Razor thin margins in the House and Senate mean that Biden will not have full reign to pursue the more expansive aspects of his campaign. Still, we expect major changes in the next four years. In this week’s episode, Lauren and Robert identify seven themes the administration is already following, and seven investment ideas to match.
LAUREN GOODWIN: New Administration, new themes for markets. Here’s what matters.
LAUREN: Live from our respective coronavirus social distancing outposts, I’m Lauren Goodwin.
ROBERT SERENBETZ: And I’m Robert Serenbetz
LAUREN: and this is Market Matters from New York Life Investments.
ROBERT: In this podcast, we the strategists at New York Life Investments will share insights from the Multi Asset Solutions team: what we think matters as we manage investment solutions.
LAUREN: That includes Mainstays’ diversified portfolio series, including the Income Builder fund, as well as bespoke solutions for our partners.
ROBERT: By sharing perspectives and engaging with you – our listeners – we can all become better investors.
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LAUREN: Welcome everybody, it’s the week of February 15, 2021, and today we are going to mix up our format for a conversation on the new Administration and what it means for markets.
ROBERT: That’s right. Instead of breaking up this episode into a conversation and a portfolio pause, we’re going to come straight at you with seven investment ideas related to the new administration.
LAUREN: Most administrations begin with energy, and this one has been no exception.
ROBERT: Some of our listeners have submitted questions expressing surprise at executive orders and other priorities. We’re here to break them down and explain what they mean for investors.
LAUREN: Razor thin majorities in the House and Senate mean that Biden will not have full reign to pursue the more expansive aspects of his campaign. That said, we expect some major changes in the next four years, with implications for investors.
ROBERT: Let’s get right to them, then. Our team has thought a lot about these themes, and so the way we’ll share them with you is for Lauren to explain the theme itself, and then I’ll explain the investment idea.
LAUREN: A classic laundry list, but we promise it’s more fun than it sounds. Ready?
LAUREN: Our first theme has to do with More fiscal spending: We expect Democrats to move two tranches of spending this year – COVID relief, which is already under way, and a “Build Back Better” infrastructure package. 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.
ROBERT: With interest rates due to stay low for the foreseeable future, we don’t see the debt component as being a relevant risk for the near term.
LAUREN: Great point. There is an investment-related point to be made about whether this fiscal spending is too much and could overheat the economy. Frankly, we won’t know until we now how quickly the economy can get back up and running once we all get vaccinated. Based on how things are going so far, I expect the government to play it safe rather than sorry. It’s easier to manage an overheating economy than try to pick up a bruised one.
ROBERT: Related to this trend: Investors expecting economic growth to improve typically 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. Our guest Adam Schrier a few weeks ago talked all about that.
LAUREN: Shoutout to Adam. Our second theme is Infrastructure. I just mentioned two tranches of expected fiscal spending…. The second tranche is likely to focus on infrastructure, including surface infrastructure, research and development in technology, broadband access, and alternative energy.
ROBERT: There are many different ways to think about infrastructure, from who finances it, who implements it, and who benefits from it. We like to think about capturing this theme in a couple of ways. One is via infrastructure-focused funds. Another is municipal bonds. LG, I believe last week you were saying that the muni space is where a lot of the “nitty gritty” associated with infrastructure plays out, which is applicable here. One word of caution on that, though: 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.
LAUREN: Our third idea has to do with higher taxes, and here we get into budget reconciliation.
ROBERT: Oh boy.
LAUREN: It’s high-stakes political drama! In order to use the reconciliation process, Democrats will need to finance some of their spending through – you guessed it – 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.
ROBERT: Okay, but you said “For the most part”. What about the other part?
LAUREN: 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. And I can see why. If you look at the numbers, 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%.
ROBERT: Yikes, okay, I see. So the capital gains tax will feel more targeted towards the wealthy rather than the general public, which makes it a potentially attractive target if you’re trying to address income inequality.
LAUREN: Exactly. The pros and cons of that can be left for another time. For investors: look. These proposals are relatively “light touch” compared to Biden’s full proposals, but higher taxes always present a market risk. If tax increases look more likely, then that impacts companies’ bottom lines and could trigger market volatility. 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.
ROBERT: Investors concerned about this dynamic, or about higher tax bills, can consider several different ideas but I’ll mention two. First, tax-advantaged strategies, such as municipal bonds, may benefit as taxes rise. Second, an expected tax hike could lead corporations to announce special dividends. Investors positioned to capture those gains would see an income increase.
LAUREN: Our fourth theme is related to a genuine focus on environmental protection and climate change. Robert, since this is more your area of focus lately, do you want to explain that one?
ROBERT: Biden Administration is highly focused on climate change and environmental protection, and they’ve taken several actions to reflect that already. However most of these steps are regulatory changes and executive orders. They matter, but fall short of investors’ fears of urgent and rapid decarbonization.
LAUREN: A little easier on investors, maybe not so great on environmentalists.
ROBERT: Exactly. From an investment perspective, though, investor preference is already rapidly changing towards taking environmental concerns into account. We expect that to accelerate under the new Administration. There are lots of different ways to implement that idea in a portfolio. 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.
LAUREN: What about the energy sector itself? Typically, as the economy improves, traditional fossil fuel-related companies do better because demand for energy is higher. Will that play out again this time?
ROBERT: Yes to traditional, but yes to green energy, too. We do think that value sectors, including energy, are likely to receive a boost from improving economic growth, but we expect alternative energy technology and services to benefit from Biden’s policy stance.
LAUREN: We’re going a bit long today so we’ll make these last ones speedy. Our fifth idea is related to healthcare. And here, more of the same: some definite changes, but not the blue wave changes that some investors feared. As an example: 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.
ROBERT: The drug price legislation you mentioned – bipartisan, by the way. The Trump Administration was also keen to address drug prices – is likely to be negative for the pharmaceutical sector. Other areas of healthcare are likely to experience positive benefits from expanding health insurance coverage
LAUREN: Our sixth investment idea has to do with regulation, which of course impacts the environment and financial services, and healthcare and several other sectors we’ve already mentioned. Biden’s cabinet picks point to stronger regulations in areas, such as environmental protection, 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.
ROBERT: Several sectors could be impacted by this idea, but the biggest one for investors is the tech sector, because it’s such an important part of equity market indices. In general, increased scrutiny on the technology sector could reinforce a trend towards small caps, value, and international equity over the course of the year.
LAUREN: Tech will continue to play an important role in the economy and investing, so we don’t think it makes sense to drop all of your tech investments. Tech companies are also highly profitable. Think about it more as some other companies having the potential to catch up as tech faces these headline risks.
ROBERT: all right, LG, the last idea. Let’s bring it home.
LAUREN: Our list investment implication of the new administration has to do with immigration. We don’t have an immediate investment takeaway for this one, but a streamlined process for including well-educated, taxpaying foreign workers into the U.S. population could improve demographics and productivity.
ROBERT: Demographics and productivity are both important for long-term economic growth and competitiveness.
LAUREN: That’s it. Seven priorities the administration has already been working on, and seven investment ideas.
ROBERT: Whether you like the administration’s priorities or not, these are the ways we think they could play out in a portfolio this year.
LAUREN: Coming up next... this week's I'm watching something a bit wonkier in the marketplace. Due to the Fed's activity, policy changes, and bank activity, there has been a lot of demand for short-term treasury bills. So much so that the short end of the treasury curve is dipping pretty close to zero. I don't think it will amount to anything, but there may be more attention payed to the Fed's technical rate-setting, the IOER rate in particular, and so if you see something like that in the headlines, just know that any activity there is not related to the Fed's broader monetary accommodation. It's just a technical issue that they're clearing up.
ROBERT: I will keep it simpler with two things to watch, (1) fiscal stimulus dynamics, and (2) U.S. retail sales will be published for January this week. We are looking for an improvement in that context since we have seen more fiscal stimulus in the pipeline.
LAUREN: That’s it for today. We’ll be back next week for more Market Matters.
ROBERT: Let us know what matters to you.
LAUREN: If you have a question or topic of interest, reach out to us on social media.
ROBERT: That’s right. You can send us your questions or highlight what matters to you by finding us on LinkedIn.
LAUREN: You can also follow our views on our *new* website at newyorklifeinvestments.com and clicking “insights”.
ROBERT: Until then, I’m Robert Serenbetz.
LAUREN: And I’m Lauren Goodwin. See you next time.
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