Stock-market investors are already betting on an infrastructure spending spree

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Investors are once again factoring in the prospect of a big round of long-term infrastructure spending even as U.S. lawmakers work toward a short-term round of relief that’s expected to come in near President Joe Biden’s $1.9 trillion price tag.

Analysts have already started to “embed expectations” for infrastructure spending, as evidenced by a 25% surge in projected 2021 earnings for companies in the S&P 500 machinery sub-index since June, as opposed to an average rise or around 6% for companies the broader S&P 500 index, said Mark Hackett, chief of investment research at Nationwide, in an interview.

The machinery group, which along with the broader industrials sector is seen as a primary beneficiary of a boost in infrastructure spending, has rallied around 118% from its pandemic lows set last March, versus the S&P 500’s 78% rally. Industrials are up more than 86% from those lows, while materials stocks, which investors also expect to benefit, have bounced 95%.

No doubt, part of those gains are down to other pro-cyclical factors, including vaccine rollouts, falling COVID-19 cases, and two heavy load of near-term fiscal stimulus, Hackett said. At the same time, investors are also aware that infrastructure spending is quite likely to lead to tax increases which could blunt the upside for stocks.

U.S. Treasury Secretary Janet Yellen, in a Thursday interview with CNBC, said tax increases on corporations and high-income individuals would be used to pay for part of Biden’s infrastructure plan. Yellen said there wasn’t yet a cost estimate for an infrastructure plan that’s still being put together.

Meanwhile, companies that already have a “green” or eco-friendly tilt may be poised to benefit most within the sectors and industries likely to reap the benefits of an infrastructure program, said Elizabeth Vermillion, equity analyst at CFRA, in an interview.

That includes companies like construction-equipment giant Caterpillar Inc. CAT, +3.88%, which offer a variety of battery electric and alternative-fuel equipment that could be favored as part of a Biden plan. Trucking companies could also benefit as they look to piggyback on the build out of infrastructure for electric vehicles.

Companies related to 5G mobile phone infrastructure may also benefit, she said. That includes not only carriers and the companies developing 5G technology, but also industrial companies that will be building towers, putting wires in the ground and building out the grid.

At the same time, investor enthusiasm may be curbed by memories of 2016, when optimism ran rampant for a big infrastructure push after Donald Trump’s election victory. Those efforts came to nothing, with “Infrastructure Week” eventually becoming a political punchline.

Plenty of skepticism remains.

Part of the political appeal of a large-scale infrastructure package is it’s ability to put people back to work. But if the economy does pick up momentum as vaccine rollouts continue, the resulting fall in unemployment could serve to undercut enthusiasm for infrastructure spending, said Nicholas Colas, co-founder of DataTrek Research, in remarks at a Thursday online seminar hosted by Capital Institutional Services.

Meanwhile, if a plan is enacted that includes corporate tax hikes that unwind a portion of the Trump cut from 35% to 21%, investors should expect to see the biggest headwinds for utilities and communications stocks, the two biggest beneficiaries of the tax reduction, Hackett said. The third biggest hit would be suffered by industrial companies, blunting some of the upside from the increased spending.

It isn’t only stock-market investors that are starting to pencil in prospects for more spending on infrastructure, Hackett said. Rising inflation expectations, in part, also reflect that potential as does the related rise in U.S. Treasury debt yields.

Indeed, while economists at Bank of America said they remained skeptical of inflation prospects around the globe, they see the U.S. as an exception. Big rounds of fiscal spending already in the pipeline and perhaps to come, including up to $2 trillion in infrastructure spending over four years, remain an upside risk to the inflation outlook, wrote Ethan Harris and Aditya Bhave, in a Feb. 5 note.

The past week saw stocks end mostly lower but not far off all-time highs, with the S&P 500 SPX, -0.77% losing 0.7% and the tech-heavy Nasdaq Composite COMP, -2.46% down 1.6%. The Dow Jones Industrial Average DJIA, +0.09% eked out a 0.1% weekly gain.