Financials: What the election may mean for stocks

The election could affect tax policy and the regulatory environment.

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Key takeaways

  • The most impactful policies on the financial sector would be those that support the economic expansion and stimulate inflation.
  • The financials sector has benefited from lower tax rates as many US banks and consumer finance companies primarily do business domestically.
  • A win by the Democrats could mean a slightly tougher regulatory environment and the corporate tax rate could go up. Control of the Senate may be key to tax rate changes. International companies would be less impacted by higher taxes.
  • A Republican win in the presidential election could mean stability or further loosening of some regulations and possibly a continuation of the tax cuts from 2017.

Elections and your money

Learn how different 2020 election outcomes could impact your finances.

The 2 major political parties take different approaches to taxes and regulation. While both can affect the financials sector to some extent, "the reality is that the financials sector is heavily correlated to the economy, much more than an election cycle. When the economy performs well, financials typically perform well," says Matt Reed, manager of Fidelity® Select Banking Portfolio (FSRBX) and the Fidelity Select Financial Services Portfolio (FIDSX).

Viewpoints talked to Reed to get insights into what types of policies could impact the sector and how he's planning for the fourth quarter of 2020. The highlights:

What themes are you keeping an eye on as the election approaches?

Reed: I think the economy is probably the most meaningful thing for the financials sector as a whole.

What I'm looking for, from both parties, is how they intend to support both consumers and the expansion of the business cycle. What really matters for the sector is the strength of the economy. Rising inflation can be seen as one indication of economic strength. And inflation is one theme that has been underrepresented in the last decade of investing. It has been persistently below average or below the target the Federal Reserve would prefer. The Fed's target inflation rate is 2%.

The degree that policies, in conjunction with what the Fed is doing, can help reignite inflation will be the most important. Inflation in the 2% to 3% range often indicates an active and healthy economy. It means that money is being spent on goods and services at a relatively quick rate because there's confidence in the economy and that's a good environment for financials.

The good news here is that both Democrats and Republicans are focusing on getting the economy going again, though their plans might differ.

We know the policies of the current administration—they have been focused on lowering taxes and simplifying some regulations to support the economy.

From the Democrats, there have been a number of proposals from different people, at different times, as well as ways to pay for them. Examples include bankruptcy reform, fiscal stimulus, housing policy changes, financial transaction or bank taxes, as well as increases in corporate and personal taxes. Some of the proposals may not be likely to be enacted, but in general, higher taxes could impact earnings for companies that do most or all of their business in the US.

Taxes are a key topic this year. How could tax policy affect the sector?

Reed: Financials, as an industry, was a beneficiary of the corporate tax reform in the Tax Cuts and Jobs Act because there's a lot of domestic business in the sector. So a modest change in the corporate tax rate, in theory, could impact them a bit more than the rest of the S&P.

One change proposed by the Democrats is raising the corporate tax rate from 21% to 28%. That could create some winners and losers. A global business, for example, has a lower domestic tax base, relative to peers and could be a winner. Generally, higher taxes would have less of an impact on international businesses or those with less exposure to US tax rates.

A change in the corporate tax rate could be a slight headwind for the sector relative to the market. But if the tradeoff is a growing economy with inflation running at, or slightly above, the Fed's target of 2%, that's likely to be more important to the market than a modest change in the US corporate tax rate. More financial-specific taxes could be a risk as well, though which, if any, and the structure of implementation will matter a lot. Generally policies that include fiscal stimulus seem most likely to help push inflation higher in my view.

Regulation is an important factor for the financials sector. What has the regulatory environment been like for the past 4 years and what would you expect if the Democrats won in November?

Reed: Post-financial crisis, there were a lot of good things done in terms of increasing the stability of the financial system. New regulations were written and banks were required to have more capital. But it eventually got to the point where there was a desire to simplify some of the requirements and reduce a few of the onerous regulations on smaller and mid-sized banks.

The Trump administration and the Fed have improved the regulatory environment for banks. The Fed signaled a desire for more stability and simplicity in capital requirements, with constructive refinements to regulation. They also helped rationalize regulatory costs at smaller banks and said that banks are generally well-capitalized.

I would say most of what's been happening in the last few years has been incremental and more about refining, fine-tuning, and trying to balance what makes sense for the system. There have been dozens of small changes. One of the big ones was that we moved from a regime of pushing capital requirements higher on the banks to saying the system has enough capital.

There was bipartisan agreement recently on the decision to ease stress-testing requirements on banks under $50 billion. Banks under $50 billion dollars in assets are probably not systemic. The need for them to produce thousands of papers annually to justify something like the dividend they plan to pay was unnecessary. And frankly it was putting them at a competitive disadvantage because that cost burden is much higher for them.

Under a Democratic administration, we could see a slightly tougher regulatory environment. At this point it isn't clear which policies are likely to feature prominently. I don't think it would be the sea change that we had right after the global financial crisis with Dodd–Frank but it could be a risk for some financial companies if a more aggressive direction is taken. Dodd–Frank was legislation passed after the global financial crisis. It tightened regulations on banks and financial institutions to protect consumers and reduce systemic risk.

Are there any businesses you think would benefit from one party versus the other?

Reed: So when you look at the election in the context of taxes and regulatory policies, you'd assume a Republican victory could be helpful to banks, consumer finance names, and generally domestic-focused businesses with more exposure to US tax rates.

With a Democratic victory, global financials and parts of insurance with more global operations may benefit relative to other firms if tax rate changes are US-focused. Consumer-facing parts of the insurance segment like mortgage insurers, among others, may benefit from further fiscal support to consumers. Mortgage insurers are likely less exposed to any changes that may occur at the Consumer Financial Protection Bureau.

It's somewhat counterintuitive but historically capital markets have, on average, performed well in the first 6 months after a Democrat was elected to the White House. That could be because the capital markets industry includes businesses that have global operations or the reason could be the effect of additional activity in the sector following elections.

But, again, whatever policies come into play, whoever is in the White House, if they do manage to stimulate inflation that would be the biggest game changer of all of the potential outcomes.

Perhaps as valuable would be some stability in regulation as banks plan for the future. Pricing your business with an understanding of the cost of goods sold is something that is taken for granted sometimes. But when regulations change that's not always going to be true, so some stability there would help.

Republican sweep Continued focus on refining regulations and keeping taxes relatively low could help keep costs down for businesses and help them try to increase growth.
Republican White House with divided Congress The administration could continue to work with the Federal Reserve to reduce regulations in the financials sector.
Democratic sweep Taxes could go up on corporations and the regulatory environment could be slightly tougher, possibly with a focus on consumer protection.
Democrat White House with divided Congress Consumer protections could be strengthened through increased regulatory oversight.

The opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates.

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