Why One Bank Thinks Big Tech Is ‘The Most At Risk’ If Joe Biden Takes The Oval Office

What’s at stake in November?

Well, quite a bit, as it turns out. For many critics of the current administration, no less than the future of democracy in America is up for grabs. On top of concerns about the erosion of the country’s institutions, the civil unrest sweeping the nation is a testament to the idea that decades of inequality and social injustice will no longer be tolerated. The fact that the protests reached the doorstep of the White House on June 1 speaks to the urgency of the situation.

But, for investors, the main issue is corporate taxes. It’s terribly callous, I know. And the idea that market participants are more concerned with protecting the bottom line, defending margins, and facilitating an environment that’s conducive to EPS-inflating buybacks, itself speaks to why large swaths of the populace are so fed up.

Be that as it may, a 7 percentage point swing in the corporate tax rate is a huge deal for the 10% of the country that controls nearly 90% of corporate equities and mutual fund shares (figure above).

That’s why when it comes to analyst notes previewing the election, the focus is squarely on taxes. It’s not just the direct hit to the bottom line, but also the prospect of reduced buybacks coming off a year during which the corporate bid is expected to collapse by half thanks to the financial impact of the virus.

With gross share repurchases in free fall and equity issuance rising as companies raise cash, net equity demand from corporations is seen plunging 80% in 2020, on Goldman’s estimates.

That’s the setup headed into the election. The point: If the result is unfavorable for corporations, it will be insult to injury.

“Tax cuts have been the single biggest policy outcome of [Trump’s] presidency”, SocGen’s Sophie Huynh writes, in a new US equity strategy piece out Tuesday. “Among Biden’s proposals, we estimate that the proposed tax increases would have the greatest potential impact on the US economy and would likely cause a market reaction”, she adds.

That much we know. The next question is which sectors and names would get hit the hardest if one assumes the market will immediately price the expected impact of tax changes in a vacuum (i.e., without regard for the feasibility of quickly changing tax policy and/or without considering potential offsetting factors that would benefit corporate bottom lines)?

For Huynh, the answer is pretty straightforward. She screens for stocks with i) 2018-19 effective tax rates below 21%, ii) 2018-19 EBIT margins below the S&P 500, iii) Merton DD below the S&P 500 (weighted) average, and iv) more than 61% of revenues generated in the US. The list is as follows:

But more important is her discussion of big tech, the driving force behind US equity outperformance (versus the rest of the world) and one of the only places one can look for reliable top- and bottom-line growth.

“We think US ‘Big Tech’ would be the most at risk if Biden is elected and we see a likelihood of a blue wave in Congress”, SocGen says, in the course of warning that big tech is “at the crossroads of several tax proposals”.

On Monday, I mentioned that the rally in tech, while disconcerting for a number of reasons not least of which is lackluster breadth, at least makes some measure of sense when you consider that the companies shouldering a disproportionate share of the burden are also chipping in a larger portion of overall profits compared to the dot-com bubble. Of course, profit concentration is itself a concern, as is revenue concentration. Here’s SocGen’s Huynh:

While a sector shift within the US equity landscape throughout decades makes sense as progress and innovation push the economy forward, the largest companies account for an ever growing part of the US economy, which we find worrisome. While industrial companies were dominating in the 1970s (peak in manufacturing employment in the late 1970s), electronics and IT took over in the 2000s, with the revenues of the top 15 companies within the S&P 500 at 11- 12% of GDP. In 2020, the top 15 companies’ revenues are equal to 16.3% of US nominal GDP (the revenues of Walmart, Amazon and Apple combined represent 5% of US GDP). Thus, there is an increasing focus on antitrust issues, with a particular focus on Big Tech.

It’s with this in mind that the bank continues to believe in shorting what they call the “New Tech Basket”.

Compared to “Old Tech”, new tech are consumer-facing companies and platforms with user-generated content. As we’ve seen over the past several months, the user-generated content question is becoming very problematic. Facebook is staring down a veritable advertiser revolt tied to hate speech, and Twitter is battling to keep misinformation off the platform, an effort which has been criticized by some Republicans as intentionally biased against conservative voices (apparently, Twitter isn’t within its rights as a private company to point out to users when politicians say things that are demonstrably false).

That is a liability, alongside known risks tied to anti-trust concerns. Here is the composition of SocGen’s “Old” and “New” tech baskets:

To be sure, the Trump administration has not been shy about threatening tech companies. The president’s grudge against Jeff Bezos is the stuff of legend, and last month, he issued an executive order targeting social media giants. No one took that seriously until William Barr spoke up and lawmakers began debating the merits of stripping social media companies of Section 230 protections.

But as hard as Trump is on tech, SocGen appears to believe that the combination of those risks (which will persist under Biden) and the prospect of a corporate minimum tax and higher GILTI rate, makes big tech even more vulnerable under a Democratic sweep scenario.

Throw in the ongoing debate about a universal digital tax, and you’ve got a pretty solid rationale for a bear case.

“We continue to recommend our short New Tech Basket”, Huynh says, driving home the point, and citing three themes:

1. Antitrust law (Biden is calling for more investigations);
2. Social media issues with the liability of users’ posts, privacy breach and data leaks; and
3. The digital taxation problem

And yet, all of this comes as the post-COVID reality tends to favor many of trends associated with “new” tech. I suppose that’s what makes a market, as they say.