The potential winners and losers
This leads us to seven broad conclusions, implying the following credit 'winners' and 'losers' (Table 1).
Table 1: The sectors that could stand to gain and lose1
|Potential outcomes of Congressional gridlock||Winners (opportunities in lower-rated credit)||Losers (stick to the largest, strongest, best-in-class)|
|Less than (feared) corporate tax hikes||
|Moderate fiscal stimulus ambitions||
Consumer-facing sectors (e.g. retail)
|Potential public infrastructure spend||
Metals and mining
|Focus on climate change||Clean energy||
Oil and gas
|Less hawkish foreign policy||
|Firms competing with Chinese imports|
|Healthcare reform ('public option')||Healthcare (e.g. insurers, pharmaceuticals, hospitals)|
Playing the lack of tax hikes
We believe the Georgia Senate seats only offer President-elect Biden enough support to partially repeal the Trump 2017 tax cuts, perhaps by a third to a half. Furthermore, in our view, they may not be made effective until 2022.
In our view, all corporates will benefit from smaller tax hikes than initially feared, but credit investors could potentially see the best performance from ‘cuspier’ credits experiencing the largest marginal impact.
Meanwhile the banking sector underperformed in 2020 on fears over tax hikes (as well as loan losses from the pandemic and a flatter rate curve) and consequently we believe it is due for some ‘catch up’. Even though we also have banking in a ‘loser’ category (relating to potential enhanced enforcement of Dodd-Frank rules) we still see it as a winner overall for fixed income investors, especially if fiscal support for the economy steepens the yield curve.
This is because new banking regulations may constrain aggressive and riskier lending (such as credit card and high yield loans). But this is much more of a worry for equity, rather than bond, investors. However, bondholders will need to watch management’s appetite to turn to M&A to appease equity holders.
Turning to personal taxes, it is likely that Biden will be able to largely repeal the $10,000 ‘SALT’ (state and local tax) deduction cap (implemented by the Trump administration). This had limited the extent to which residents of ‘high tax’ states (such as New York and California) can deduct state and local taxes on their federal tax returns. This had increased migration to ‘low tax’ states (such as Florida and Texas), particularly given increased trends towards remote working, and appetite from some employers for partial relocations. We now expect this trend to slow down, but not reverse. This is particularly important for commercial real estate investors, and for example, increases the importance of security selection within CMBS.
Playing a 'less intense' fiscal stimulus policy
Even with 50 Senators, budget reconciliation rules limit President-elect Biden’s ability to deliver game-changing fiscal stimulus. This implies knock-on effects on consumer-facing areas such as retail (a sector with is already facing rampant disruption) that are potentially less positive than initially hoped (albeit more positive than under a Republican-controlled Senate).
As such, within retail we see the best value in the strongest household names, such as large supermarkets. Elsewhere, even as we emerge from the pandemic retail remains one of our least-favorite sectors.
The process of life getting back to ‘normal’ will be gradual – implying no distinct V-shaped recovery for, say formal apparel outfitters. Secondly, although higher savings have created pent up consumer demand – we expect this to burst into the leisure sector (for example, as families book their first vacations since the pandemic began) rather than retail.
Playing the pivot to pro-climate policy
The oil and gas sector will likely come in the crosshairs of Biden’s climate initiatives, at a time when investors are increasingly aware of ESG-factors.
Nonetheless, we believe Biden’s policies will take at least two years to impact oil and gas production, meaning short-term exposure to strong names may be appropriate. However, we would avoid any long-term exposure, particularly over 10-years.
Similar is true of pipelines, where for longer-term exposure we would prefer (environmentally cleaner) natural gas pipelines.
The clean energy industry itself is currently in an early (and potentially ‘high growth’) stage. As such, fixed income investors may wish to consider convertible bonds, given the potential equity upside.
Playing the potential for an infrastructure public spend
Basic materials, commodities producers and companies that manufacture products used in construction are could potentially benefit here. We see value in high yield and crossover-rated equipment and rental companies.
Companies that produce steel, iron, copper, and cement could potentially benefit from increased demand from public infrastructure projects. The current surge in housing demand will also be a tailwind for these sectors as the pandemic has prompted swathes of millennials to buy their first homes in the suburbs.
In our view, even in the event there is no infrastructure plan passed in the end, we still expect such credits would benefit from worldwide (including green infrastructure) initiatives overseas, such as those to be financed by the EU’s proposed recovery fund.
Playing less hawkish foreign policy
The dwindling threat of continued trade wars is potentially most beneficial for large importers, but we believe the largest marginal beneficiaries will be mid-market manufacturers that tend to raise capital in the bank loan market. The way to benefit may be through rigorous security selection within middle market CLOs (see A fresh look at the CLO market for more).
Playing election winners and losers
For us, it’s not just a case of ‘buy the winners’ and ‘sell the losers’. We see opportunities across both.
Within winning sectors – we often see the best value found further down the capital structure. Within ‘losing’ sectors – we prefer sticking to the largest, most competitive household names with the greatest staying power. They are most likely to remain resilient and may even be able to capitalize on the misfortunes of weaker competitors. As always, security selection will be crucial to playing the election winners and losers.