Thursday, March 25, 2010

Divergence and Healthcare - Ari Paul

The theme for the last 6 months has been a divergence in fundamentals between bullish corporate data and a bearish macro climate. The trend continues.

Fueling the stock rally of the last month have been rumors that many companies are on the verge of increasing dividend payouts and share buybacks. Large US companies are sitting on lots of cash. Many halted share buybacks and held off increasing dividend payouts to be conservative in the dangerous economic climate. As optimism returns and their cash piles grow, they will soon start returning money to shareholders in various forms. Investors are rightly taking this as bullish for stocks. Also, the stock markets of some strong developing countries like Israel and Argentina are setting new all-time highs. Inflation has remained under control, and interest rates are stable.

We’ve simultaneously been getting bearish macro data. Home prices and sales have resumed their downward decline and consumer sentiment dropped slightly. Germany seems to have taken a stand against bailing out Greece and is looking to introduce measures that will make it easier to kick the next crisis country out of the Eurozone. Basic measures of economic activity like the Baltic Dry Index (a measure of international shipping activity) and US freight volume have turned down. None of these measures are collapsing, but they appear to be (at least temporarily) stagnating; they undermine the idea that we’re in the midst of a robust recovery.

My basic thesis is unchanged; corporations are generally healthy because their debt has been transferred to the government. Households are in terrible shape, and the government’s balance sheet is in terrible shape. Below is a graph of transfer income as a percentage of total income – it shows that the resilience in the US consumer may be due to a 4% increase in government “gifts” to the consumer over the last few years. Consumers spend that money and companies seem to prosper, but of course it’s not a free lunch. At some point the “gifts” either create inflation, crowd out productive investment, or lead to a crash when the government eventually tightens credit.

A note on the recently passed healthcare bill: Serious investors believe it adds roughly half a trillion dollars to the US debt over the next decade. It also will certainly self-destruct since no rational healthy person would pay for insurance when you can get insurance on your way to the hospital for the same price as a healthy person (by law), and the penalty for being uninsured is a paltry $750 or 2.5% of income. Drastic changes must be made to the bill for it to work at all, and at some point, we really will have to bend the cost curve down to avoid bankruptcy as a country. There still isn’t the political will for the obvious technocratic fixes like tort reform and ending state insurance monopolies.

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