Liz Looks at: Fiscal Firepower

By: Liz Young · September 16, 2021 · Reading Time: 5 minutes

The Politics of Investing

Over the weekend and earlier this week, we got a more detailed look at the reconciliation bill proposed in the House as debates heat up again in Washington. We will continue to hear about this in coming weeks, especially as we approach the debt ceiling later in fall. The final bill is something we need to take heed of as investors.

Not every political negotiation or policy change warrants attention, but there are elements of this reconciliation bill that could alter the landscape for businesses and taxpayers. While some of these elements will not affect all sectors equally, all of these pieces matter for markets.

Investors should also note that government spending accounts for almost 18% of GDP and, like it or not, is an important part of the US economy.

What Comes First: Spending or Taxing?

Long story short, tax announcements hit markets first. In this case, we’re looking at tax hikes on corporations and top-bracket individuals (including small businesses that use individual tax rates). I’ve never met a company that welcomes a bigger tax bite out of its bottom line.

How big of a bite will it be? Mosquito bite or shark bite?

The proposed corporate tax hike will take the rate from its current 21% up to 26.5%. The key word here being “proposed.” This bill is what was brought forward in the House, and still needs to be negotiated and then reconciled with the Senate’s version before reaching a final state.

Also, this draft proposal outlines spending and tax changes that will occur over a number of years. For simplicity, we will only focus on 2022 here. A 26.5% rate would be expected to shave roughly $42 billion off of 2022 S&P 500 earnings, which is only a 2.3% bite.

However, although that rate will get the headlines, there are more tax changes that could affect corporations. Namely, taxes on multinational revenue, tobacco taxes, and pharmaceutical controls, among others. Also, the Senate tax proposal is expected to be more aggressive than the House version—so when all is said and done, tax changes will likely shave more than the above-mentioned 2.3% off of 2022 earnings.

But the proposed tax changes will not affect all industries equally and there are a couple worth a callout.

The Usual Suspects

I don’t remember the last time a debate didn’t include healthcare as a topic, and this time is no exception. To be clear, I am bullish on the healthcare sector long-term because I believe the pandemic forced the marriage between healthcare and technology to speed up, helping to build efficiencies and a better cost/revenue structure overall. Also, the demand for health care around the globe is forever changed and forever necessary.

That said, as proposed, this bill would likely be a headwind for pharmaceutical companies and a tailwind for managed care, medicaid HMOs, and hospitals. Much of the expansion in spending would benefit the latter, and would be paid for by price controls and spending cuts on pharma. Markets have largely anticipated the hit to pharma as stocks most sensitive to these cuts have underperformed the broad index and the healthcare sector overall since February.

Another topic that gets a lot of airtime is energy. The transition from fossil fuels to renewable energy is a focus of this administration and is a large component of the House proposal. Specifically, it includes subsidies and mandates for the use of renewable energy that are offset by regulating fossil fuels. Beneficiaries of this piece of legislation would be companies involved in electric vehicles and the production/delivery of renewable energy.

The Rest Is Yet to Come

I can’t stress enough that this was a proposal and a draft at that. What matters here is that we had a break from Washington debates at the end of August—that break is over now. This is a component of the wall of worry investors are facing in the fall, if only because it introduces uncertainty, and markets do not take kindly to prolonged uncertainty. All told, this does not change my long-term optimistic outlook on equities, but it also does not change my near-term expectation that we will trudge through some more mud before the path clears.


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