This post was written with contributions from Charlotte Irwin. Charlotte is a Research Strategist in the ETF and Mutual Fund Research Team.
As the 2018 midterm congressional elections draw closer, let’s look at how the results could impact Health Care, Energy, Infrastructure, Defense and Tax Reform. Here, I will break down these key issues under two scenarios—a Democratic sweep or Republican sweep. While these two potential outcomes result in distinctly different paths for Health Care and Energy, there is some agreement on the other issues, with variations in how much and where to spend.
#1. Health Care
Given that Congress was unable to pass the American Health Care Act (AHCA), President Trump signed an executive order that eliminated a key ACA subsidy, pushing premiums higher on ACA exchanges and destabilizing a key tenet of the law.
If Republicans maintain majority control of the House and increase their Senate majority by at least one seat, they would likely have the votes to pass more substantial reform or repeal ACA in its entirety. This poses a potential risk to Hospitals and Health Care Service Providers, as uninsured individuals will still require treatment and emergency care—increasing the risk of non-payment for services rendered. Republicans could also repeal the medical device tax, a 2.3% excise tax set to come back into effect in 2020, and benefit Health Care equipment firms.
Drug pricing reform continues to be a hot topic for the president. While unique in its potential to drum up bi-partisan support, to date Congress has focused only on pharmacy benefit managers (PBMs). A bill to ban pharmacy gag clauses currently sits on the president’s desk for signature.
However, if Democrats gain control of both houses, pressure could shift from PBMs to directly target pharmaceutical firms through measures like increased imports, broadening the availability of generics, and the passage of the FAIR drug pricing act that would require manufacturers to publicly justify their price levels.
- Health Care Services (SPDR S&P Health Care Services ETF, XHS)
- Pharmaceuticals (SPDR S&P Pharmaceuticals ETF, XPH)
- Health Care Equipment (SPDR S&P Health Care Equipment ETF, XHE)
In August, the Trump administration moved to repeal the Clean Power Plan (CPP), a 2015 directive requiring states to devise plans to shift away from coal and traditional emissions-intensive power generation in favor of cleaner renewable energy sources.
A Republican sweep would continue to benefit traditional energy producers, with less regulation and additional lands open for leasing, including areas in the outer continental shelf. If Democrats win the House and/or Senate, they are likely to challenge the newly proposed Affordable Clean Energy (ACE) Rule that is forecasted to be less restrictive than the CPP on carbon emission requirements and support using traditional fossil fuel power. Any re-introduction of the CPP or a new mandate altogether will favor clean energy sources at the expense of traditional sources. A transition to a world with lower emission generating power supply may benefit firms driving innovation in the clean energy sector, including solar, wind, geothermal and hydroelectric power.
- Clean Power Initiatives (SPDR S&P Kensho Clean Power ETF, CNRG)
- Low Carbon Mandates (SPDR MSCI ACWI Low Carbon Target ETF, LOWC)
- Oil & Gas Exploration and Production (SPDR S&P Oil & Gas Exploration & Production ETF, XOP)
- Oil & Gas Equipment Services (SPDR Oil & Gas Equipment & Services ETF, XES)
The American Society of Civil Engineers estimates that we need to spend $4.5 trillion by 20251 to fix an infrastructure system in dire need of repair. The president campaigned on the promise of a $1.5 trillion infrastructure spending package, and infrastructure generally receives broad bi-partisan support. Last month, Congress passed America’s Water Infrastructure Act of 2018 with fairly strong bipartisan consensus. This bit of bipartisan cooperation went largely unnoticed but may signal forward progress.
A Democrat-controlled Congress would favor a larger infrastructure package, something sizable enough to make a splash in the 2020 elections. Funding would be the only roadblock. With our deficit already ballooning from recent tax cuts and increased government spending, infrastructure improvement may require new taxes, like a carbon tax.
If Republicans maintain their control of Congress, Health Care reform is likely to trump infrastructure spending. This may lead to state and local authorities taking the lead on more targeted infrastructure reform that focuses on aviation, water, or rails, rather than on large broad sweeping changes. Programs that would benefit infrastructure firms would still occur, but a Republican Congress would likely spend less than a Democratic Congress.
Either way, intended to last a half century or more, these interconnected and efficient infrastructure projects won’t be the same roadways of Eisenhower’s Interstate system.
- Intelligent Infrastructure (SPDR S&P Kensho Intelligent Structures ETF, SIMS)
- Intelligent Infrastructure (SPDR S&P Kensho Intelligent Structures ETF, SIMS)
Defense appropriations are also a noticeably bipartisan issue. In September, Congress approved a defense spending measure to direct more than $670 billion to the Defense Department.2 And defense spending is likely to increase in any political scenario.
President Trump’s plans for a Space Force by 2020 must pass through Congress. Republicans have historically backed increased funding for space-related industries because test and launch sites are largely located in rural, conservative districts. The 2019 defense spending bill included appropriations for $12.5 billion to be allocated to national security in space.3 While just 2% of the total $670 billion budget, that figure is $1.1 billion higher than the 2018 fiscal budget request and 18% higher than the five-year average.
Democrats are more concerned with modernizing the military by eliminating outdated programs. This means heightened IT awareness with a focus on cybersecurity and advanced weaponry. Opening up the bidding process is also likely, potentially benefiting next-gen security firms.
- Next-gen and Cyber Security (SPDR S&P Kensho Future Security ETF, FITE)
- Space and the Final Frontiers (SPDR S&P Kensho Final Frontiers ETF, ROKT)
#5. Tax Reform
This is an easy one to break down. The Democratic party would want to repeal portions of the Tax Cuts and American Jobs Act of 2017 while a majority of Republicans want to push the cuts further, making certain personal tax cuts permanent and reducing the capital gains tax.
Tax reform from a Republican controlled Congress would likely benefit consumers and domestic market segments and industries, as it did back in December of 2017 when small caps outperformed large caps by more than 6% in the six months after tax reform.4 A reduction of tax revenue combined with the desire to increase spending may also lead to an increase in inflation expectations and higher interest rates, benefiting banks through higher lending income. Conversely, if the Democrats repeal tax cuts as rates fall and inflation trends lower without the fiscal stimulus impact from lower taxes, this may favor bond proxies like dividend exposures.
- Dividend Growth (SPDR S&P Dividend ETF, SDY)
- Dividend Yield (SPDR Portfolio S&P 500 High Dividend ETF, SPYD)
Get informed, get out and vote
The results of the midterms, which also include gubernatorial elections and local contests, will shape US politics for at least the next two years. A Republican-controlled Congress will be viewed as an endorsement of the president’s agenda. If the Democrats gain control, they will oppose many of Trump’s policies. In a previous post, I discussed a third option, the possibility of a split Congress and how that could result in greater gridlock.
Finally, as you think about how to position your portfolios for a potential congressional power shift in Washington, think about trade. Congress has limited oversight on trade because the president can impose tariffs without congressional approval. Trump’s White House cited Section 232 of the Trade Expansion Act of 1962 when recently imposing the steel and aluminum tariffs. But there have been discussions for Congress to curtail some of this power. If Democrats control Congress, legislation to curtail presidential trade powers may get more support. Meanwhile a Republican sweep may lead the president to act more boldly given his party’s win. If that occurs, expect more pressure to be applied to China, impacting emerging market sentiment.
3SpaceNews.com, as of 03/21/2018.
4Bloomberg Finance L.P., as of 10/11/2018, from December 20, 2017–June 26, 2018.
Prior to 06/25/2019, the SPDR S&P Kensho Future Security ETF (FITE) was known as the SPDR Kensho Future Security ETF (XKFS), the SPDR S&P Kensho Intelligent Structures ETF (SIMS) was known as the SPDR Kensho Intelligent Structures ETF (XKII), the SPDR S&P Kensho Final Frontiers ETF (ROKT) was known as the SPDR Kensho Final Frontiers ETF (XKFF), and the SPDR S&P Kensho Clean Power ETF (CNRG) was known as the SPDR Kensho Clean Power ETF (XKCP).