1. The healthcare decline — opportunity or trap? While the U.S. market has rebounded strongly from the correction that unfolded at the end of 2018, not all sectors have performed well. Healthcare in particular has lagged the broader market, as early jockeying by Democratic presidential hopefuls has pushed the political conversation further in the direction of radical healthcare proposals, such as Medicare for All, that would upend the current economic structure of healthcare delivery in the U.S. Investors looking for bargains among healthcare stocks should be careful. When political storms rage, they are rarely kind to the businesses in their path.
We look back at the performance of healthcare stocks in the early 1990s, between the election of Bill Clinton after a campaign that focused on healthcare reform, and the final defeat of his proposed Health Security Act at the end of 1994. That time was overall a positive one for U.S. stocks — but not for healthcare stocks, which endured considerable volatility and underperformed significantly. It may be true that the U.S. electorate is not ready to embrace single-payer or some other similarly radical change, but the public debate will continue for some time, at least until the 2020 election — and while that debate is ongoing, healthcare is in general a sector that active investors may want to avoid, or at least approach with great caution. Add in the various more modest proposals that are being made by politicians on both sides of the aisle — such as the Trump administration’s proposal to index U.S. drug prices to those in Europe — and you have a classic situation of political headwinds that should lead active investors to find better places to put their money to work.
2. In the “crypto winter,” is it worth paying attention to Bitcoin and blockchain anymore? After the Bitcoin crash of 2018, is it all over for cryptocurrencies and for blockchain, the technology that they helped to popularize? Some say Bitcoin mania was like the tulip bulb craze; others say it was the beginning of a technological revolution. The latter is likely closer to the truth. In many ways, the emerging blockchain universe is comparable to the early stages of a new internet — rather than an internet of communication, it is a secure, decentralized internet of finance and exchange. What the crash revealed is simply that the real promise of these new technologies is further away than the evangelists (and snake oil salesmen) wanted anyone to believe. As the “crypto winter” goes on, under the ice there are regulators, big financial actors, entrepreneurs, and engineers at work trying to bring the blockchain dream closer to fruition. Gamblers looking to make a fast buck should probably look elsewhere — but intelligent investors should patiently “watch this space” so that they’re ready as the regulatory environment and the technology mature.
3. Market summary. We continue to be bullish on the U.S. economy and on U.S. stocks. The “new normal” that was promoted a few years ago has turned out to have been a “new abnormal,” as investment and productivity turn up. Central banks around the world have “stepped dovish” as we noted last week, removing the overhang posed to investor sentiment by the fear that central banks on autopilot would tip the global economy into recession. Earnings season has begun in the United States; so far, earnings are, overall, beating expectations. We believe that growth and earnings will accelerate as 2019 progresses. The current stimulus being implemented by the Chinese government is not large by historical standards, and is occurring in the context of China’s ongoing efforts to rein in excess indebtedness and leverage in the shadow banking system. Still, we believe this stimulus will continue. We continue to like emerging markets as well, given the turn in global growth trends and the possibility of a resolution to trade tensions between the U.S. and China. After lagging for years, emerging markets are cheaper than usual relative to developed markets. We particularly like some emerging-market Asian manufacturing exporters. Should the dollar mount a significant rally, though, investors would be better served by staying in the U.S. However, as long as dollar strength remains muted, emerging markets and gold will be supported.
Healthcare: Buying Opportunity or Trap? Taking Stock of Past Lessons
The strong recovery of the U.S. stock market in 2019 year to date has not treated all sectors equally (rallies rarely do). Healthcare has been a particularly noteworthy laggard in spite of fairly consistent earnings growth, having gone sideways while the market as a whole has moved higher. (It has recovered somewhat from its fourth quarter lows, but is still down nearly 6% from the high of early December.)
U.S. Healthcare Sector Performance vs S&P 500, 2019 Year-to-Date
Source: Bloomberg, LLP
Does this mean that some healthcare stocks may be starting to present buying opportunities? Investors should always be alert to circumstances in which market participants’ irrationality opens up the chance to buy high-quality, discount merchandise.
Whether it is wise to take that chance depends on the bigger context, as well as investors’ risk tolerance and investment horizon. This is where, inevitably, political considerations come into play. A stock’s fundamentals cannot be considered in isolation from the political and regulatory environment, when those have a potentially significant impact on future earnings potential.
Lessons From History
The overhang for healthcare is political. Specifically, many of the candidates for the Democratic Party nomination in 2020 have adopted the platform of single-payer healthcare (that is, government-sponsored and guaranteed coverage) which was most recently promoted by Vermont senator Bernie Sanders during his 2016 Democratic primary campaign. Obviously, a move to a single-payer system would involve radical changes to the economics of U.S. healthcare delivery, and that would throw the profitability and survival of many healthcare-sector companies into question. There are many other proposed reforms being floated by the current administration and others — and even those that are modest in comparison with single payer could still be extremely disruptive. (An example is the administration’s proposals to investigate the indexing of U.S. pharmaceutical reimbursements to those of European countries — which would be in essence an indirect and partial adoption of European price controls.)
We can think of two other circumstances in which the U.S. healthcare system faced the possibility of radical change. One was the period of debate and initial implementation of President Barack Obama’s Affordable Care Act between 2008 and 2010. That period is not very helpful to examine, because it also spanned the financial crisis, the Great Recession, and a major market crash — in short, a good deal of extraneous noise that makes its effects hard to evaluate.
More interesting is to consider the beginning of Bill Clinton’s first presidential term, between his election in November, 1992 and the final failure of his proposed Health Security Act in September, 1994 — a period during which his administration tried, and failed, to enact sweeping healthcare reform.
During that period, as during the present year, the healthcare sector drastically underperformed the broad stock market. It closed the period essentially flat, while the broad market was up nearly 11%. Healthcare also endured significant volatility as the controversy and infighting played out — at the worst, underperforming the broad market by more than 25%. By the end, it was recovering sharply as it became apparent that the Health Security Act would never make it into law.
U.S. Healthcare Sector Performance vs S&P 500, 1992–1993:
Would You Really Want to Own That Red Line?
Source: Bloomberg, LLP
While holding healthcare stocks during that period was not ultimately a catastrophe, it was certainly an unnerving and unrewarding exercise.
Then, as now, observers could point out that radical reform was unlikely ever to be implemented. (Of course, the political climate is different now; an Axios poll in February showed that almost 74% of Millennial and Gen Z voters agree with the statement that “government should provide universal health care,” and this cohort will make up 37% of eligible voters in 2020. They don’t seem to make it to the polls that much, however.)
Even if as we believe, the arrival of a single-payer system is really many years away in the United States (or may never occur), the 1992–1994 period gives investors some clear lessons. Healthcare stocks during that period were indeed cheap in relation to their anticipated earnings — but they were cheap for a reason.
Further, they are not now as cheap as they were then. On a forward price-to-earnings basis, healthcare stocks are trading at a discount of about 17% to the S&P 500, versus their long-term average of a 12% discount. Back in 1993, they traded at a discount of nearly 24%. In short, there is plenty of room for multiples to contract still further as the political pressure mounts between now and November, 2020.
An investor mulling a foray into healthcare at this juncture to take advantage of its discount should therefore ask herself a few questions.
First, “How do I evaluate the political risks? What is the likelihood that a reform as radical as single-payer might actually become law in the next few years?” (We think the answer is “Not high, but higher than it was in 1993.”)
Second, “Do I think the present opportunity is the best I’ll get, or is it likely that there will be further volatility and further declines?” (We think the answer is, “There will very likely be deeper declines, depending on how the Democratic nomination process proceeds.”)
Third, “Are there other investment areas that are better positioned? Is the opportunity cost too great to allocate funds to healthcare?” (We think the answer is, “Yes, there are better areas, and the opportunity cost of investing in healthcare would be high.”)
And fourth, “If I can handle the political risks, and I think this is a good opportunity, do I have a time horizon of at least 18 months, and can I psychologically endure a 25–30% or greater drawdown in the meantime?” (This is a question that investors can only answer for themselves — and the more honest they can be with themselves, the better.)
Investment implications: We are advocates of active investing. We advocate concentrating attention in countries, sectors, and industries that are experiencing, or that our careful research leads us to believe will soon experience, tailwinds rather than headwinds. We do not believe that investors must hold stocks from all sectors and industries at any given time. At this juncture, we believe the political risks faced by the healthcare sector are substantial and rising. Even if those risks do not materialize, the volatility faced by the sector is unlikely to abate. The underperformance of healthcare stocks is likely to continue, and their discount to the broad market is likely to widen before it narrows again. Investors seeking an attractive entry point would be, we believe, well-served by further patience and by a careful monitoring of the ongoing political process in the leadup to the 2020 presidential election in the U.S. We believe that there will be better opportunities elsewhere in the meantime. If your analysis leads you to seek healthcare exposure now, we advise entering positions slowly.
Whatever Happened With Bitcoin and Blockchain?
“Winter is coming.” In fact, as far as Bitcoin and blockchain go, winter has already arrived. Yet neither Bitcoin nor blockchain projects have disappeared, and development is ongoing. So where do things stand, and is this an area to which investors should give any thought?
A Brief Recap: What Is Bitcoin, and What Is Blockchain?
For those who missed our crypto coverage in the period before the Bitcoin bubble burst in 2017, here’s a quick recap.
Bitcoin is digital money. It differs from the money in your bank account because the entities that are ultimately responsible for keeping track of the money in your bank account are your bank and its auditors — that is, it’s centralized. Bitcoin has no centralized entity doing that job. Instead, the job is done by a decentralized network of computers, using a cleverly constructed system of computations and cryptography to keep transactions secure and ensure that no invalid transactions can occur. (We wrote some more detailed explanations of how Bitcoin works back in 2017 — give the office a call if you’d like to receive a copy.) Participants in that network are rewarded for their work by the automatic creation of new Bitcoins and by voluntary transaction fees that Bitcoin users add in order to speed up the approval of their transactions. The total supply of Bitcoins is capped by the system at 21 million, and once that’s reached, no more will ever be created.
The decentralized ledger that keeps track of how much Bitcoin any given user has is called a “blockchain.” As the Bitcoin bubble inflated, the blockchain idea also became a craze, spawning thousands of projects and cryptocurrency tokens modeled on Bitcoin but with a variety of other uses. Many in mainstream finance and technology began looking at blockchain to see if the technology might be able to streamline and digitize everything from asset purchases and sales to gaming, logistics, title searches, and food safety. Name the area and there was some fiery evangelist saying, “It would be better on a blockchain!”
Needless to say, a lot of that was straight-up hype, greed, and misinformation.
What’s Happening Now?
The 2017 bubble inflated and burst, the tide of crypto and blockchain interest receded, many projects were shelved, and mainstream financial firms delayed or dialed back their plans. Negative news came fast and furious. Many projects that had raised money by creating blockchains and selling tokens turned out to be scams. Token exchanges around the world, almost all of them completely unregulated, turned out to be doing classic manipulations to juice token prices and fleece the unwitting. Inadequately protected exchanges were hacked and tokens were stolen. As the crypto tide flowed out, it revealed a lot of garbage and naked swimmers.
With all that said, however, crypto and blockchain are not dead. Depending on who you talk to, these technologies are either like tulip bulbs (that is, the bubble was insane, it burst, and now it’s over) or like the internet after the dot-com crash — a revolutionary technology that is still in the early innings, coping with cycles of hype and despair, with its real glory days still to come. It’s tough to say, but our feeling is that the latter picture is closer to the truth.
The analogy with the early internet is apt. Just as the internet itself is basically a decentralized network of servers which communicate using agreed-upon protocols, the various blockchains are networks of computers conducting secured transactions using agreed-upon protocols. In essence, blockchain projects are building a secure, decentralized internet of exchange. That has revolutionary potential to disrupt a lot of financial and economic players by removing intermediaries. Connect it to the burgeoning internet of things, and you can see why the evangelists got so excited. We still believe the technologies being created around blockchain will have revolutionary impact.
However, what the Bitcoin craze revealed is that all this is further away than the evangelists wanted to believe. There are huge problems in the way. The present writer first experienced the internet in the mid 1970s when his father, a university professor, showed him an ARPANET connection, complete with a suction-cup modem cradle to hold a Bell telephone handset. Twenty years would pass before the founding of Amazon [NASDAQ: AMZN], and more than thirty years before the world-wide web became a fixture of daily life that everyone carried around in their pockets thanks to Apple’s iPhone [NYSE: AAPL].
The problems that cryptocurrencies and blockchains still need to deal with are the same ones we’ve been identifying for two years. Those problems fall into three broad categories: regulatory, technological, and (derived from those) the lack real-world adoption.
• On the regulatory front, the crypto and blockchain world is still far too “wild west.” The blockchain revolution is all about finance and commerce, and until the world’s regulators deeply understand it and have laid the proper groundwork, no one will feel secure.
• On the technological front, transactions are still too slow and expensive. Bright minds are working on that problem, but no obviously superior solutions have yet emerged.
• And on the adoption front, because of the inadequate regulation, most crypto and blockchain activity is still comprised of black or at best gray market transactions and pure speculation — not an environment that’s yet appealing to the big actors like Intercontinental Exchange [NYSE: ICE] and Goldman Sachs [NYSE: GS] who have been exploring their entrance into the blockchain and crypto universe.
The best that we can say is “watch this space.” The hype has subsided, and many quiet, early blockchain and crypto advocates are grateful. They view the present “crypto winter” as a process which will winnow out the bad projects and the bad actors, give regulators time to come to grips with what they need to do, and let the real innovators roll up their sleeves and solve the problems. It will certainly be disruptive, but for now, it’s too early to identify the winners.
Investment implications: There will be more money to be made with crypto and blockchain — but not yet. Gamblers looking for easy gains should look elsewhere. Perceptive investors should watch and listen, to be ready to act when the time is right. We’ll keep you posted. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s clients own AAPL and AMZN. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.
The U.S.: Bullish
We continue to be bullish on the U.S. economy and on U.S. stocks. The low-growth “new normal” that was promoted a few years ago has turned out to have been a “new abnormal,” as investment and productivity turn up.
Central banks around the world have “stepped dovish” as we noted last week, removing the overhang posed to investor sentiment by the fear that central banks on autopilot would tighten too far and tip the global economy into recession. The market’s V-shaped recovery from the late-2018 correction is likely in part a response to that shift in tone from global central banks.
Earnings season has begun to unfold in the United States; so far, earnings are, overall, beating analysts’ expectations. Revenues are coming in at a 5% growth rate, the lowest since the last quarter of 2016. We believe that growth, and earnings, will accelerate as 2019 progresses. Overall, the momentum of corporate profit growth in the U.S. remains strong. (This is one of the key indicators we pointed out to investors in our Recession Watcher’s Guide.)
China and Emerging Markets: Bullish
The current stimulus being implemented by the Chinese government to address that country’s economic deceleration is not large by historical standards, and is occurring in the context of China’s ongoing efforts to rein in excess indebtedness and leverage in the shadow banking system. Still, we believe this stimulus will continue. Further, the government has communicated its desire for the Chinese domestic stock market to advance with calm and stability. The government needs stronger capital markets in order to get funding to the small businesses that are the engines of economic and employment growth. It will likely continue to talk up stock markets, and act to cool them off if they seem to be getting involved in speculative frenzy.
We continue to like emerging markets as well, given the turn in global growth trends and the possibility of a resolution to trade tensions between the U.S. and China. After lagging for years, emerging markets are more inexpensive than usual relative to developed markets. We particularly like some emerging-market Asian manufacturing exporters.
Gold and the Dollar
Of course, as always we note that the thesis for China and emerging markets above depends on a cooperative, sideways-to-lower dollar. Should the dollar mount a significant rally — for example, in the event of troubles in Europe — investors would be better served by staying in the U.S. However, as long as dollar strength remains muted, emerging markets and gold will be supported.
Thanks for listening; we welcome your calls and questions.