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Written by: Lauren Goodwin and Robert Serenbetz | New York Life Investments
While market attention was focused on Robinhood and GameStop, the Biden Administration kicked off its first week in office with a long list of executive orders. Some observers were surprised at the more progressive aspects of Biden’s moves. They should not be; so far, everything that has happened was spelled out during the campaign.
Democrats’ win of both Senate seats in Georgia means that the party got its “clean sweep” after all, but this is far from the blue wave that many investors feared. With razor thin majorities in the House and Senate, Biden will not have full reign to pursue the more expansive aspects of his campaign. Big ideas will need to be watered down to make it through congress.
That said, we expect some major changes in the next four years, with implications for investors. In this piece, we consider seven key takeaways and opportunities.
1. More fiscal spending
We expect Democrats to move two tranches of spending this year – COVID relief and a “Build Back Better” infrastructure package (explored below). This is good news for investors in 2021. A quicker return to trend economic growth contributes to stronger earnings and, by extension, stronger results for risk assets. With interest rates due to stay low for the foreseeable future, debt incurred is not a concern.
Investors expecting improvements in economic growth consider cyclical asset classes – those asset classes that tend to benefit as the economy does – such as small caps (vs. large caps), value (vs. growth), international equity, dividend-focused equity, and bank loans.
2. Infrastructure
The second tranche of expected fiscal spending is likely to focus on infrastructure, including surface infrastructure, research and development in technology, broadband access, and alternative energy (explored in #4).
Investors can capture this theme via infrastructure-focused funds. Municipal bonds may also present an interesting opportunity, as much infrastructure spending plays out in this space. Given the substantial changes to state and local finances due to the COVID-19 crisis, active management will be critical in assessing risks and opportunities in municipal bonds.
3. Higher taxes
In order to use the reconciliation process, Democrats will need to finance some of their spending through tax increases. For the most part, these increases will be modest. We expect higher corporate taxes and taxes on highest earners, but to a lesser extent than concerned investors during election season. More progressive tax schemes, such as increasing social security taxes on highest earners, appear less likely.
That said, a growing desire to curb inequality means that capital gains taxes may be in play. This idea has gained more traction as dynamics in “meme stock” trading called attention to the tension between “haves and have nots” in the economy and markets.
It’s easy to see the motivation for using capital gains taxes to reduce inequality. Capital gains and dividend income alone make up 32% of the total income earned by those in the top 1% or earners, compared to 2% of the total income of the bottom 80%. [AMJ1] In addition, preferential tax rates for capital income relative to labor income, and the ability to defer gains, make capital gains a politically attractive and targeted way to address income inequality.
On the face of it, higher taxes present a risk for markets. Fears of preemptive selling and a desire to front-run tax changes will likely trigger market volatility as the likelihood of tax hikes increase. This could especially affect the stocks that have seen the sharpest capital gains in recent years, which means large-cap technology and communications stocks may be disproportionately affected.
However, there is some risk on the upside here given that these potential tax changes would likely be viewed as “light touch”. We don’t expect these tax increases to take effect until 2022, even if announced earlier.
Investors concerned about higher tax bills can consider three investment ideas:
- Tax-advantaged strategies, such as municipal bonds, may benefit as taxes rise.
- An expected tax hike could lead corporations to announce special dividends. Investors positioned to capture those gains would see an income increase.
- Skilled managers could assess which companies will be most impacted by changes in the tax code, and shift portfolio positioning.
4. A genuine focus on environmental protection and climate change
The Biden Administration is highly focused on climate change and environmental protection. Actions taken to date reflect this priority: naming climate change a threat to U.S. national security, mandating a move to electric vehicles for federal services like the postal service, reconsidering drilling on federal lands, and reinstating several environmental protections.
These regulatory changes and executive actions are a good first step, but will likely fall short of the significant action required to combat climate change – due to political and social hurdles. So, while we anticipate the trend towards sustainable investing to increase over time, investor fears of urgent and rapid decarbonization in the U.S. may be overdone.
Instead, the trend this year is likely to come in the financial community through the disclosure and analysis of climate related financial and sustainability disclosures with an ESG framework. The flow of assets will continue its steady and dominant movement to ESG—becoming mainstream within the decade.
Corporations that fail to transform their business models to focus on environmental impact, social good, and solid governance will lose ground to others that have the adaptive flexibility to thrive in a new world that values smart, clean, and healthy activities.
Investors that fail to transform their thinking around adopting an ESG framework may be exposed to unintended risks down the road via rising costs, regulatory change, and stranded assets. Investors must be forward thinking: what will be the cash flow from a company or asset in the next five to ten years?
While value sectors, including energy, are likely to receive a boost from improving economic growth, we expect alternative energy technology and services to benefit from Biden’s policy stance. Investments that implement ESG analysis, and thematic investments that consider climate change, biodiversity loss, clean green energy, efficient supply chains, inequality, and human health are also likely to experience structural tailwinds.
5. Healthcare
Democrats are likely to pass legislation that cuts drug prices significantly. We also expect to see higher subsidies for insurance under the Affordable Care Act, and expanding Medicaid. Any broader overhauls of the healthcare system, including creating a public option, have little chance of becoming law.
Drug price legislation is likely to be negative for the pharmaceutical sector. Other areas of healthcare are likely to experience positive benefits from expanding health insurance coverage.
6. Regulation
Biden’s cabinet picks point to stronger regulations in areas, such as environmental protection (already discussed), consumer protection, and data security. These changes are likely to be implemented through rules created or enforced by the agencies themselves, not by sweeping legislative changes. For investors, this means that a sector focus could be appropriate.
Increased scrutiny on the technology sector could reinforce a trend towards small caps, value, and international equity over the course of the year.
7. Immigration
While immigration does not prompt an immediate investment takeaway, a streamlined process for including well-educated foreign workers into the U.S. population could improve demographics and productivity, both important contributors to long-term economic growth and competitiveness.
[1] Congressional Budget Office (CBO), December 2020. https://www.cbo.gov/budget-options/56847
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