Markets & Finance

S&P's 2008 Election Outlook


Next year's Presidential contest could have big implications for defense, health-care, and energy stocks

From Standard & Poor's Equity ResearchFrom Standard & Poor's weekly investing newsletter The Outlook

While it's impossible to predict the No. 1 news event of 2008, there's no doubt the U.S. Presidential election will be a contender for the top spot. Will the Democrats retake control of the Presidency? Will Republicans maintain their hold? Will a third-party contender be the surprise choice? While Standard & Poor's Equity Research cannot predict the outcome of the Presidential election, our strategists and analysts believe news from all the candidates will certainly move markets in 2008.

In general, the Standard & Poor's 500-stock index has performed well during Presidential election years, showing average election-year gains of 8.6% since 1945. The market has posted gains 80% of the time in Presidential election years.

While past performance is no guarantee of future results, S&P's Investment Policy Committee believes (based on many factors, including the Presidential election cycle) the S&P 500 will end 2008 at 1,650. That would represent a 6% increase from our yearend 2007 target of 1,560.

S&P Chief Investment Strategist Sam Stovall foresees three major Presidential election campaign issues: 1) Iraq/defense spending, 2) health care, and 3) energy.

Industrials/Defense

S&P thinks the 2008 election could be very significant for defense contractors, particularly if there are Democratic majorities in both houses of Congress and a Democratic President. Following such a victory, we would likely become neutral on the defense sector vs. our current positive stance, due to the projected reduction in defense spending.

We also think both parties will generally support spending on projects related to construction and engineering and industrial machinery, although the two parties might favor different types of projects in these areas. We expect the Democrats would focus more on environmental projects, including emissions control, water infrastructure, and alternative energy. We see the Republicans, on the other hand, being more interested in a larger budget for the Defense Dept. and the Homeland Security Dept., which, on top of aiding defense companies, would also likely assist construction and engineering companies that serve that area.

Of course, any spending related to the maintenance of our nation's infrastructure from a safety standpoint (following the Minneapolis bridge collapse) will be spoken about favorably by both parties. We see a large potential positive impact from infrastructure upgrades for bridges (which could benefit Lincoln Electric (LECO), Illinois Tool Works (ITW), and Kennametal (KMT)); roads (potentially benefiting Astec Industries (ASTE), Terex (TEX), and Bucyrus International (BUCY)); energy infrastructure (likely aiding Emerson Electric (EMR) and ABB (ABB)); and greater efficiency in manufacturing (which could benefit ABB, Emerson, Rockwell Automation (ROK), and Roper Industries (ROP)).

In terms of trucks and rails, the Democrats appear more willing to regulate or impose more restrictions on the transportation sector. This could make operating trucks and trains more costly.

There are two areas where we could see politicians becoming active (not necessarily tied to the Presidential election): 1) an increase in the fuel tax and, 2) at the state level, general increases in sales and corporate tax rates. The trucks and rails industries are well advanced in implementing fuel surcharge clauses in their contracts, and both industries have covered more than 90% of increased costs through surcharges. There has been a lot of noise about the need for rails to invest in their infrastructure to support projected traffic increases over the next 20 years. However, a general standoff has occurred, as the rail managements say they will not invest in projects that don't meet the minimum return-on-investment-capital threshold. Translation: We demand government help via tax credits, otherwise investment will be slow in coming; and government officials (Democrats) appear stuck in the "paygo" loop, where new spending must be offset by reductions elsewhere.

A Democratic President may focus more on environmental projects, including emissions control, water infrastructure, and alternative energy, plus transportation-related projects. SAFETEALU (Safe, Accountable, Flexible, Efficient Transportation Equity Act: A Legacy for Users) expires in 2009, so the funding size of a new transportation bill will determine whether more highway, airport, and bridge projects are booked. A Republican President may focus more on the defense budget and homeland security. This could have a big effect on companies that run construction and engineering projects largely dependent on public funding, especially URS (URS), which does a lot of federal work, and its EG&G unit, which it acquired a few years ago and is completely devoted to federal projects.

Health Care

In health care, the most visible topic to date has been the implementation of an all-inclusive health insurance program intended to cover the uninsured population. Such a program would likely include direct pricing negotiations between the federal government and drug manufacturers, adversely affecting the pharmaceutical firms.

The big winners, in our view, would be the hospitals, because they have been negatively affected by rising levels of bad debt and the use of emergency rooms by uninsured individuals.

Another important election-year issue we are tracking is generic biopharmaceuticals. The Democratic candidates have been vocal advocates for the removal of barriers blocking generic drugs and of creating a pathway toward biogeneric approvals at the Food & Drug Administration. However, there are numerous reasons why we think generic biopharmaceuticals are a distant threat to the U.S. biotech firms. First, these compounds are very difficult to manufacture. They are produced from human proteins, as opposed to raw chemical ingredients used to make traditional pharmaceuticals, so that plant validations alone would take years. Second, we don't think the FDA as currently constructed has ample resources, not to mention risk tolerance, to take on a generic biopharmaceutical approval process.

In the medical-device sector, we can't identify any specific threats from the health-care proposals issued by the candidates, and note that the industry is already grappling with the fallout from a wave of high-profile product recalls, a more restrictive FDA approval process, increased oversight of physician and patient notifications, increased requirements for postapproval safety studies, and changes to Medicare reimbursements for several important device categories. We think a universal health-care insurance plan would benefit the group simply because it would likely be a financial benefit to the hospitals that purchase medical-device products.

Energy

We believe that a Democratic administration might make it easier to pass certain energy legislation, as the perceived favoritism of Republicans toward Big Oil would disappear. Ironically, we may see renewed interest in opening up areas for domestic drilling, which could drive up demand for drilling rigs. This also supports a bipartisan interest in decreasing reliance on foreign sources of crude oil and natural gas.

Democrats would likely encourage greater use of ethanol, biodiesel, and fuel-efficient vehicles with financial incentives and greater research and development. One version of a proposed alternative energy bill has the mandated amount of ethanol derived from corn doubling from 7.5 billion gallons to 15 billion gallons per year, but given what this would do to corn prices, we think it will have trouble gaining acceptance. The same bill calls for 20 billion gallons per year of cellulosic ethanol, which is a non-corn-based form of ethanol that, as yet, doesn't have viable technology to produce it.

Democrats could pursue a climate change bill, but the caucus is divided over the pursuit of nuclear power. One area where Democrats could pursue Big Oil with vigor is on the topic of price levels. It's conceivable that legislators could hold hearings on prices—especially if we have a cold winter following the election in November.

Finally, it's very possible that whoever wins the 2008 election will pursue higher royalties or taxes from energy companies.

Consumer Discretionary

Regardless of which party gains the White House, advertisers will likely be the big winners, as spot TV advertising spending is projected to rise 9% to 10% in 2008, according to the Television Bureau of Advertising.


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