After Democrats obtained a narrow majority in the House of Representatives in the midterm elections, both House Democrats and President Trump will likely be looking to make at least some deals. That does not bode well for a number of stocks, including defense stocks, pharmaceutical stocks and pharmacy benefit managers, or PBM, stocks. Investors, especially those with a short- to medium-time horizon, should consider names in those sectors as stocks to sell.
Why Trump and Democrats Will Probably Look to Make Deals
To retain their majority, House Democrats will have to convince moderate voters in the swing districts that Democrats narrowly won that they are moderate and can be productive. For his part, President Trump will likely have to convince at least some moderate voters, i.e., centrist suburban women and independents that he can make deals that will make the country and their lives better.
Furthermore, Trump, Pelosi and Senate Democratic Minority Leader Chuck Schumer will have to make deals because the country as a whole and a number of key constituencies of both parties have problems that need to be solved. Specifically, unions which mostly support Democrats, need the jobs that a major infrastructure initiative would provide, while many businesses, who mostly support the GOP, want the profits that an infrastructure initiative would bring.
Other businesses, meanwhile, just want the country’s crumbling infrastructure to be improved. Finally, there is growing evidence that Wall Street, which provides a large amount of money to both parties, is becoming upset about the country’s debt issues. And if the government doesn’t at least slow its accumulation of debt soon, the whole country will have huge problems.
In order to fund an infrastructure bill and make progress on reigning in the debt without raising taxes (tax hikes are probably a non-starter for Trump and GOP senators), the parties will have to reduce the money that the government pays to certain special interests.
Defense Will Probably Be Cut
President Trump very much believes in assuring that America’s armed forces are vastly superior to those of other countries. But his clashes with Lockheed Martin (NYSE:LMT) over the cost of the F-35 and with Boeing (NYSE:BA) over the cost of Air Force One indicate that he is able and willing to cut the amount of money that the Pentagon pays to contractors. And with Secretary of Defense Mattis widely believed to be leaving soon, Trump could look for a new defense secretary who more fully shares the president’s inclination to get more for the Pentagon’s money. That will be music to the ears of Democrats, most of whom have historically been eager to cut defense outlays.
Although defense stocks will probably perform well over the longer term, given the continued widespread tensions with Iran in the Middle East and with China in Asia, threats of budgetary cuts will probably weigh on defense stocks in the short to medium term.
Some Healthcare Stocks Are in Trouble
Of course, the federal government spends a tremendous amount of money on healthcare and a group called the Committee for a Responsible Federal Budget says, “By 2028, one-third of federal dollars not spent on interest will go toward health spending, and by 2040, nearly 40 percent will. ” That trend is, of course, unsustainable.
In a trend that doesn’t bode well for healthcare stocks, President Trump and his administration, unlike previous GOP administrations, have shown a willingness to reduce the amount of money that taxpayers and consumers give to companies in the sector. For example, the administration recently said that it would look to reduce the amount that Medicare “pays for some expensive drugs for cancer and arthritis in a move to bring the costs more in line with the prices paid in European countries,” NPR reported last month.
With Democrats taking control of the House taking control of the House, more such initiatives could be undertaken by Congress and the administration, since Democrats historically have not been all that friendly toward drug companies. As The Washington Examiner wrote in a recent article entitled, “Pelosi-Trump overtures making Big Pharma sweat bullets,” “Tackling high drug prices is a centerpiece of the Democratic agenda and remains a top priority of the White House.”
As House Democrats and the White House look to tackle high drug prices, PBMs are likely to be thrown under the bus. As I pointed out in an article published in May, the president and his administration have criticized the PBMs, with Trump saying that “the administration was ‘very much eliminating the prescription drug ‘middlemen.'” Since PBMs do little or nothing to help consumers or drug development, lowering their profits seems like a logical way for the government to reduce healthcare expenditures.
With all of that as a backdrop, here are five stocks to sell:
On page three of its 2017 annual report, Lockheed Martin disclosed that 69% of its net sales were obtained from the U.S. government, and it appears to rely on arms sales for the majority of its revenue, as all of the key products and programs described by the letter to stockholders in its annual report relate to defense.
Consequently, LMT stock could be meaningfully hurt by any worries about cuts in U.S. defense spending. Moreover, LMT stock, with a trailing price-earnings ratio of 35 and a price-book ratio of 214, , isn’t too cheap, making it more likely to decline on concerns about defense outlays.
Merck and Eli Lilly
Merck (NYSE:MRK) has developed successful but quite expensive cancer treatment Keytruda. That’s exactly the type of drug that Trump and the Democrats are likely to target for Medicare cost savings. Meanwhile, Eli Lilly (NYSE:LLY) has come under fire for raising the prices of several of its drugs, making it also vulnerable to Medicare cost savings initiatives.
Moreover, Merck stock and Eli Lilly stock have done well compared with their peers in recent years. While the SPDR S&P Pharmaceuticals ETF (NYSE:XPH) is down slightly since August 2016, MRK stock is up nearly 20% since that time and LLY stock has soared about 45% since then. Given that outperformance, both stocks may be more vulnerable to profit taking and valuation declines than their peers if the government starts looking to cut drug prices.
CVS and Express Scripts
As I noted in my May article, both CVS (NYSE:CVS) stock and Express Scripts (NASDAQ:ESRX) stock aren’t that cheap, considering the threat that increased government regulations pose to their business model.
CVS stock is trading at a trialing price-earnings-ratio of 27 and a forward P/E of 11, while ESRX stock has a trailing P/E of 11.5 and a forward P/E of 10.3. Both stocks could easily get crushed if the president even comes close to fulfilling his threat of “eliminating … the “(drug) middlemen.”
As of this writing, Larry Ramer did not hold a position in any of the aforementioned securities.