Utilities: How the election could impact stocks

The outcome could shape tax policy and the shift to renewable energy.

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Key takeaways

  • A Democratic administration could lead to corporate tax hikes and policies favoring renewable energy and electric cars and trucks.
  • Utilities may be better positioned than other sectors in the event of higher corporate taxes, as they can pass tax increases on to clients, increasing cash flow.
  • If new climate protections are put in place, it would likely help accelerate the ongoing move to renewables and electric cars. The biggest winners could be coal-fired utilities that may be able to go green more quickly, and companies that help manage the grid.

Elections and your money

Learn more about how the 2020 election outcome could impact your finances.

The utilities sector outperformed the S&P 500® Index during the COVID-related selloff in the spring, but it's lagged behind economically sensitive parts of the market through the recovery.

What difference could the election make in the outlook for utilities?

Viewpoints met up with Douglas Simmons, manager of Fidelity Select Utilities Portfolio (FSUTX). His take: A win for the Democrats could be a plus for utilities, accelerating electricity demand and the shift to renewables. A Republican victory may mean continued deregulation, less environmental regulation at the federal level, and the extension of lower taxes.

How might this election impact the utilities sector?

Simmons: There are a couple major policy differences between the parties that could impact utilities in the coming years. Utilities are a highly regulated sector that is converging with the energy sector as transportation becomes increasingly electric and a long-term move toward renewable energy takes hold.

A Democratic administration, particularly with control of Congress, could bring increasing federal policy support for the electrification of cars and trucks and renewable energy production, along with the prospect of higher corporate tax rates.

A Republican administration would probably let the states continue to set policy around energy production and push for lower corporate tax rates.

How would the outlook for renewable energy change?

Simmons: As the economics of renewable energy have changed and society has become more concerned about emissions, we have seen increasing use of solar power, wind power, and other renewable resources. That is a long-term trend and I think that will continue, regardless of the outcome of the election. At this point, renewable energy represents about 10% of the market. I think we could see renewables make up close to 40% of energy production by 2030. This election has the potential to accelerate that trend. Under the current administration, the states have mandated what percentage of their energy should come from renewable sources. I think that would continue with another Republican administration. But a Democratic administration may create a federal mandate that drives the adoption of renewables.

If the Democrats pursue emissions reductions, it could accelerate the electrification of transportation, meaning policies that promote electric cars as well as heavy duty trucks.

With these changes, I think you will see a focus on hydrogen storage of renewable energy and the development of a more modern electrical grid. Utility companies have to install new equipment to handle renewable energy generation—like meters to measure the production and consumption from a household. There are some well-known renewable energy producers, such as NextEra Energy (NEE), and Dominion Energy (D), which could offer regulated renewable growth. But I think the entire utilities sector could benefit from these trends. In fact, the biggest beneficiaries may be companies that are using coal now but may be able to go green more quickly.

Republican control of Congress or the White House would likely maintain the status quo for utilities and clean energy. A status quo would mean less aggressive policies focused on decarbonization, which would benefit utilities focused on pipeline construction or liquid natural gas exports. It would also benefit fossil-heavy-merchant power generators such as Vistra Corp. (VST) and NRG Energy (NRG). These companies bear the costs to comply themselves and do not pass on environmental costs to customers as regulated utilities do.

What could this mean for utilities companies?

Simmons: Utilities companies are highly regulated, and are limited in what they can charge and how much they can spend. Basically, the more money utilities can invest, the more they can charge. Under a Democratic administration, utilities would likely need to invest in technology to meet new environmental standards. That could increase their rate base, and I think that could lead to earnings growth.

Some names tied to electrification, like Tesla (TSLA), have been trading at very high valuations. But the companies that provide infrastructure around the electrification of the transportation fleet have not really been getting much of a multiple boost. I think the utilities and companies that manage the grid could potentially see higher valuations as the theme of electrification takes hold.

What about tax policy?

Simmons: I think a Republican administration would push to keep taxes low on corporations. If Congress and the White House are split between parties, it would be harder to change tax policy.

A Democratic sweep might mean higher taxes. Higher taxes would be a negative for companies that pay tax, and I think it's largely negative for every sector in the S&P, except for utilities. Very few utilities actually pay cash taxes because of immense tax credits from investing in solar and wind. Yet they are allowed to collect taxes in customer rates at the corporate tax rate. Therefore, raising tax rates actually increases cash flow.

How is the sector positioned relative to the market?

Simmons: Within the US stock market, the utilities sector has been in the middle of the pack over the last year. In the down market in the spring, the sector outperformed, but it has lagged amid the recovery. That's largely to be expected because, overall, these companies are not as economically sensitive as some other sectors.

Right now, I think a lot of investors are focused on stimulus and the recovery. But at some point, the market may begin to focus on the election, and I do think that could be a catalyst for the group.

Second, some people are starting to get worried about the broader market. A lot of stocks are trading at higher price-to-earnings multiples than they were before the downturn, but utilities have become cheaper. The sector was trading around 21x earnings before the COVID crash in March. By late August, they were trading at about 18x earnings. They also went from trading at a premium to the market to around a 10% discount to the market. As of August 24, utilities were the cheapest they've ever been compared to bonds, meaning that they were yielding more than they ever have historically versus United States Treasurys and corporate bonds. Though utility stocks are generally less volatile than some other sectors of the stock market, they are still subject to the ups and downs of the stock market. In general, the bond market is less volatile; however, fixed income securities carry interest rate, inflation, and liquidity risk.

At the same time, I think the fundamentals for the sector have been very stable. Even with COVID, I think the sector's earnings could grow in the second quarter, and we could see a rebound next year. Going forward, I think earnings could easily keep growing—especially if you have this tail wind of renewable energy proliferation. So I think the sector looks attractive on an absolute and relative basis, and the fundamentals look stable.

Republican sweep Continued deregulation of fossil fuel energy production and possibly further corporate tax cuts
Republican White House with divided Congress Regulatory regime continuing to favor fossil fuels but further corporate tax cuts less likely
Democratic sweep Potential federal mandates to accelerate renewables and limit emissions, plus higher corporate tax rates and slowing defense spending
Democrat White House with divided Congress More federal support for renewable energy and electrification of transportation, but tax hikes less likely

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