Investors have thus far underestimated the likelihood of Democrats enacting significant changes to the tax code, according to the bank’s chief U.S. equity strategist, implying that any forward progress in Washington could cause headaches for traders before the end of 2021.
“Congress intends to increase corporate taxes in order to fund reconciliation legislation. However, the stock market is only partially pricing an increase in the tax rate in 2022,” wrote David Kostin, Goldman’s chief U.S. equity strategist.
He explained that Goldman’s 2022 S&P 500 earnings forecasts include expectations for a scaled-back version of President Joe Biden’s tax plan. According to the bank, the domestic corporate tax rate will rise to 25% from 21%, and the passage of roughly half of the proposed increase in tax rates on foreign income will reduce S&P 500 earnings by 5%.
What worries Kostin the most is that his clients do not appear to be pricing in what he sees as a likely change to the US tax scheme.
Democrats are in the process of drafting $4.5 trillion in fiscal spending, which includes a $1 trillion bipartisan physical infrastructure package and a $3.5 trillion budget reconciliation bill plan to combat climate change and poverty.
Moderate Democrats, such as Sen. Joe Manchin, D-W.Va., have insisted that Congress pay for the onslaught of spending and have expressed skepticism about the need for trillions more in appropriations. Manchin told Federal Reserve Chairman Jerome Powell last month that he is concerned that the combined stimulus from the Fed and Congress will “lead to our economy overheating and unavoidable inflation taxes that hardworking Americans cannot afford.”
As early as this week, the House Ways and Means Committee is expected to outline revenue raisers associated with the reconciliation bill.
The Biden administration has floated a slew of tax proposals, including raising the corporate rate, raising the top rate on earnings to 39.6 percent, and taxing capital gains like regular income.
“The market appears to be pricing an increased tax rate in 2022 only partially,” he wrote. “The busy legislative calendar in September should lead to increased volatility in earnings estimates in the near future.”
With the economy and tax policies uncertain, Goldman advises investors to consider buying stocks with stable earnings and strong balance sheets. In other words, Kostin seeks excellence.
He singled out several Goldman High Quality Stock basket constituents as potentially sound investments in the coming months. Alphabet, the parent company of Google, Home Depot, Raymond James, and UnitedHealth all made the list of public companies with high quality scores.
“The market appears to be focusing on quality companies with consistent earnings,” Kostin wrote. “Since the beginning of June, high pricing power stocks have outperformed low pricing power stocks by 11 percentage points,” according to Goldman Sachs, and the Goldman high-quality basket has outperformed the S&P 500 by 5 percentage points.
Green data centers
Governments and corporations are putting pressure on data centers to reduce their carbon footprints, and as the landscape shifts, Barclays says there are several ways for investors to profit from the transition.
“We see data centers as mission-critical, and they are frequently overlooked by investors when discussing the sustainability profile of the ICT [information and communication technology] sector,” the firm wrote in a recent client note.
According to Barclays, data centers consume roughly 1.5 percent of global electricity consumption, and power costs account for roughly 70% of total operating costs. In addition, data centers are expected to consume 660 billion liters of water in 2020, up from 626 billion liters in 2014. Because data centers must have guaranteed power 24 hours a day, 7 days a week, they typically rely on backup diesel generators, which also necessitate constant temperature controls. Then there’s the equipment, which has its own environmental footprint.
Customers such as large enterprises and government agencies are “putting pressure on data center operators to attract their business, given the collective benefit to be had.”
Some countries, such as Amsterdam, Ireland, and Singapore, have imposed stringent environmental regulations on all new data centers.
“Given that data centers are the epicenter of digital infrastructure, it is critical that the sector implements and promotes more sustainable choices and solutions,” Barclays said, adding that sustainable data centers will soon shift from a competitive advantage to a business imperative.
According to the firm, capital spending for global data centers will exceed $187 billion in 2020, and there are numerous entry points for investors looking to capitalize on this theme. Renewable energy, backup power and generators, water usage, heat recycling, data storage and chip efficiency, circular design, and business continuity are the seven key investment factors highlighted by Barclays in the green data center ecosystem.
Equinix and Digital Realty Trust are two data center operators that should benefit from increased data volume and the trend of businesses moving their data centers off-premise in favor of service providers.
′′[Equinix] recognizes its environmental imperatives and has made good progress by articulating targets, issuing green bonds, and achieving green certification for 69 percent of its square footage,” the company said, noting that it operates 230 data centers in 64 metro areas.
When it comes to Digital Realty Trust, Barclays noted that the company has set targets “ahead of its peer group,” but that reaching 100 percent renewable energy usage may take 5 to 10 years because the company is “more focused on the quality of its sustainability efforts rather than the speed of implementation.”
Moving away from the physical asset owners, data centers are a multibillion-dollar end market for semiconductor companies.
According to Barclays, Nvidia has exposure to greening data centers within the group due to its work on more efficient hardware. According to the company, it powers nine of the top ten most energy-efficient computers. Seagate and Western Digital have data storage exposure, while Palo Alto Networks provides cybersecurity for businesses transitioning to more efficient cloud-computing systems.
Meanwhile, Microsoft, Salesforce, and Oracle have software offerings that touch on the green data center theme.
“We believe Microsoft is well positioned to benefit from the Green Data Center investment theme as a ‘theme leader,’ with various long-term sustainability targets relating to renewable energy and water efficiency,” the firm said of the tech behemoth.
Amazon and Alphabet are two of the largest players in the public cloud. Given the size of each, focusing on energy-efficient systems, including the use of renewable energy, has far-reaching consequences.
3M, Eaton, and Johnson Controls provide critical equipment, while Caterpillar and Cummins may benefit as data center construction progresses.
“Data centers have provided a consistent source of demand for the construction sector, with global spending expected to reach $200 billion in 2021,” according to the firm.
Of course, given the large number of companies involved in each component of data centers, measuring the environmental impact of the entire value chain is difficult. However, the firm claims that the significance will only grow.
“We believe the discussion on green data centers will grow in importance over the next 5-10 years, in tandem with reliance on digital infrastructure,” the firm said.