Industrials: What the election may mean

The election will set priorities on infrastructure, energy, taxes, and regulations.

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Key takeaways

  • The industrials sector is diverse, and some parts of the sector could benefit from Republican policies while other parts may benefit more from Democratic control in Washington.
  • A Republican win could mean continued support for lower taxes and decreased regulation.
  • A Democratic administration could mean more support for infrastructure and environmental regulations that drive demand for some HVAC and transportation products.
  • Industrials are generally economically sensitive and many parts of the sector, such as transportation and building products, are benefitting from the economic recovery, which is unlikely to change immediately based on the election results.

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The industrials sector overall has been near the middle of the pack over the last year, but the industries within the sector tell a different story: Airlines, aerospace, and defense have lagged far behind the market, while other industries, such as air freight and logistics, have been far ahead. The election could help some companies in the sector while challenging others, with each party offering up policy proposals that could benefit parts of the sector.

Viewpoints spoke with Chad Colman, who manages the industrials portfolio within the Fidelity Stock Selector All Cap Fund. Colman says a presidential win for the Democrats could drive demand for energy-efficient vehicles and buildings and upgrades to the electric grid along with investments in infrastructure. A Democratic administration, particularly if Democrats retake Congress, might also mean support for higher corporate tax rates and additional infrastructure spending. Another Republican administration might also mean support for some amount of additional infrastructure spending, along with continued emphasis on low tax rates and deregulation. No matter who wins, Colman believes the diversity of industrials will provide opportunity for stock selection.

The campaigns have been discussing infrastructure. What could that mean for industrials?

Colman: Over the years there has been a lot of talk about infrastructure spending from both parties, but no one can agree on what the spending should look like, so I'm always a little skeptical. That said, if a major infrastructure spending program does happen, it could be important for industrials.

Trump's campaign has suggested a $1 trillion infrastructure package. That package would focus on traditional infrastructure, including roads and bridges, communications, and water. For some perspective, if 100% of that money were devoted to industrial products over a 10-year period, it could add several hundred basis points to annual sales growth for the sector.

Biden's campaign has talked about a $2 trillion package. While both campaigns discuss the need for investment in communications infrastructure and water, Biden focuses heavily on climate change including energy-efficient homes and commercial buildings, upgrading the electrical grid, and low-emissions vehicles. In the proposed plan, every city with more than 100,000 people would have a zero-emission transit system, which may not happen, but gives you a sense of his priorities. I think the shift toward renewables at the expense of fossil fuels would accelerate under a Democratic administration.

Are there particular parts of the industrials space that might benefit from a focus on energy efficiency?

Colman: HVAC companies sit at the intersection of building efficiency goals tied to climate policy and the air quality issues driven by the COVID health crisis—where people want to stop the virus from circulating indoors. Companies like Trane Technologies (TT) could benefit from increased demand for new HVAC technology. Improving air quality is not as simple as putting a new filter in an existing system. That could restrict airflow or overtax a system. The key to indoor air quality is letting more outside air in, but as you let more outside air in, you use more energy and need to consider energy efficiency standards. I think upgrading HVAC systems in buildings is going to be a big theme that could last for several years under either party, but particularly if the Democrats win and pursue more aggressive climate policy.

I'd also say that when it comes to oil and gas, energy spending may not bounce back the way it has in previous cycles. The continuing move from fossil fuels to renewable energy could depress revenues for industrials companies that are heavily exposed to the energy sector. As an investor, I think it's important to understand that exposure.

What could potential changes in tax policy mean for industrials?

Colman: The current Republican administration lowered corporate taxes from 35% to 21%. If President Trump is reelected or the Republicans hold the Senate, I think that is unlikely to change. But under a Democratic administration corporate rates may go up; some people have suggested a 25% corporate tax rate. If taxes rise that much, it would be about a 5% hit to earnings on average for industrials.

What do you think might happen to defense spending?

Colman: The biggest driver of defense spending is the threat environment and there is broad recognition of China's growing military capabilities. For this reason, I don't think that there will be major reductions in defense spending regardless of the election outcome. I do think you can expect to see a slowdown in the rate of budget growth under either party and perhaps modest declines if the Democrats win.

I think Biden might review some programs, but I don't think you will see major defense spending cuts regardless of which party is in control. Historically, party control has not mattered a great deal to the defense budget. I think both parties see defense spending as an underlying job driver in their districts and are reluctant to make major cuts. Defense stock valuations have contracted in recent months.

Are there other parts of the industrials sector that look attractive?

Colman: Air travel was a growth area within the sector, but that trend was derailed by COVID and it could take multiple years for the industry to recover. Other parts of transportation are seeing great demand and pricing power. All of the rail companies, including CSX (CSX) and Union Pacific (UNP), have been benefitting.

Truckload companies have also been benefiting from tight capacity. The economic disruption caused by coronavirus drove many smaller trucking companies into financial hardship. A newly launched federal drug and alcohol clearinghouse has removed some drivers from the market. As demand has recovered into tighter capacity, publicly traded companies have benefitted.

I am also focused on a group of industrial companies that have done a good job of reallocating capital into higher return businesses. These companies have strong management teams and have had structurally improving returns. Idex (IEX) and Roper Technologies (ROP) are examples of this strategy in the sector. I think both companies have strong management teams and appear to be well-positioned for most economic scenarios. Their investments, either internal or through mergers and acquisitions (M&A), have been driving higher cash flows and returns.

How important overall is the political environment for the sector?

Colman: Industrials is an economically sensitive sector, and the economic environment is what really matters. That won't change on a dime with the election, no matter what the outcome is. But as I think about individual names and some of the industries, it is important.

Republican sweep Continued focus on deregulation and support for lower taxes
Republican White House with divided Congress Support for infrastructure spending and moderate defense spending increases
Democratic sweep Support for significant infrastructure spending and environmental mandates
Support for higher corporate taxes
Slowing defense spending
Democrat White House with divided Congress Environmental regulations and focus on low-emissions transport

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