Tax policy, regulation of big tech, global trade, and healthcare reform are all points of discourse in the 2020 U.S. Presidential Election. Read insights from Dan Davidowitz, Co-Head of the Large Company Growth team, and Tucker Walsh, Head of the Small Company Growth team, on how these key themes and factors could be influenced by this election’s outcome and their potential impact on both small and large cap companies.
Tax Policy Changes: Adapting and Mitigating
President Trump reduced the corporate tax rate to 21% from its longstanding rate of 35%. Biden’s proposal would increase the corporate tax rate to 28%, which remains below the long-term rate, and includes taxing overseas profits. We believe small companies will adapt, and large companies will likely find ways to mitigate their impact.
For small cap companies, it will be essential to observe how management teams adapt to changes rather than trying to predict the outcome. What are the different ways they reallocate their capital? Will they spend more to reinvest in the business to mitigate a higher tax rate?
For large companies, we think tax policy tends to be a more significant issue, but they have ways to mitigate the impact of higher rates. That said, we expect tax rates to increase over the long term, given the current balance of revenue and expenditures. Our worst-case scenario stress tests for our large companies, which excluded all tax mitigation factors, found that taxes would be a single-digit percentage headwind for a year. We believe this is manageable, and we think this headwind will be lower because our companies should be able to apply mitigation strategies.
Big Tech Regulation: The Burden of Proof, Net Positives, and Concerns
We view anti-trust regulation for Big Tech companies as a bipartisan issue that is unlikely to disappear with a new administration. Rulings should affect small and large caps differently, but there could be net positives.
The burden of proof in the U.S. is that these companies must be harmful to consumers, and we think it will be difficult to assert that they inflict this level of damage. A ruling to break up companies could result in a net positive from an investment standpoint. For example, with Facebook, we believe the sum of the parts (Facebook, Instagram, WhatsApp, and Oculus) is likely greater than the whole as it’s valued in the marketplace today. However, one concern is that companies could be impeded from acquiring the next great technology if they are entangled in anti-trust regulation.
For smaller cap companies, a challenge can be investing in a well-positioned business, but then a tech giant swoops in and buys its competitor. Lately, we have noticed that anti-trust noise has prevented this, to a degree. Longer-term, some smaller companies could benefit from being independent. For example, theTradeDesk prides itself on being independent of companies like Google and Facebook to serve ads digitally.
Trade and Isolationism: Agility to Expand Supply Chains
The current administration has taken a more isolationist stance in tone, overall, while policy action has been more targeted to China. We think the U.S.-China relationship will continue to be challenging, but an agile, high-quality company should be able to work through these challenges.
For smaller companies, trade affects key inputs into the business. For example, pricing changes resulting from tariffs can impact the P&L. But management teams that can be agile and think about the long-term, even though they might take a short-term penalty, should benefit over time in our view. For example, Floor & Décor and Fox Factory Holdings both adapted by sourcing supplies outside China, and now they have expanded their supply options going forward.
Nike and Starbucks are two companies we own with significant operations in China. These companies already pay large tariffs and have worked through issues with China. They also have worked to push their supply chains out of China and into other Southeast Asian countries. We think they are well-positioned regardless of trade policies.
Healthcare Reform and Drug Pricing
We view drug price reform as a bipartisan issue that should not vastly differ based on the administration in office, nor should it significantly affect Polen Capital portfolios. We think the decisions of the Supreme Court will have more influence on healthcare reform.
Today, in the Focus Growth strategy, Regeneron is the only company exposed to drug pricing, and we’ve examined the effect through different mechanisms. Currently, we do not see a significant risk.
For the Affordable Care Act (ACA), we do not expect the Supreme Court will deem it to be unconstitutional, though it is possible. ACA is likely to expand under a Biden administration. In either case, however, we do not see a significant difference in our large company portfolios based on these outcomes.
On the small cap side, the current U.S. Small and U.S. SMID Company Growth strategies have minimal exposure to drug pricing risk and no biotech industry exposure. We are underweight healthcare, which tends to be dominated by biotech in the small cap space. Many healthcare firms do not fit our investment criteria, including profitability, strong margins, and little debt.
The Fed Chair and Equity Prices
In terms of equity prices, the Federal Reserve and the Fed Chair have significantly more influence than the outcome of an election or Congress’s makeup. Interest rates have a tremendous impact, and we expect they will going forward. So, the more critical variable is the actions of Jerome Powell or his potential successor.
Specific to the small cap category, companies without earnings generally have outperformed in the current COVID-19 environment compared to profitable companies, which is where we focus. A challenge with investing in non-earning companies is that it can rely on several variables to remain unchanged for many years. One of those variables can be the Fed and interest rates. For a non-earning company, this can introduce risk from a duration perspective, and we see this as more speculative.
Big Tech: Content Regulation and Political Influence
As disseminators of information, platforms like Facebook, Twitter, and Google have a considerable influence on the political system. These platforms can provide useful information for an electorate and, at the same time, distribute misinformation and create echo chambers.
We believe this is a critical issue and continue to monitor this risk very closely. It is extremely difficult to have open content available to billions of people and regulate the content. Facebook has made strides, but we believe there is room for more progress. We continue to monitor engagement metrics regularly and seek to understand the root causes of any downward trends.
Small Cap Fundamentals: Post-Election and COVID-19
Some evidence suggests that small caps tend to perform well along with mega-cap peers following an election cycle. While COVID-19 remains an overhang and some smaller cap businesses could be fragile, we think the opportunities in the space remain bright.
Companies are maturing and going public within the small cap market. This has allowed us to seize opportunities that might not have been available in past years. To us, the key is the ability to adapt and maneuver around inevitable obstacles. We want to understand how companies achieve success and what is repeatable for the long-term rather than performance expectations following an election cycle.
The Future is Unknowable, and Uncertainty is a Short-Term Input
While the environment may feel less certain today, the future is never truly certain. At Polen Capital, we seek to understand factors like elections, policy outcomes, and Supreme Court decisions through the lens of businesses. Our exclusive focus on investing in what we believe to be high-quality growth companies often leads us to resilient businesses that can successfully adapt.
Uncertainty is a short-term input. While politics, policy, and regulation can have a meaningful impact on companies, we take a big picture view and focus on secular trends. We believe the companies we own should continue to thrive regardless of the election’s outcome.
The information provided in this document should not be construed as a recommendation to purchase or sell any particular security.
There is no assurance that any securities discussed herein will remain in the portfolio at the time you receive this document or that the securities sold have not been repurchased. The securities discussed do not represent the entire portfolio. It should not be assumed that any of the securities, transactions, or holdings discussed were or will prove to be profitable or will equal the investment performance of the securities discussed herein. A complete list of our past specific recommendations for the last year is available upon request.
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