ETFs Helped By Midterm Election Changes

November 25, 2014

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today’s article is by Scott Kubie, chief investment strategist of Omaha, Neb.-based CLS Investments.

While this year’s midterm elections generated lots of discussion, prior to the election there wasn’t a lot of discussion about which investments would benefit. Part of the reason is neither party will control both houses of Congress and the presidency. Republicans took the Senate, held the House and expanded their governorships. Yet President Obama will be in office for two more years.

The veto, coupled with a skillful use of the rules leaves the Democrats with a lot of leverage. The Republicans window may be short. In two years, 24 of the 24 Senate seats up for re-election are held by Republicans, according to information posted on Wikipedia.

While policy changes in the coming years will likely be modest because the government remains divided, there are some potential policy shifts that may provide opportunities. Below are three potential policy shifts and four ETFs that may benefit or suffer based on the election results.

Medical Device Tax Repeal: iShares U.S. Medical Devices ETF (IHI | A-88)

As part of the effort to pay for the Affordable Care Act (Obama Care), a 2.3 percent tax was levied on medical device makers, according to an article on CNN.com. Emboldened by recent results, Republicans will be anxious to change the health law in some way. At the same time, President Obama will be unlikely to do anything other than veto major changes.

A likely place of compromise is the medical device tax. Republicans get to cut taxes and claim a victory while the president doesn’t give up any of the major provisions of his signature legislative accomplishment. Device makers have lagged broader health care stocks in recent years and the repeal may allow them to catch up.

Export-Import Bank: iShares U.S. Aerospace and Defense ETF (ITA | A-81)

Republicans generally support stronger defense spending, so the initial reaction may be positive for this ETF. However, recent trends in the Republican Party have emphasized a return to a slightly more libertarian emphasis on freer markets and economic concerns. One of the targets of libertarian-leaning Republicans is the Export-Import Bank, which provides reduced costs funding for U.S. exports. Boeing is a big beneficiary of these low-cost loans. Should the program be scaled back, Boeing, which makes up 8.26 percent of this ETF, may suffer.

Export-Import Bank: SPDR S&P Transportation ETF (XTN | A-64)

The Export-Import bank is criticized for subsidizing international firms at the expense of U.S. ones. For example, if an international airline gets reduced interest payments in order to buy an airline, it can conceivably operate more cheaply than a U.S. airline without the reduced payments.

This means the international airline could charge less for tickets on the same route, favoring the international airline and reducing employment at the U.S. airline. A scaled-back Export-Import Bank could benefit U.S. airlines. XTN is about 25 percent airlines and has the highest airline allocation of any U.S. ETF.

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Tax Holiday or Corporate Tax Reform: Technology ETFs

The U.S. corporate tax rate is very high compared with the rest of the world, and the U.S. taxes foreign earnings when the cash is returned to the U.S. This policy is at odds with the trend toward lower corporate taxes.

As a result, global companies have kept large sums of cash abroad rather than returning it to the U.S. For an economy short of growth, having a tax-holiday on these assets may bring the cash home and offer increased opportunity for domestic investment.

Technology firms are the largest holders of cash in foreign accounts, according to a report in the Financial Times.

A tax-holiday may spur one-time dividends as well as further investment. While cutting corporate taxes may be politically unpopular, the expected trend on taxes is lower and a one-time event could be cast as an economic growth incentive rather than a corporate tax cut.

Real Possibilities

Because of Republicans gaining control of the Senate, these three policy options and four sectors are at the top of a limited list of policies benefiting or penalizing particular sectors. We’ll see how the political haggling works out.

Either way, investors should be careful when mixing politics and portfolios. Politics doesn’t work the same as business and its compromises often take place in public, with lots of posturing. Investors may find the posturing difficult to stomach and hard to analyze.

Bias is the biggest challenge political analysis creates for investors.

Don’t Overdo It

In 17 years with CLS, I’ve been fortunate enough to travel around the country speaking to clients who work with a financial planner using CLS. Invariably, politics comes up in the question-and-answer time.

My belief is investors tend to overreact to the swings in political mood and politics in general. Some investors seem to be watching cable news on the TV, binge-watching “House of Cards” on their iPads, and monitoring their portfolio all at the same time.

If you feel like your political views are shaping your investment strategy, turn off the TV. You’ll likely be happier and your portfolio may perform better.


CLS Investments is an Omaha, Neb.-based third-party investment manager and ETF strategist. CLS began to emphasize ETFs in individual investor portfolios in 2002, and is now one of the largest active money managers using exchange-traded funds, with more than $2 billion invested. Contact CLS’ Chief Investment Strategist Scott Kubie at 402-896-7406 or at [email protected]. Please click here for a complete list of relevant disclosures and definitions

 

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