October 11th, 2012
The first presidential debate of the election season was held week, and it served to highlight a number of key policy differences between President Barack Obama and his Republican challenger Mitt Romney. Let’s review three areas where the candidates differ and assess their potential impact on investors.
Since the Patient Protection and Affordable Care Act (PPACA) was signed into law in 2010, I’ve written on numerous occasions that it’s actually a boon for many health care companies. The law will add 35 million new customers to the health care system, as well as billions of dollars in additional spending. In other words, the PPACA is a tremendous expansion of the health care market. Although pharmaceutical companies and medical device makers will face a short-term headwind as a result of new fees imposed on their industries, the huge inflow of patients should more than offset the impact of such levies.
If reelected, President Obama can be counted on to defend the PPACA with every tool at his disposal, especially since it’s considered the signature achievement of his first term. His legacy will be severely tarnished if it’s ultimately rolled back, which is precisely what Romney has suggested he intends to do.
Instead, Romney favors a hybrid program, which maintains Medicare, but allows seniors the option of receiving vouchers for private insurance. There would be no individual mandate involved in his plan, and therefore no expansion in the pool of insured Americans.
So a Romney victory would ultimately be a slight net negative for the health care sector, but Obama’s reelection would be a net positive.
In the case of the latter, Health Care Select Sector SPDR (NYSE: XLV) has significant long-term growth potential. The exchange-traded fund (ETF) has substantial allocations to health insurers, hospitals, pharmaceutical companies and medical equipment makers. All will stand to benefit from the effects of the individual mandate.
Another major policy difference between the two candidates comes into play on defense spending.
Obama favors a zero-growth approach to the Pentagon’s budget, while Romney has proposed a $2 trillion increase in defense spending.
The defense and aerospace sectors have been pretty volatile since last year’s legislative debacle involving the nation’s debt ceiling. Our elected officials’ inability to broker an agreement on reining in the federal budget has now triggered automatic spending cuts, which are part of what is otherwise known as the so-called “fiscal cliff.” Included among the initial round of cuts is a 9 percent reduction in defense spending next year alone.
These spending cuts would have a huge impact on companies such as Northrop Grumman (NYSE: NOC) and General Dynamics (NYSE: GD), which primarily serve one major client: The US Department of Defense.
So should Romney win in November, his proposed increase in defense spending would be a huge positive for PowerShares Aerospace & Defense ETF (NYSE: PPA), which holds about 50 companies involved in the defense industry in its portfolio. Among the ETF’s holdings are the aforementioned Northrop Grumman and General Dynamics, as well as names such as Textron (NYSE: TXT), L-3 Communications (NYSE: LLL) and FLIR Systems (NSDQ: FLIR).
Finally, there’s the taxing question of dividends.
Obama favors allowing most of the Bush-era tax cuts to sunset, including the favorable treatment of dividend income. Dividends would revert from being taxed at the current 15 percent level to being taxed as ordinary income. Romney favors maintaining the status quo, while introducing further tax cuts to boot.
There’s been a great deal of anxiety among income investors over whether an Obama victory will cause a mass exodus from dividend-paying stocks. But such fears are overblown.
After all, it wasn’t the introduction of the 15 percent rate that inspired a sudden surge of interest in dividend stocks. Rather, the Federal Reserve’s successful effort to force interest rates to historic lows is what truly brought dividend-paying names into favor. The Fed’s policy makes it nearly impossible for investors to generate decent levels of income from bonds without taking on inordinate amounts of risk. So I would expect most investors to stick with their current allocations until there’s a shift in interest rates, and that’s not even on the radar for at least another year.
That said, there’s no denying that a Romney victory would favor income investors, and as a result Vanguard Dividend Appreciation ETF (NYSE: VIG) would remain attractive.
The ETF holds a basket of 133 stocks, all of which have raised their dividends in each of the last 10 years. The fund currently yields 2.1 percent. With just over $12 billion in assets, I wouldn’t be surprised if the fund garners additional inflows during what would essentially be a relief rally.
Northern Trust launched two new ETFs last week, both of which use its “factor tilt” approach to portfolio construction.
FlexShares Morningstar Emerging Markets Factor Tilt Index (NYSE: TLTE) holds a basket of companies based in the emerging markets. But what differentiates it from its peers is that small-cap and value stocks will receive heavier weightings than they would in a typical market-cap weighted fund. That methodology resulted from extensive research that shows small-cap and value stocks tend to outperform growth stocks over the long term. That said, large-cap stocks comprise about 48 percent of the fund’s portfolio, while mid-caps receive a 20 percent weighting.
Geographically speaking, China figures prominently in the fund’s holdings with an 18 percent weighting, followed by South Korea (15 percent), Taiwan (12 percent), Brazil (11 percent) and South Africa (9 percent). From a sector perspective, financials receive the largest allocation at 23 percent of assets, followed by materials and technology, which each receive 13 percent weightings.
The fund charges a 0.65 percent annual expense ratio.
FlexShares Morningstar Developed ex-US Markets Factor Tilt Index (NYSE: TLTD) follows the same basic methodology, though it’s applies to developed-world geographies outside the US, such as Japan, the UK, Germany, Switzerland, Canada and Australia.
The ETF charges a 0.42 percent annual expense ratio.