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Parts of the market have already priced in future gains from the new US president’s policies
Thursday 21 Jan 2021 Author: Yoosof Farah

Joe Biden is now officially president of the United States, something which is likely to have implications for your portfolio.

His policy plans, ranging from infrastructure and renewable energy to technology and healthcare, will have direct impact on indices like the S&P 500 and FTSE 100, as well as a lot of the big companies held in a wide range of high-profile funds.

INFRASTRUCTURE STOCKS

One of Biden’s most talked-about policies has been his ‘Build Back Better’ plan, with a pledge to spend $2 trillion within the next four years on upgrading America’s ageing infrastructure.

The most talked about part of that plan involves making big investments in clean energy, and we’ll discuss Biden’s green energy plans in more detail later in the article, asking whether all the gains have already been made in clean energy stocks or if there’s still further upside to come.

But he has also committed to revamping the country’s traditional infrastructure like roads, rail and bridges, as well as build over 1.5 million new affordable, sustainable homes and retrofit another 4 million to make them more energy efficient.

It’s likely these plans would increase demand for the services of equipment rental firm Ashtead (AHT), as well as building materials supplier CRH (CRH) and plumbing and heating product provider Ferguson (FERG), all of whom have a big presence in the US.

WHAT ABOUT HEALTHCARE?

Biden is also planning major changes in healthcare policy, including bringing back the Affordable Care Act, also known as Obamacare, which mandates that all Americans need to have some form of health insurance or risk paying a penalty.

He also hopes to lower drug prices, introducing a bill that would penalise pharmaceutical companies for any price hikes that are higher than inflation, requiring them to pay rebates to the Medicare programme.

$1.9 TRILLION STIMULUS PLAN

The first item for Biden’s in-tray is getting his proposed $1.9 trillion stimulus plan through Congress, which comes as US jobless claims have repeatedly come in worse than expected in recent months.

The number of Americans actively collecting state jobless benefits came in at 5.3 million on 2 January, significantly below the 10.6 million at the height of the pandemic but still well above pre-pandemic levels of 1.7 million.

‘Employment is a crucial indicator of the economy and it has not been giving many positive signals for a while now,’ says Neil Birrell, chief investment officer at Premier Miton Investors. ‘This is a step backwards. Even if there are anomalies in the data it looks like the virus is increasing in its impact.’

Biden’s proposed support package, called the ‘American Rescue Plan’, involves direct payments of $1,400 to eligible Americans, raising jobless benefits from $300 to $400 a week, as well as $400 billion to boost vaccination and testing, and $150 billion for state and local government.

Having risen in anticipation of Biden’s plan, markets fell after the news was announced with concerns about the cost of the package.

The yield on 10-year US government bonds, known as Treasuries, was pushed to its highest since March on expectations the government will need to borrow more to fund the spending. Yields move higher as bond prices fall.

Analysts fear this could lead to higher interest rates or tax hikes, which could negatively impact equity valuations. Rising yields threaten to weigh on companies with longer-duration cash flows such as tech and growth shares.

Simple ways to invest in the US stock market

For those who want to play the US market under the new Biden era, there are two simple options to consider.

An ETF following the S&P 500, like iShares Core S&P 500 (CSP1), could be a good choice for someone looking for long-term growth from the US stock market. We currently prefer the S&P 500 index to the tech-heavy Nasdaq index given the possible headwinds the tech sector faces if Biden gets at least some of his plans through Congress. However, it must be noted that the S&P 500 does include some tech stocks.

The alternative is to buy an ETF following the Russell 2000 index such as L&G Russell 2000 (RTWP), which contains more domestically focused companies that are more likely to benefit from an economic bounceback and recovery in value stocks.

It’s worth pointing out you’d be buying into the Russell 2000 after it has already rallied strongly in anticipation of big stimulus plans. The S&P 500 on the other hand fell after the president-elect’s $1.9 trillion support package proposal (14 Jan) – the market’s way of saying which index is likely to benefit the most, at least in the short term.

THE BIG TAX ISSUE

Beyond Covid, Biden’s main economic policies are to raise the minimum wage and invest large amounts into green energy, moves which were designed to go down well with the two main types of traditional Democrat voters – young people and blue-collar workers.

Biden also plans to raise corporate tax from 21% to 28% and will look at ways to control ‘Big Tech’ and what a Democrat subcommittee in the House of Representatives called ‘systematic and continuing abuses’ of their monopoly power. There is a separate section in this article on this topic.

Analysts at RBC forecast before the election that Biden’s tax plans could bring down the S&P 500’s earnings per share (EPS) by around 9%, while analysts at Jefferies estimate that for some companies, every 1% rise in corporate tax could impact EPS by 1.5%.

BIDEN STILL FACES CHALLENGES

Steve Wreford, a global thematic equity portfolio manager at Lazard, warns Biden doesn’t have ‘carte blanche to do whatever he wants’, pointing out the Democrats may have a clean sweep but it is not a blue wave where they have a massive majority. ‘There are some quite conservative figures in the Democrat side of the Senate who will prevent some very dramatic things from happening,’ he says.

It’s a fair point. After all, Biden only won 51% of the popular vote, and control of the House of Representatives narrowed considerably following the election, with the Democrats’ majority going from 35 seats to 10. Their 222 seats in the House is only four above the 218 needed for a majority.

In addition, Democratic control of the Senate is as thin as possible and technically the seat count is 50-50, meaning they only have control via vice president Kamala Harris’ tie-breaking vote.

The outlook for healthcare stocks

When it comes to healthcare, Trevor Polischuk, manager of the Worldwide Healthcare Trust (WWH), believes passing any controversial legislation will be very difficult for the Democrats because their majority control is so narrow.

‘We have identified an important number of moderate Democratic Senators and Representatives who would not support any harmful healthcare bills and would “walk across the aisle” and vote with Republicans,’ he says.

Many investors will be cautious towards large cap pharma and large cap biotech stocks due to increased uncertainties under Biden, such as caps on drug pricing.

However, his policies could generate a better backdrop for tools and diagnostics firms, hospitals and managed care companies. And there should be a favourable environment for small and mid-cap biotech stocks where innovation and not product pricing is the key driver of valuation.

WHAT DOES THE NARROW MARGIN MEAN FOR TAXES?

Asset manager BlackRock believes a Democratic majority could well pave the way for major green investment but sees greater fiscal spending to be largely funded through more government borrowing rather than higher taxes, given the Democrats’ slim majority in both chambers of Congress.

‘The policy revolution has brought on greater tolerance for higher debt globally, yet just how long such attitudes could last is key,’ says BlackRock. ‘Modest increases in corporate taxes may be possible, but large-scale changes including raising taxes on high-income earners, appear unlikely, in our view.’

IMPACT ON COMMODITIES

Biden’s win and the Democrats’ Congress majority could also have implications in the world of commodities, with copper highlighted as a beneficiary due to a weakening US dollar.

Many see the dollar potentially weakening further under a Biden administration, given that compared to Trump, Biden would likely reduce uncertainty in international trade policy, reducing the need for the dollar as a safe-haven asset.

And Liberum analyst Ben Davis points out that where the dollar weakens, copper – a global economic bellwether – tends to strengthen, and notes that copper prices have been ‘heavily supported’ in the last three quarters by the weak dollar.

He says: ‘With support from the Fed ongoing and a major stimulus programme to come, we expect the dollar to remain under pressure. This, along with a vaccine-driven global economic recovery, should continue to support copper.’

Strengthening copper prices should provide a tailwind to earnings for many of the big FTSE 100 miners including pureplay copper producer Antofagasta (ANTO).

There is also an interesting read-across to Japan, where the anticipated easing of tensions between the US and China could indirectly benefit Japanese exporters.

Naoki Kamiyama, chief strategist at Nikko Asset Management, thinks that if consumer demand from the world’s biggest economy increases, it will benefit Japan both directly and indirectly. ‘This is not only because Japan’s exports to the US would increase, but that its exports of parts and machinery-related infrastructure to other countries, notably those in Asia which cater to the US market, would also increase,’ he says.

Compared to Donald Trump, Biden is expected to take a more low-key approach to Washington’s trade deficits with its allies. Biden’s ‘Made in America’ plan to bring back critical supply chains to the US is a potential concern for export nations, but its impact is likely to be relatively limited on Japan which already possesses significant US production capacity.

IS IT TOO LATE TO RIDE THE RENEWABLES WAVE?

Renewable energy stocks have soared on the back of Biden’s election win and the Democrats taking the Senate too, given his ambitious plans which he has pledged to deliver upon in his four years of office.

Exact details are thin on the ground, but as part of his $2 trillion ‘Build Back Better’ infrastructure plan Biden has pledged to make a ‘historic investment’ in clean energy by the end of his first term in 2025, and put enforcement mechanisms in place to ensure the US becomes a ‘100% clean energy economy’ and net-zero carbon by no later than 2050.

The very real chance of big, meaningful amounts of money flowing into the renewable energy sector has sparked some massive gains in clean energy stocks.

But with some becoming five-baggers since their March lows and soaring far above their pre-pandemic levels, the natural question to ask is whether most of the good money has already been made.

For example, popular clean energy exchange-traded fund Invesco Solar ETF recorded gains of 233% in 2020, most of it towards the back end of the year, first as investors bet on a Biden election victory and then when he actually won.The ETF is now trading on a forward multiple of 53.2 times earnings, meaning expectations for the underlying stocks are now sky high.

Certainly, Wreford at Lazard is one who thinks it will be hard to find winning equity investments in the clean energy and renewables industry. He points out that ‘when capital goes into an industry, returns go down.’

The portfolio manager explains: ‘We always look for more than a total addressable market story. Just because a market is going to get big, that is not enough for a return on an opportunity. If demand is going to be met with massively increased supply, that doesn’t translate into good shareholder returns.

‘Our view is that with one or two limited exceptions, we think the vast majority of returns in the world of sustainability will be eaten away. The broader idea of wanting to be more energy efficient and moving towards electric vehicles and reducing emissions, that will move forward. We just need to be very careful about where we pick our spots.’

Others are more optimistic. Randeep Somel, manager of the M&G Climate Solutions Fund, says Biden’s win and the Democrats clean sweep ‘represents a huge opportunity for climate-focused sustainability companies both in the US, and also worldwide’.

He points out Biden’s pick for treasury secretary, former Fed chair Janet Yellen, has also advocated a carbon tax to both help climate goals and raise much needed revenue to implement climate policy. ‘The Georgia results means this policy will at least now be put to both chambers for serious discussion and a vote,’ he says.

Analysts at Goldman Sachs say European giants EDP, EDPR, Orsted and RWE are well placed to enjoy higher earnings from activity in US renewable energy investment, while National Grid (NG.) and Iberdrola would benefit from investment in power grids.

They also note that eight of the top 10 global renewable developers are European, creating even more opportunity for EDP, EDPR, Orsted and RWE in Biden’s policy changes.

‘In such a fragmented industry, we believe that the scale achieved by these renewables majors brings significant advantages, which translate into premium returns (versus those of much smaller developers).’

RWE (RWE:ETR) €37.75 BUY

German energy giant RWE has been tipped by analysts as a potential big beneficiary of a Biden presidency and investment into clean energy.

The company is the world’s second largest player in offshore wind, behind Orsted, and the third largest renewable energy generator in Europe. It also has operations in parts of Asia and North America.

The company says it ranks among the top 10 onshore wind companies in the US, saying: ‘We develop, own, and operate some of the most efficient, highest performing renewable energy projects in the United States.’

As noted by Goldman Sachs, those with scale are a lot better placed than the smaller developers in being able to capture the upside from the $600 billion of investment set to go into the sector during the 2020s.

Its peer Orsted has a lot of the same positive tailwinds as RWE – the one snag is that this has very much been recognised by investors, with Orsted trading on a 12-month forward price to earnings (PE) ratio of 51.

RWE on the other hand has a cheaper valuation with a PE of 18.8, but the multiple demanded of its peer shows the potential for its shares.

Considering the soaring valuations of many stocks in the renewables sector now, finding companies which still have meaningful share price growth ahead looks difficult. But there are still pockets of relative value in the sector, and RWE stands out as a key stock to buy.

POINTS TO CONSIDER FOR TECH STOCKS

Many market commentators have suggested Biden’s inauguration as president represents a turning point for tech stocks, namely a less favourable backdrop.

Regulators worldwide are taking a much firmer stand on the scale and power of big tech companies. There is a growing sense that major tech platforms like Alphabet’s Google, Facebook and Twitter are not up to the task of governing themselves or their users.

The rampant spread of misinformation, proliferation of hateful and violent content, and monopolistic power that limits competition are just some of the criticisms levelled at big tech.

In the US, members of Congress have acknowledged that government’s hitherto light-touch approach to antitrust enforcement in the digital marketplace has failed.

‘The power of these companies has become so big that they cannot avoid being part of the conversation about societal issues,’ says James Anderson of Scottish Mortgage Investment Trust (SMT).

‘That the conversation is about who controls media and data makes some of those shares less attractive,’ adds Baillie Gifford fund manager Tom Slater.

These are hot issues in the US and elsewhere and Biden will want to send a message that he will be a president with a firm, if friendly, hand.

‘Biden has a reputation for “reaching across the aisle” to forge deals with Republicans,’ says Walter Price, who runs the Allianz Technology Trust (ATT). That makes ‘draconian changes seem unlikely’, in the fund manager’s opinion, with ‘decent checks and balances’ more likely to be put in place.

‘This should bode well for technology as an enabler for so many things, including green energy and infrastructure,’ he adds.

Polar Capital fund manager Ben Rogoff hopes policymakers and society will recognise and support the positive impact of technological adoption on tackling the wide array of problems humanity faces, from climate change to financial inclusion.

Regulatory overhaul is one area for investors to watch, but there are other cyclical factors that could hurt tech share prices in 2021, such as rising inflation. That could see interest rates rise and, in simple terms, investors may decide that the relatively high valuations of many tech stocks are no longer worth paying if cheaper growth is available elsewhere.

‘If we go into a reflationary and then inflationary environment, tech is not the area you want to hide in,’ says Andrew Warwick of Newton Investments’ real returns team.

That’s not to say investors should dump all high-quality tech companies with great long-range growth prospects. A better approach would be a considered re-examination of these stocks.

‘If we saw inflationary pressures mounting, it would prompt some reshaping of my portfolio,’ admits Allianz’s Walter Price. ‘But any prospect of higher prices could take years to play out and, in the meantime, inflation is likely to remain subdued.’


DISCLAIMER: Co-author Steven Frazer owns shares in Scottish Mortgage and Allianz Technology Trust.

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