Post-Georgia Senate Runoff Election Thoughts
Blue Wave, Green Policies
Recently, the voters of Georgia elected two Democratic Senators in an upset win over Republican incumbents. Although the “Blue Wave” never materialized in the last election, this recent victory was a significant one for the Democrats who now hold the presidency and control majorities in both houses of congress. The increase in Democratic control could have substantial policy implications that may affect investment portfolios.
First off, it’s clear that President Joe Biden has placed a “green” agenda front and center. Two of his first moves in office were to rejoin the Paris Agreement for reducing carbon emissions and announcing that all government vehicles, a fleet of nearly 650,000, should be transitioned to battery power. These moves were a blow to the already beaten-down fossil fuel industry that was suffering from a massive COVID-driven demand drop. On the flip side, any investments related to new-era energy surged such as electric vehicle stocks as well as the components of electric vehicles such as cobalt, lithium, nickel and other metals that are instrumental in battery construction. Moreover, while it’s clear that the future of energy will include a continued reduction in fossil fuel, the transition will take time. Given the COVID demand drop many drilling operations were taken off-line and a short-term spike in oil-based fuel prices is a very real possibility with any sudden surge in demand. Such a surge would be welcome news to energy giants Exxon, Chevron, BP and transporters like Enbridge and Energy Transfer Partners all of which remain depressed.
Another key area of focus for the Biden administration will be policy related to wealth inequality. Wealth inequality has taken center stage during COVID as the stock market surge widened the wealth gap as billionaires added $4 billion in wealth while many remained unemployed. Biden has already proposed raising the minimum wage for federal employees to $15 per hour and many politicians are calling for broader application of minimum wage policies as well as mandated benefit increases and improved health plans. It’s likely that other pro-labor policies will have wide support from the current administration. The implication here is that companies with a significant labor force may begin to see margins squeezed. Companies like Walmart, Amazon, Kroger, Home Depot, Starbucks and Target that have large numbers of lower-paid employees could be facing declining margins and adverse stock price impacts.
It is also fair to expect higher taxes in general as the government attempts to fund spending and, perhaps, begins to see some pressure to work back toward a balanced budget. As you may recall, the Trump Administration lowered the corporate tax rate. Given the substantial profitability of U.S. corporations and wealth gains by corporate leaders in recent years there will likely be support for reversing many of those changes. Of course, increased taxes will further squeeze business profitability. While there is not an obvious “loser” with this change, it’s noteworthy that tax policy combined with pro-labor policy is likely to disproportionately strain businesses with weak balance sheets and poor cash flows. We’d advise putting an emphasis on the “quality” factor in equity portfolios and begin to minimize exposure to weaker companies including “zombies” (i.e., those with cash flows insufficient to cover interest payments) that have relied on cheap debt to survive.
It’s also noteworthy that continued support payments to Americans are likely. Biden called the most recent COVID relief bill a “down payment” suggesting that it was not sufficient and that more would be coming. The implications of these continued payments are tricky to assess. The payments were so substantial in 2020 that America’s disposable income collectively was actually higher in 2020 than if COVID had not happened. Moreover, we now have substantially more in savings than we did at the start of the pandemic. If the virus mutates or vaccines are delayed we could expect continued lockdowns and spending that mimics 2020. That is, customers will further increase savings deposits, work from home, order take-out, shop on-line, play video games, log hours on social media, do yard work and buy a lot of groceries. In that world, the winners are the 2020 winners (e.g., Amazon, Walmart, Doordash, Lowes, Zoom, Microsoft, Twitter, etc.). However, if we regain freedom of movement the build-up of savings could create an economic surge. Most notably, energy stocks could come roaring back as well as travel, airlines, tourism, various real-estate sectors and restaurants.
Given the enormous COVID support bills, inflation presents the biggest “wildcard” for all of us on the investing front. With Democratic control, Janet Yellen as Treasury Secretary and Jerome Powell as head of the Federal Reserve, we are likely faced with continued “easy money” policies. Such policies could contribute to an eventual inflation issue. If/when high inflation materializes, it will collectively hurt stocks as consumers divert spending to basic necessities. Moreover, if inflation climbs too high, the Federal Reserve would be forced to raise rates leading to a potentially allergic reaction by the equity market. Given the potential for inflation, some allocation to real-assets, commodities and precious metals continue to make sense for investment portfolios, in our view.
In summary, we think the prospect of continued stimulus in the short-term will keep the economy moving given that it will largely convert directly to consumer consumption. This will probably create favorable headlines for the equity market in the short term. Moreover, the build-up in savings is likely to create a short-term economic surge as COVID impacts dissipate. However, the medium term picture is less rosy for the equity market. For one, government spending is going primarily to consumption and not projects that improve productivity or production capacity. That will have adverse medium-term GDP growth impacts. Moreover, companies will eventually face increased margin pressure from rising labor costs and higher taxes while also dealing with a renewed call for anti-monopoly action. Lastly, the steady flow of money into the system is creating the potential for high inflation – a condition we have not faced in 40 years. So, in summary, placing an emphasis on quality companies is critical along with adding investments that will provide some hedge against inflation risk.
