarios, ascribing a net positive, negative, mixed case (with issues pulling in both directions), or limited impact. In the case of a disputed election, equity markets would undoubtedly weaken. Ahead of such a scenario, investors could position defensively in low volatility sectors like Utilities and deploy caution on sectors more reliant on consumer or business sentiment.
Potential Election Outcomes and Their Impact Across Sectors