2020 Election: A Brief Guide for Fixed-Income Investors | Lord Abbett
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Institutional Perspectives

A survey of expert views on the potential impact of the 2020 election on select segments of taxable and tax-free, fixed income.

Read time: 6 minutes

 

As part of our continuing coverage of the November 2020 U.S. election and its potential implications for asset markets (read the previous entry), this week’s Market View features viewpoints from Lord Abbett investment professionals on how the vote may influence key investment sectors and asset classes. This time, our roster of experts includes Partners and Portfolio Managers Daniel Solender, Kewjin Yuoh, and Jeffrey Lapin; Managing Directors and Portfolio Managers Adam Castle, Christopher Gizzo and Kearney Posner; and Portfolio Manager Eric Kang. Our survey will conclude next week with further insights from Lord Abbett investment leaders on the 2020 U.S. vote, and what it may mean for key segments of the equity market.

Leveraged Credit

In our view, the largest macroeconomic factor driving positioning within the leveraged credit market continues to be the effects of COVID-19; we expect comparatively less impact from the upcoming election. That said, we would note that there is typically volatility heading into a U.S. election, and we continue to watch for emerging policy proposals that could affect issuers in some of the bigger industries like healthcare, consumer services, and energy.

We believe if former Vice President Joseph Biden wins the 2020 U.S. presidential election, wholesale changes to the energy industry likely will not be a policy priority. Instead, we think that Democrats’ spending priorities will be, in part, centered around infrastructure. Biden’s Build Back Better plan seeks to create jobs needed to build a modern, sustainable infrastructure and facilitate the adoption of clean energy. We have been adding some cyclical exposure, in part based upon a view that infrastructure—especially green infrastructure—could benefit under a scenario where the Democrats take the White House. But we also think there are elements of any infrastructure plan that could have bipartisan support, should Republicans retain control of the Presidency and/or Senate.

On the healthcare front, we believe keeping drug prices in check is another bipartisan issue, with the potential for continued, negative headline risk for pharmaceutical companies. However, we are constructive on healthcare providers and technology companies, as we do not anticipate any significant, near-term impact on these industries from a regulatory standpoint. Additionally, Biden has expressed support for mental health priorities, which could benefit larger providers of behavioral health.   

Investment-Grade Fixed Income

In our view, elections are a lesser factor with regard to portfolio positioning in fixed income. Historically, elections have not been material influences on market performance, though there could be some short-term volatility. The 2016 U.S. election is a classic example; given the surprise result (a victory by Donald Trump), we saw significant volatility in Treasury yields (lower) and risk assets (wider), but volatility was short-lived before yields normalized, and risk assets reverted to pre-election spreads and continued tighter on positive economic fundamentals. 

There is always uncertainty around event risk, so there is a pricing-in of that uncertainty in the volatility market, which is very difficult to separate out, but no doubt there is some election premium within volatility markets. And that uncertainty and higher volatility should be reflected in risk assets as well; to that end, we do feel that, given where valuations are now relative to economic fundamentals, we will have to watch election-related uncertainty carefully, especially in terms of how it may influence spreads in the runup to November 3.

Corporate Bonds

Within investment-grade (IG) corporate bonds, we are cognizant of current valuations against the backdrop of COVID-19 related headlines. We believe that the recent actions by the U.S. Federal Reserve (Fed) have created a highly favorable environment for IG corporates, especially at the front end of the yield curve; of course, valuations have significantly retraced since March. 

Against this backdrop, we have a nuanced view on the election itself, despite the stark differences between President Trump and former Vice President Biden. Given the significant shock to the global economy brought about by COVID-19, we believe post-election priorities for either candidate will be a continued focus on economic rebuilding, and broader policy shifts will be a secondary focus. We believe the industries that will be most impacted by the election will be consumer cyclicals, financials, healthcare, and energy.  

Consumer cyclicals may potentially benefit broadly from a Biden win/Democratic sweep, as we see increased focus on stimulus, combined with a near-term tailwind from homebuilding and suburban relocations. However, in the intermediate term, we could see headwinds for incumbent automakers, as policy shifts will favor a move toward electric vehicles, and a stronger focus on consumer protection pressures financing margins.

In addition to a likely new Fed Chair, financials may possibly contend with more stringent regulatory backdrop under a Biden administration. We believe this would center around increased consumer protection, with proposals for stronger mortgage, student, and auto lending regulation. We view this as having more negative implications for equity rather than credit. More radical changes, including big bank breakups or financial transaction taxes, seem to be lower probability for now.

Healthcare may potentially be reshaped by a Biden win/Democratic sweep, with a renewed focus on the ACA and Medicaid expansion—this could be positive for providers, with more of a mixed impact for insurers. Drug pricing will garner headlines (potentially positive for generic drug firms, negative for branded pharma), but meaningful change will rely on a Democratic sweep. Even with a sweep, we view a Democratic supermajority as being a less likely outcome, so we think more bipartisan cooperation on drug pricing is likely.

In energy, we’ve been reducing our exposure to oil servicers and remain underweight pipelines, as we view increased focus on regulation and clean energy initiatives as a potential negative for both sectors.

Liquid and Securitized Products

In terms of the market for asset-backed securities (ABS), we see the election as a relatively low-impact event. We think that government spending and tax policy may receive higher attention relative to business regulation. As such, consumer finance is less likely to be affected by a new Democratic administration in the same way that it was under the Obama White House in the wake of the 2008–09 global financial crisis. 

Education finance reform is also a possibility under a Democratic Congress. We believe that any such legislation potentially could lead to an increase in refinancing of FFEL (Federal Family Education Loan) student loans into Federal Direct Loans. Such legislation could also lead to an increased application of need-based loan modification. These have potential to create both prepayment and extension risks for various parts of the student loan ABS market.

Municipal Bonds

We see three key policy areas as potentially having the most meaningful impact on the municipal bond market’s performance: tax policy, healthcare, and infrastructure. A Democratic win in the general election may lead to higher tax rates, based on previously expressed policy positions, which potentially could support demand for tax-free bonds. Further, a new administration may broaden the scope of the original Affordable Care Act signed into law under the Obama Administration. We think any healthcare legislation that increases the number of insured individuals would be supportive for municipal bond issuers in the healthcare sector, as hospitals and health systems are less susceptible to unpaid bills, and more individuals receive health services to remain healthy. Finally, we believe a prospective Democratic administration likely will attempt to implement an infrastructure plan. This may lead to higher, new issue supply, which would place downward pressures on the market at times.

How do all these factors influence our outlook?

  1. For tax policy, the outlook is neutral to positive for municipals. With the U.S. deficit growing, we believe that election of a Republican president likely would mean tax rates would stay at or near current levels, which would sustain a favorable environment for demand. Should the Democrats prevail, we think tax rates would have a greater possibility of increasing, which would also be positive for demand. 
  2. For healthcare, Republicans’ legislative plans remain unclear, but so far, the sector has held up relatively well under the current administration. If Democrats win, certain provisions of the Affordable Care Act might be reinstated, which is positive for the sector because more people are covered, meaning fewer unpaid bills for providers and more people getting services to stay healthy. 
  3. If Democrats win the White House and Senate to control the government, there is a higher probability of successful legislation boosting infrastructure spending. This could increase the supply of new muni bonds coming to market. While this may put some upward pressure on yields, we think the market would successfully absorb the new supply; overall, it should be a neutral factor for the market. 
  4. We see a higher probability of a program like the Build America Bonds (BAB)1 launched under the Obama Administration, if the Democrats gain power. Should the new initiative hew closely to the BAB program, it would lead to an increase in taxable municipal bonds, which would be another reason why the tax-exempt market would not be too pressured by a Democrat-initiated infrastructure plan. 


Next week, it’s equities’ turn, as
Market View continues to explore the investment implications of the 2020 U.S. election.

 

Build America Bonds were taxable municipal bonds that featured federal tax credits or subsidies for bondholders or state and local government bond issuers.

 

A Note about Risk: The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. Fixed-income investments are subject to various other risks including changes in credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications, and other factors. Lower-rated securities are subject to greater credit risk, default risk, and liquidity risk. Credit risk is the risk that debt issuers will become unable to make timely interest payments, and at worst, will fail to repay the principal amount. Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes. Although U.S. government securities are guaranteed as to payments of interest and principal, their market prices are not guaranteed and will fluctuate in response to market movements. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Income from the municipal bonds held could be declared taxable because of changes in tax laws. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Because many municipal instruments are issued to finance similar projects, conditions in these industries can significantly affect an investment. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state, and local taxes may apply. Investments in Puerto Rico and other U.S. territories, commonwealths, and possessions may be affected by local, state, and regional factors. These may include, for example, economic or political developments, erosion of the tax base, and the possibility of credit problems. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors, and each investor should evaluate their ability to invest long term, especially during periods of downturn in the market.

Statements concerning financial market trends are based on current market conditions, which will fluctuate. All investments involve risks, including the loss of principal invested.

This material is provided for general and educational purposes only. The examples provided are for illustra­tive purposes only and are not indicative of any particular investor situation.

This Market View may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize, or that actual returns or results will not be materially different from those described here.

The Affordable Care Act is the name for the comprehensive U.S. healthcare reform law enacted in 2010 and its amendments. The law addresses health insurance coverage, healthcare costs, and preventive care.

Asset-backed securities (ABS) are collateralized by a pool of assets such as loans, leases, credit card debt, royalties or receivables. An ABS is similar to a mortgage-backed security, except that the underlying securities are not mortgage-based.

Federal Family Education Loans (FFEL) included four components: Stafford loans, unsubsidized Stafford loans, Federal PLUS loans, and Federal consolidation loans. FFEL loans are no longer offered; instead, the U.S. Department of Education offers direct loans through the William D. Ford Federal Direct Loan Program. There are three types of direct loans: direct subsidized loans for undergraduate students who have financial need; direct unsubsidized loans for undergraduate, graduate, and professional degree students; and direct PLUS loans for graduate and professional degree students, and parents of dependent undergraduate students.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education. No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein. If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in Market View are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research, or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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