Looking ahead at what lies beyond ‘Build Back Better’
Senator Joe Manchin has withdrawn his support for US President Joe Biden’s Build Back Better legislation. Manchin’s opposition effectively kills the budget reconciliation bill in its current form, after months of negotiation.
Senate Majority Leader Chuck Schumer has said that a vote will still be held in January on a revised Build Back Better reconciliation bill, but absent substantive changes, we don’t expect Manchin to change his mind. The Dem- ocrats will be forced to scale back their expectations, focusing on fewer priorities and funding them on a permanent basis. This opens up the possibility that a more streamlined budget bill may still be presented for consideration during the first quarter of 2022.
We believe that a smaller and less expensive reconciliation bill is still possible, albeit likely to encounter numerous obstacles.
But, while uncertainty has increased, we note the following:
• The collapse in negotiations does not significantly alter the growth outlook. A failure to pass the bill should reduce GDP growth slightly relative to current expectations for next year, but only by a few tenths of a percent for an economy that’s likely to grow close to 4%. The risk of higher—or alternative minimum— corporate taxes is also eliminated if a plan does not pass, so the net effect on corporate earnings should be close to zero.
• Despite regulatory uncertainty, we prefer healthcare. The drug pricing proposals in the Build Back Better bill would have had only a limited impact on the pharma sector, in our view. If passed, we think the removal of the regulatory overhang would have created a catalyst supporting a positive repricing of pharma sector stocks. That outcome is now uncertain, but we continue to prefer the healthcare sector. First, slowing growth in the second half of 2022 should favor more defensive sectors such as healthcare. Second, valuations are attractive; over the last 20 years, the global healthcare sector has traded at an average 10% premium to global equities, but today this premium is just 2%. Pharma stocks appear particularly cheap, with the MSCI All Country Pharma index trading at an 18% discount to the MSCI All Country World Index on a 12-month forward price-to-earnings basis. And third, in medtech, which accounts for around a third of healthcare market capitalization, we expect revenue growth to pick up in 2022 as hospital access recovers from the winter COVID-19 wave and the backlog of procedures is dealt with.
• The investment opportunity in the net-zero carbon transition remains intact. Shares in renewable energy firms such as solar companies and electric vehicle makers slipped after Manchin’s announcement. But the case for investing in the net-zero carbon transition goes far beyond US fiscal support. With 136 countries responsible for 88% of global emissions making net-zero pledges, according to Net Zero Tracker, the energy transition has become a critical investment theme. Most of the reductions in global CO2 emissions through 2030 will be driven by replacing some fossil fuel usage with renewable energy. We see opportunity across greentech, clean air and carbon reduction solutions, as well as in carbon trading strategies and ESG leaders. We see value in select global automakers with EV exposure in the US, Europe, and Japan, and select EV OEM pure-plays in China, as well as select EV component, sensor, and battery makers in these markets. Read more on investing in the net-zero carbon transition.
The timing of Manchin’s decision was unexpected and comes at a time when markets are worried about slowing growth due to the omicron variant and the prospect of Federal Reserve policy becoming less accommodative. The fiscal news has contributed to market volatility, but is secondary to these other risks, in our view.