Determining the impact from a change in administration has historically been hard to predict. Political positioning and external factors can have a profound impact on the policies that make it from the campaign trail to the bill-signing ceremony.
As such, we prefer to focus on the long-term implications of the different key priorities of each party and the related impact to valuations at the company level.
As highlighted by John Rekenthaler, the effect on stock market returns for three years after a presidential election has been attributed to broader economic trends rather than the winner’s party affiliation. And from a long-term macroeconomic point of view, the outcome of the election will not significantly impact our forecast.
Generally, if President Donald Trump were to be re-elected, we don’t foresee many significant policy changes and expect the status quo. If former Vice President Joe Biden were elected, but the Senate remains in Republican hands, we think he would be able to implement some of the policies he has advocated, but the scope would be more limited, and any sweeping changes in healthcare law or the tax code would be muted. Finally, if there is a Democratic sweep across the presidency and Congress, then the Democrats would have wide latitude to implement the party’s priorities.
We’ll discuss the economic implications of three policy areas in which the winner could hold significant sway.
How Election Outcomes Could Affect International Relations
Under either a Trump or Biden administration, we expect that there will continue to be a significant amount of friction between the United States and China. Threats of a trade war or additional tariffs would be amplified under Trump, who has taken a publicly antagonistic stance toward negotiations.
We anticipate that the Biden administration would take a traditional, diplomatic approach to negotiating with China; yet even so, underneath the publicly made statements, we expect tensions between the two countries to continue as China looks to expand its global influence. For example, we may not see existing trade tariffs lifted immediately, but those tariffs may be used as a bargaining chip for negotiating with China.
The key priorities from either administration will be:
• To protect American technology and intellectual property.
• To open Chinese markets to U.S. companies.
• To limit China’s growing global influence and military expansion.
Trade negotiations with China will become increasingly more complex as other trends play out. For example, the coronavirus has increased concerns about the fragility of international supply chains. While the U.S. will look to open up Chinese markets, many corporations are considering revamping their supply chains. In order to lessen reliance on China, companies may shorten their supply chains by moving back to, or at least geographically closer to, the U.S.
We expect companies like Rockwell Automation (ROK), Fastenal (FAST), and W.W. Grainger (GWW) would benefit from this trend. However, even after incorporating this trend into our forecasts, we think the market has gotten ahead of itself in its valuations for each of these three companies. All three have Morningstar Ratings of 2 stars as their price/fair values are between 1.2 and 1.3 times.
What the Election Could Mean for Tax Policy
It’s no secret: Democrats and Republicans differ greatly in their views of tax policies.
Under a Trump administration, we would expect a continuation of existing policy and the potential to either expand or extend additional tax cuts. However, any changes would be fairly modest as the House of Representatives is almost certain to remain under Democratic control.
Under a Biden administration and Democratic Senate, we expect that corporate tax rates would quickly be raised from 21% to 28%. This increase would have different effects on stock valuations depending on a company’s earnings composition.
For example, in the corporate sector, a company whose earnings are predominately generated domestically, that is modestly leveraged, and is already paying taxes at the current rate would see its enterprise valuation drop approximately 7% to 8%. The full impact of the increase in tax rates over the broad market would be more muted as corporations look to tax strategies to lower their effective tax rate.
Within the banking sector, we estimate that stock valuations would drop between 2% and 6%, with regional banks being hit the hardest and larger global banks at the lower end of the range. Although the stock prices for some banks might experience pressure if it appears that tax rates are headed higher, we think that from a sector perspective, the impact to financial services would be moderate.
Our price/fair value for the sector is right at fair value as opposed to the rest of the market (excluding energy), which is approximately 7% overvalued. Among the large U.S. banks, we think Wells Fargo (WFC) is significantly undervalued at about half of its fair value, earning the stock a 5-star rating. Among the regional U.S. banks, there are eight banks that we rate with 4 stars: Comerica (CMA), Fifth Third (FITB), Huntington Bancshares (HBAN), KeyCorp (KEY), M&T Bank (MTB), Truist Financial (TFC), U.S. Bancorp (USB), and Zions Bancorp (ZION).
Utilities earnings and valuations might be less sensitive to an increase in corporate tax rates. Regulators typically set customer rates based in part on utilities’ aftertax earnings. As such, utilities can raise customer rates to reflect higher corporate taxes.
Infrastructure and Possible Election Outcomes
Both candidates have advocated for greater infrastructure spending. Considering that infrastructure spending has a high economic multiplier effect and leads to new jobs, which would be especially helpful during this time of high unemployment, it is more likely than not that a deal will get done no matter who wins the election.
Under a Trump administration, we expect that infrastructure spending would be concentrated on more traditional projects like highways, bridges, and mass transportation.
Companies that provide the raw materials and aggregates would benefit from new multiyear infrastructure spending programs. These companies include Vulcan Materials (VMC), Summit Materials (SUM), and Martin Marietta (MLM). Firms that may benefit from more transportation spending include those that supply heavy machinery and materials processing for building and repairing highways and bridges, such as Caterpillar (CAT) and Terex (TEX), or provide engineering and construction services, such as Jacobs Engineering (J) and KBR (KBR). Across this group of companies, KBR appears to be the only stock that we think is meaningfully undervalued. It is rated 4 stars based on its price/fair value of 0.79. Each of the other companies is rated 3 stars, except for Terex, which is Under Review.
Under a Biden administration, we expect that infrastructure spending would also include energy-efficiency and clean-energy projects. For example, funding could be granted to retrofit commercial properties to improve energy efficiency, transforming them into “green buildings.” Between 40% and 60% of energy consumed by commercial real estate is used by HVAC systems. Companies that specialize in HVAC, like Johnson Controls (JCI), Trane Technologies (TT), and Carrier (CARR), may see additional demand. We think Johnson Controls and Carrier are fairly valued with 3-star ratings, whereas Trane appears overvalued at 2 stars.