The presidential election is a little over a month away.
It’s a big deal for the country. It’s also a big deal for Wall Street. And it
means analysts will do some scenario planning to figure out what each outcome
means for their sectors.
For industrial investors, the election should boil down to
five big issues: Tax rates, China, defense budgets, environmental regulation,
and infrastructure spending.
There are potential pluses and minuses for industrial firms
in that list—depending on who wins. Investors may be required to rebalance the
industrial portion of their portfolios as November approaches.
Tax Rates
President Trump cut corporate tax rates. It helped boost
industrial company income, especially for firms doing most of their business in
the U.S. Railroads, for instance, do most of their business in the U.S.
Take CSX (ticker: CSX). Its effective tax rate fell from 37%
to 23% and earnings growth from the end of 2015 through the end of 2019 was
about 20% a year on average. Earnings growth the five years before the tax
change was about 7% a year on average.
Raymond James’ industrial team expects corporate income
taxes to rise in a Democratic sweep scenario—one where Biden takes the White
House and control of the Senate flips.
They project it will be harder to raise taxes if Biden wins
and Republicans retain control of the Senate. They don’t expect tax increases
if the status quo is maintained.
Environmental Regulations
Raymond James added that any tax headwind in their
Democratic sweep scenario could be offset with benefits resulting from green
regulations and infrastructure spending.
Those benefits would accrue to a subset of the industrial
universe.
Cowen sustainable energy and industrial technology analyst
Jeffrey Osbonre says investors have been looking at solar companies including
SolarEdge Technologies (SEDG) and Enphase Energy (ENPH). That pair has already
run up 107% and 173% year to date, respectively. Osborne still rates both
shares the equivalent of Buy though.
Infrastructure
Biden’s environmental plan is tied into his infrastructure
plan. He is targeting upgrades to the electricity infrastructure as well as
access to universal broadband. That, in theory, will benefit some engineering
and construction firms including Quanta Services (PWR).
Quanta has the distinction of being universally loved by the
analysts covering the company. Thirteen out of 13 analysts rate shares Buy. The
average Buy rating ratio for stocks in the Dow Jones Industrial Average is
about 58%. The average analyst price target is $57. Shares recently traded
around $51.
Military Spending
Conventional wisdom holds that Democrats are more likely to
cut military spending than Republicans. Raymond James Industrial Team says it’s
more likely spending will be maintained by either administration.
There is some investor trepidation in sector stocks though.
Large defense contractors trade for about 14 times estimated 2021 earnings.
That is a small premium to the historical average, but it’s well below where
the market is trading. What’s more, the S&P 500 is trading for about 20
times estimated earnings, a near 20% premium to its historical average.
China
Roughly 10% to 20% of U.S. industrial sales are generated in
Asia—excluding Japan. The majority of that comes from China. (Detailed Chinese
sales are difficult to come by.) The U.S. industrial economy has already lived
through tariffs and trade tension. They may have to again. None of the Chinese
tensions hurt industrial stocks materially though.
Industrial stocks in the S&P 500 rose about 10% a year
on average from the end of 2015 through the end of 2019. The S&P 500 gained
12% a year on average. There is a 2 percentage point gap, but it isn’t all that
noteworthy. In the five years before the start of 2016, industrial stocks
returned about 9% a year on average.
Looking Ahead
Rebalancing among sectors is one option for industrial
investors. Wholesale changes, however, probably aren’t warranted. There are too
many variables to figure out exactly how one party will impact a sector, at
least in the short run. And investors will have to weigh the impact of fiscal
stimulus and possible inflation regardless of who wins in November.
Still, it’s never a bad idea to prepare. And scenario
planning is a good tool.
Write to Al Root at allen.root@dowjones.com.
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