Although President Trump has vowed to contest the election result, it is widely acknowledged that Joe Biden has won both the electoral college and the popular vote by a comfortable margin and is due to take office on 20 January 2021. However, it is not yet clear to what extent he will be able to implement key portions of his programme, as he will need the support of the Senate for major decisions. The race here is still ongoing and currently the Democrats have 48 seats but need 50 to gain control. Two seats will be decided on the 5 January in a run-off election in Georgia and the Democrats need to win both seats to control the Senate. If they fail, passing key legislation, such as healthcare reform or tax increases, through the Senate will be much harder.
Below we consider what President Biden can do regardless of the outcome of the Senate race, how he might govern if the Democrats do win control of the Senate, and what his likely approach would be if the Senate remains in the hands of the Republican party.
Regardless of who controls the Senate, Biden can be influential on several domestic and international policies. Biden’s more traditional approach to internal and international politics will reduce uncertainty and promote a more positive environment for investing at home and abroad. This should benefit stocks in the US as well as around the world.
At home, Biden has made it a priority to work for all Americans and to help the middle class. Abroad, Biden will look to repair relationships with US allies and international organisations, including with NATO and the World Health Organisation, and it is expected that the United States will re-join the Paris Climate Agreement.
Biden is also looking to shape relationships with foreign governments in a more traditional fashion. He signalled that he would enter into another international deal with Iran. He would support the continuation of a tough policy towards Russia and possible sanctions. Biden will remain tough on China, but the narrative will shift from a trade war to a concerted effort to find a common ground for better trade practices.
Democrats winning a narrow majority in the Senate means that Biden will be able to implement a large part of his agenda. Investors would likely become enthusiastic about world trade as Biden starts a new relationship with China and other countries, altering the direction of the last four years. The implementation of tax increases and new regulations would have a noticeable but overall moderate impact on the US economy.
Biden plans to raise taxes to subsidise an industrial recovery while reducing the debt burden. His main proposal is to raise the corporate income tax rate from 21% to 28%, with a 15% minimum tax on large corporations. This does have a negative impact on the profitability of US companies overall, but this will be compensated to a large extent by stronger economic growth boosting corporate revenues and a tax credit programme designed to support medium and small sized companies.
Biden plans a new 10% ‘Made in America’ tax credit for companies that invest in the US, which aims to revitalise US manufacturing facilities and bring back jobs that were sent overseas. This will benefit smaller companies as well as specific companies that are onshoring a portion of their production currently located abroad.
We also believe that small cap and mid cap companies trade at an interesting discount versus large cap companies as the following chart illustrates:
Biden plans to renew efforts to control and reduce drug prices. Biden also intends to eliminate tax breaks for prescription drug advertisements and remove tax incentives for pharmaceutical companies to move production overseas. This may only be a mild headwind for the healthcare sector; we note that when the Affordable Care Act (ACA, also known as ‘Obamacare’) was implemented, many healthcare stocks ended up benefiting. While drug and treatment prices were lowered, new customers were created, thus increasing the overall spend on drugs and healthcare services. Hence, we believe that healthcare could thrive even if there is an initial shock.
Biden could reduce some of the technology sector’s tailwinds. President Trump’s trade-war rhetoric has muted investors’ appetite for sectors other than technology, and as a result the prices of this small group of stocks rose much further than the broader market since 2017. Biden could lift some of the tariffs by negotiating with China and this could reduce the relative appeal of the technology sector versus more cyclical sectors such as industrials. In addition, he has stressed that antitrust (competition) laws must be enforced, which could imply tighter regulation.
Biden could support increased regulation of the financial sector and this could have an impact on profitability. However, this could be countered by an economy that performs better and where long term yields rise somewhat, thus increasing the profitability of the sector. Biden’s plan for a green new deal means a renewed focus on tackling climate change. Biden has announced a $2 trillion subsidy plan to achieve 100% clean electricity by 2035, which suggests a strong outlook for renewable-energy companies. Meanwhile, traditional oil and gas producers would likely come under pressure.
If the Senate stays in Republican control, it will be harder for Biden to fully realise his agenda and a number of his proposed reforms will not be implemented. This is the best outcome for the stock market as international relations improve and Democratic policies that are perceived as a negative for business are reduced noticeably. In this scenario, investors become enthusiastic about world trade as Biden starts a new relationship with China and other countries, altering the direction of the last four years. The more radical changes that Biden wants to implement are not supported by Republicans, hence we expect that major changes on issues such as taxes and regulation are unlikely to pass through the Senate.
We expect that Biden’s plan to raise taxes is unlikely to gain traction. Tax increases for specific strategic sectors could still be agreed between Democrats and Republicans, but essentially the Republicans will ensure that tax rates remain low. Biden’s plan for drug price control could find some sympathy among Republicans but they will reject any other form of expansion of Obamacare. It would therefore be unlikely that Biden will make much headway in the space beyond the common ground that Republicans already agree upon.
The new president could find some support for additional regulation of the technology sector amongst Republicans. However, they will likely limit the effectiveness of these new regulations to preserve the integrity and profitability of these businesses, as they believe that deregulation is the path to a more vibrant economy.
Biden’s wish for regulation of the financial sector will likely face resistance as Republicans have a strong incentive to continue to deregulate the sector, believing that deregulation of financials will promote easier lending standards and stimulate the economy.
Biden’s plan for a green new deal will be met with strong opposition from the Republicans who take a different view on fossil fuels as they seek to support the production of oil within the United States and maintain energy independence. However, Republicans could support a transition towards greener energy if this does not directly threaten the domestic oil industry.
In our view, the most positive outcome for the equity markets would be a Biden presidency, but with the Republicans retaining control of the Senate. This would give investors the benefits of a less volatile and confrontational president, but with fewer regulatory or tax changes.
However, even if the Democrats take control of the Senate, we believe that the effect of Biden’s policies will only have a moderate negative impact on the economy. Overall, whether the Democrats or Republicans take the Senate, we think that a new business cycle is starting in the United States and that US equities have the potential to generate strong earnings growth on a three-year view.
Recently, we have increased our allocation to US equities through active managers that we believe can identify themes the market will reward. The portfolio has the necessary components – including a dedicated allocation to smaller companies – to perform well in most scenarios. However, we are ready to increase the allocation to any of our recommended active managers if we believe that a specific investment theme may outperform.
If you have any questions relating to this investment bulletin, please contact your usual Saunderson
If you would like further information about our services or would like to arrange a complimentary, obligation-free telephone conversation or meeting to discuss your requirements, please contact us.GET IN TOUCH