Sunday, November 17, 2013

Economic Commentary: Healthcare

  I attended a healthcare conference on Friday and learned a few things, but I'll start with a personal anecdote. I recently had my annual physical and received the itemized bill. The standard battery of blood tests cost $1300 as part of the Northwestern university medical system. My physician asked me to retake two of the tests because of lab errors. I'm on a high deductible plan and so I was curious if I could get the same tests done less expensively elsewhere. The exact same tests were offered at numerous labs around Chicago for $130. Why would any individual or any insurance company agree to pay 10x more than necessary for routine blood tests? How can such an enormous pricing disparity persist?

The Current State
   US healthcare spending is about double that of comparable countries with similar outcomes. A little bit of this difference comes from superfluous procedures and tests, higher medical liability insurance premiums, and hospital emergency room procedures. But the vast bulk of the disparity comes from higher prices on the same medications and procedures.

  The trillion dollar question is why do the same procedures and medication cost 2x-5x as much in the US as in other developed countries? 

Prices are higher here primarily for two reasons:
   1. Prices are not transparent.  This is, I believe, by far the biggest issue. A hospital in the US often charges literally 30 different prices for the same procedure to different constituents, and these prices are not public. Every insurance company receives a separate price, as do medicaid and medicare patients and the uninsured. This lack of transparency means there's no price competition. Consumers usually have no idea in advance what they will be charged for a procedure and so they can't comparison shop. This means that not only is there no competition between providers on price, but there isn't even any substitution. With price transparency, consumers would go to hospital A for the services it provides most efficiently and hospital B for the services in which it specializes, which would yield a lower effective cost of service, even if the prices themselves didn't change at all. In most comparable countries, there's some government entity that can see all prices and is able to purchase the healthcare from the most efficient providers in each category. This is also true with pharmaceutical drugs. In the US, two pharmacies within a 10 mile radius will offer the same drug at a 400% price disparity. The disparity persists because consumers don't know, and don't care. Which brings us to #2.

 2. No one pays directly. No one is simultaneously both incentivized and capable of being an intelligent purchaser of healthcare in the US. Consumers are mostly on low deductible plans or medicaid and medicare, and so most don't care about the prices they're being charged. Insurance companies are somewhat incentivized to negotiate for lower prices, but in many cases they can pass their costs on to consumers, and they're stymied in their ability to negotiate by consumers' preference for broad coverage networks. Insurance companies can't limit their coverage to just the most efficient providers, because consumers will buy other insurance plans that give them access to a broader network.

The Future
   The key trend in healthcare is towards choice. It's not clear if and when pricing information will become more transparent, but many other aspects of healthcare are becoming shoppable. There are now both public and private systems for rating doctors and hospitals and much more performance data is being collected by the government. This has created opportunity for startups that help hospitals improve their performance figures (like a company that is installing RFID sensors into soap dispensers to insure that all physicians wash their hands), as well as by 3rd party medical providers that now have the data to convince consumers they're better. The CEO of One Medical Group spoke at the conference; their tag line is, "The doctor's office reinvented." They provide more convenient care (e.g. offering consultations by skype to patients that would rather not trek into the office) that also provide cost savings (e.g. by encouraging earlier patient-physician contact, they catch problems earlier when they're cheaper to fix.) The battery of new data allows One Medical Group to provide a strong pitch to patients that the quality of care they provide is better than that of traditional, much larger institutions.

 The presenters at the conference all believed that sudden, radical change was unlikely. Rather they expected increasingly large cracks in the traditional healthcare model, cracks that will be filled by startups that treat healthcare like consumer electronics.


Tuesday, June 11, 2013

The Tepper Rally and the End of the 30 year Bond Bull Market

   From November of last year through May 22nd, equities crawled higher, slowly but consistently for a whopping 26% rally.  The last few days of the move were nicknamed the "Tepper" rally, because hedge fund titan David Tepper went on CNBC to explain why he was bullish.  The doubters were concerned that as the Fed tapers quantitative easing over the next year, the reduction in easy money may prove fatal to equities and possibly most other assets.  The Fed is currently buying $85 billion a month in treasury and mortgage securities and investors wonder how much of the equity rally was because of this buying and if it ends, will the equity rally reverse?
   Tepper explained that while the Fed will be reducing its stimulus, the size of the fiscal deficit is shrinking even faster.  The fiscal deficit has fallen from about a peak of $1.4 trillion in 2009 to $1 trillion in 2012.  Next year was previously projected to fall slightly to $850 billion but the latest estimates put it at closer to $600 billion.  This $400 billion reduction in the deficit from 2012 to 2013 comes primarily from an increase in taxes from higher personal income and corporate profitability.  
   From a basic value investing perspective, the market appears roughly fairly valued.  I think the greatest risk to equity performance is currently Japan.  Japan is the world's third largest economy and if it faces a crisis, the contagion effect will be drastic.  
   Bill Gross is the founder of PIMCO, the word's largest bond fund with $2 trillion in assets under management.  Gross recently said that he thinks the 30 year treasury bull market finally ended this April.  Over the last month we've seen a sharp increase in treasury shields, but they're still quite low in any sort of historical context.  Over the last 50 years, 10-year yields have averaged about 6.6% and they're currently 2.2%.  That 6.6% number is probably a bad anchor since it included the severe inflation of the late 70s and represents the period with the highest consistent GDP growth that humanity has ever seen.  Still, 2.2% 10-year yields are unsustainably low in any sort of growth environment.  
 Gross predicts that while the Bull market ended this April, the Bear market won't start for another 3 to 4 years.  He suggests a generally range bound market in treasuries in the mean time, albeit with higher volatility.  I think Gross is likely right.


Friday, March 22, 2013

Backpacking in South America and a Global Update


   I spent January and February backpacking through Argentina, Chile, Peru, and Ecuador.  I wish I could write an analysis of the economies and societies as detailed as I did for China last year here, but I didn't gain comparable insight.  There are a few key themes worth briefly discussing, and a few specifics that I think you'll find interesting.  I'll then delve into a update on global markets.

South America: Most of South America is export driven with a focus on raw commodities.  China provides much of the marginal demand for commodities ranging from cattle to iron, so several South American countries are nearly a levered play on China.  Much of the continent faced intermittent civil war until just 35 years ago, so social institutions are weak and corruption is rampant.  
  Argentina is in the midst of a currency crisis, which will likely become a fiscal and political crisis in the next two years.  Wealthy Argentines are pulling their money out of the country as fast as they can circumvent the capital controls in place, and I wouldn't suggest fighting the smart herd.  One funny anecdote that highlights Argentine problems - the magazine ''The Economist'' publishes a ''Big Mac'' index, comparing the prices of McDonald's Big Mac across countries as a half-serious inflation index.  The government of Argentina ordered McDonald's to lower the price of its Big Mac in Argentina to make inflation appear lower.  McDonald's responded by lowering the price, but hiding the item from the menu.  If you walk into a McDonald's in Buenos Aires, you won't see the Big Mac advertised, but can request it and get a half-price meal.
  From a social perspective, Chile has a strong work ethic and social fabric, but is overly dependent on copper (42% of exports), and has a stifling bureaucracy; crossing the border from Mendoza into Santiago by bus required a 4 hour layover at border security where I had to stand in 3 separate lines to get various documents stamped.  Domestic service industries are nascent at best.  Peru and Ecuador lack the social institutions and infrastructure to support fast economic growth in the near future.  Of the four countries I visited, I'm most optimistic about Chile in the medium and long-term.
   Finally, one random point of interest about global real estate - I met an Argentine entrepreneur/investor named Jose who made the point that between 1965 and today, the population of the world doubled with plenty of population growth in the US, and even in Western Europe, so obviously there was strong demand for new homes and offices.  Today, the population of the western world is stagnant, and in many places shrinking.  Instead of a growing pie, we now have a shrinking pie in many areas.  For every new "hot spot" development, blocks of other homes must become abandoned.  Any time you see an underpopulated area that you think will prove a good investment, you need to ask yourself, where will the people come from to fill it and what other area must become underpopulated?  Real estate is fundamentally local, so there will certainly be areas of high growth and great returns to investment, but the secular trend is for stagnant demand.   Housing trends of the last century were supported by relatively consistent population growth that has now ended.  This argument even applies to much of the Eastern world.  China's population has stagnated and Japan is shrinking.  World population growth is coming almost entirely from India and Africa.  

Global Update: I recommended shorting the Yen in early 2012 and it's come down around 17%, with half that move coming in the last few months.  This is a big move for a currency and this trade has become a little crowded from a short-term technical perspective...but I still love the position and think it has a long ways to run.  I discussed the logic here; since then Japan has gained a new central bank head who was brought on specifically to print money and induce inflation.  This may end up looking like the best and most obvious trade of 2013 and 2014; I suggest selling on any pullbacks if you're not already in the trade.  
   Equities have continued their "stealth rally", a series of small winning days that have largely left the retail investor behind and many professionals too as people wait for significant but nonexistent dips to buy.  Retail investors stepped up their investments in mutual funds in the last three months, chasing recent moves as always, but more buying pressure has come as corporations buy back their own stock with cash on hand or newly issued debt.  It's perfectly sensible for companies to pursue these buybacks, but it has historically anticipated periods of poor equity returns for the market as a whole going forward.  
   The federal reserve is knee deep in the fourth round of quantitative easing with $85 billion in purchases of mortgage securities and treasury bonds each month.  I think they'll likely end the MBS purchases within the next 6 months since Fed officials have acknowledged they're ineffective; the MBS buying is just turned into profit for a handful of lenders and big banks and is having little effect on mortgage rates.  How long Fed bond purchases continue is anyone's guess.
   Finally, there's currently a bank run going on in Cyprus, which creates a risk that Cyprus could leave the Eurozone and set a bad precedent for the PIGS.  The problem is that the ECB/EU organizations are reluctant to simply write a blank check to solve the problem, and Cyprus' debt is so great relative to its GDP that the only way to cover it may be to seize individual deposits from banks.  Still, the total problem is just $13 billion, a trivial sum in the scheme of Eurozone problems; this will likely be easily resolved soon, but there's a small risk that it will be the straw that breaks the overburdened camel's back.  
Ending corruption:  I promised Jose that I would ask for the input of my brightest friends and colleagues on ending Argentine corruption and that of other South American countries.  Jose has done his own research and estimates that the Argentine government accepts about $3 billion in bribes annually to dole out state construction contracts and similar projects.  This creates massive dislocations and inefficiencies.  Jose is looking for ways to make a difference, and exploring ideas like creating a Wikileaks type site to expose the corruption of individual politicians.  Some other ideas include creating an agreement with global financial institutions (either imposed from above like the Basel accords or as a voluntary organization), to stop funneling dirty money out of Argentina.  If politicians had no way to get sums larger than $1 million out of the country without anyone noticing, bribe taking would be greatly reduced.  We're looking for creative and practical ideas.