US Presidential Election

Stocks sensitive to election outcome

ROBBERT VAN BATENBURG, LOUIS CAPITAL MARKETS

The credit crisis forced President-elect Obama and John McCain to put the economy at the centre of their campaigns and both launched a range of proposals to address this issue. I now highlight the companies that stand to benefit and suffer from Obama’s plans to solve this staggering problem. Obama’s plans will benefit the domestic car makers, infrastructure companies and municipal bonds. His mortgage relief plans should benefit low-end home builders. Beyond the plans to address the credit crisis, healthcare and taxes are the main issues. Obama’s plans hurt the healthcare insurers while helping the discount retailers. However, it was considered before the election that on balance a McCain victory was considered more favourable to the stock market.

Details
In previous election notes LCM highlighted which stocks would benefit and suffer from each of the candidate’s plans and how a potential Obama victory was expediting M&A among companies with large family stakes (hike in capital gain tax) and high market share concentration (anti-trust risk). Economic conditions deteriorated drastically since the summer and both candidates made economic recovery plans the centrepiece of their campaigns. The following article discusses the current proposals of Obama to deal with the economic crisis and the potential implications for stocks and sectors.

Obama’s plan to deal with the credit crisis
The following proposals are intended to be implemented immediately after Obama takes office:

a) US$50 billion to prevent state budget shortfalls, especially to help finance infrastructure projects, but also to offer relief for residential heating costs. This should benefit infrastructure companies like Foster Wheeler (FWLT) and Granite Construction (GVA).

b) A US$3,000 credit to companies for each job created in the US as well as capex tax relief for small companies, which should benefit staffing agencies like ManPower (MAN).

c) An additional US$25 billion (on top of the US$25 billion already approved) in loan guarantees to US auto makers to help them retool for next generation fuel efficient cars. This should benefit General Motors (GM) and Ford (F). Note that GM is in merger talks with Chrysler. The Bush Administration has indicated that it is unwilling to finance a merger between the two but Obama has stated that he would meet with the Detroit Three immediately after taking office to develop a strategy to make them more competitive (Detroit News). This could mean less job cuts in a GM-Chrysler merger but a financially solvent GM with the help from the US Government. If GM gets financial help, Ford may ask and get similar financial support.

d) Homeowner assistance which consists of
• 10% Universal Mortgage Credit that benefits low income home builders such as DH Horton (DHI) and Pulte Homes (PHM).
• More aggressive modification on mortgage terms
• Reforming the bankruptcy code to allow bankruptcy courts to modify an individual’s mortgage payments and
• Broaden mortgage restructuring and legal protection for mortgage service companies. The latter would benefit mortgage service providers like PHH Corp (PHH).

e) Additional support for financial markets if necessary, such as
• Extending insurance on all deposits or guaranteeing a broader range of bank liabilities
• Extending the Treasury Department’s purchases of assets beyond mortgage backed securities to individual mortgages, student loans, car loans and credit card loans
• A funding backstop to the state and municipal bond market to enable agencies to raise capital (municipal bonds). All this benefits municipal bonds (ETF is TFI).

OTHER MAJOR ISSUES

Unionisation/wages
One of President-elect Obama’s initial proposals has been to “strengthen the ability of workers to organise unions” and he is a co-sponsor of the Employee Free Choice Act which means that Unions have more power to force workers to join their Union. This would be especially negative for retailers. Obama also wants to raise minimum wages to US$9.50 per hour by 2011 from US$7.25 next year. This hike follows last year’s and should be a negative for those companies that primarily employ minimum wage workers. Wal-Mart (WMT) this summer was accused of encouraging managers and salaried workers to vote for McCain and Home Depot (HD) recently held meetings with employee-relations managers on how union legislation would impact their business (WSJ). McCain opposed the Employee Free Choice Act.

• Healthcare
Obama plans to create a new national plan featuring guaranteed access to all applicants, comprehensive benefits, portability, means-tested subsidies and affordable premiums, co-pays and deductibles. Large employers would be required to offer coverage or else contribute to the new government plan. The managed care industry, such as UnitedHealth (UNH), Wellpoint (WLP), and Aetna (AET) would suffer from these plans, as the plans propose a number of changes for the individual market, such as guaranteed eligibility and community rating, which could hurt the ability of insurers to underwrite policies accurately. While Managed Care Companies would be forced to accept all applicants, many healthy individuals could choose a less-comprehensive plan or decide to go without coverage altogether leading to adverse selection for the industry.

Lastly, Obama would require that at least 85% of premiums be used for medical costs, thus pressuring margins. Obama also forecasts to save US$43 billion per year by importing foreign drugs and negotiating bargains from drug companies. We believe that, under Obama, the branded prescription drug makers (ETF PPH) may start a new round of consolidation to achieve cost savings to offset lower prices.

• Energy
Obama continues to promote expanding the ethanol-based alternative fuel program although he has heeded some of the ethanol fuel critics. Obama is in favour of a large cap-and-trade CO2 system which would hurt the coal miners (ETF KOL). The Committee for Responsible Federal Budget estimates that Obama’s plan would raise US$100 billion in 2013 alone from carbon credits. Obama proposes to invest approximately US$15 billion per year in clean energy, such as biofuels, hybrids and a digital electricity grid. Obama promotes the use and expansion of hybrid cars. This benefits especially Energy Conversion Devises (ENER), which patented the Nickel Metal Hydride storage technology that is used in today’s hybrid electric vehicles.

• Taxes
Obama has proposed closing corporate loopholes and tax havens as well as making foreign sourced profits subject to domestic corporate tax rate, which may mean a higher effective corporate tax rate. Obama proposes tax cuts for low and middle income earners while raising the highest marginal tax rates and capital gains and dividend taxes for high income earners. Obama’s tax plans will motivate the highest income earners to use more tax shelters such as tax free municipal bonds and limited partnerships.

On the other hand, the higher expendable income of the lowest income earners benefits discount retailers such as Wal-Mart, Family Dollar Store (FDO) and Big Lots (BIG). Windfall profit taxes on oil companies are a negative for the oil and gas sector but have the (unintended) effect of reducing supply which may benefit oil prices.

Obama had his first speech on the economy as President Elect last Friday. His economic team was standing behind him, and we could see Former Fed Chairman, Volcker, Former Labour Secretary Reich and Former Treasury Secretary Rubin among them. But closest to him were the Governor of Michigan Granholm and former Michigan Congressman Bonior. What that means, I think, is that Obama is going to bail out the car makers first and foremost (since Michigan is the home state of the big three).

In addition, some had hoped for a word of nuance from Obama in that Friday press conference, something that would allude to a more centre left, pragmatic approach to the economy so that the markets would be assured that the at times rather “anti-business” stands from both candidates was nothing more than campaign rhetoric. Obama did not provide that word of nuance which worried the markets somewhat. Also, in his economic recovery plan, Obama called for immediate actions for when he would become president including homeowner assistance and additional support for financial markets. Again, the fact that he’s mentioning car makers but not housing/financial sector explicitly, implies he may use his political goodwill on bailing out car makers and helping the jobless first, which is a disappointment for the markets.

If I may speak frankly, I think the markets are realising that President-elect Obama may be spending a good number of months on (dealing with) the bailing out of large swathes of the US economy and that it may takequite some time for the economy to recover. Bail-outs are never good for the markets and set a bad precedent for the economy as a whole. The Government, unfortunately, has been forced into a situation of backstopping entire sectors and this is going to hang over the market for months.

Conclusion
Some of Obama’s proposals such as raising the capital gains and dividend taxes for top earners and subjecting foreign sourced income at domestic rates will reduce investors’ after-tax return on equity and are, therefore, negative for the stock market. Obama appears to have a wider set of plans to deal with the credit crisis, which may help to offset this negative factor partially.