We’ve got a lot to talk about this week. We’ll start with Greece and what it means for all of you and then we’ll look at my three favorite leading economic indicators to see what they have to say about the future. We’ll finish up with some concrete strategies and recommendations and two pieces of outside commentary that are must-reads.
Let’s get straight to it.
Greece has failed. Officially.
I know you guys are probably sick of talking about Greece. Greece this and Greece that. I apologize, but this is a really big deal.
Last week Greek bond yields blew out to around 10% which forced them to capitulate and send the IMF a formal request for aid. This week their two year bonds traded at a 17% yield. On Tuesday, S&P cut their rating to junk. Thanks for warning us, S&P! This sent the markets into a bit of a tizzy.
Do you guys remember when we said that those people buying 10-year Greek bonds at 6.3% were nuts? Turns out, that was nuts. Hope those guys didn’t get knocked out of that trade. It looks like bondholders might have to take 30-50 cents on the dollar for that Greek debt if they do default on some of their payments. That could add up to about a $250 billion loss.
Greece is getting bailed out, though. Right now the EU is circling the wagons and figuring out how big of a bailout package they’ll need to assemble and which countries will need to participate. How furious are you if you’re a German taxpayer, living one of the few bastions of fiscal prudence in Europe, now forced to bail these irresponsible, entitlement-laden economies out? If I was Greek, I sure wouldn’t be vacationing in Bavaria this year.
But Greece will get the last laugh. Kind of sad, no? The biggest lesson that we’ve learned is that if you are large or systemically important, you should take all the risk you can. The odds are someone will rescue you when (not if) you screw up. Amidst all the chatter that “Capitalism and free markets have failed! We need to get the government and more regulation involved!” I wonder if anybody recognizes that it wasn’t capitalism and free markets we had to begin with. It was capitalism with a gigantic, taxpayer-funded net.
Long ago Warren Buffet put it into words that made sense to the rest of us.
“Capitalism without failure is like Christianity without hell.”
That is what’s going on here. If nobody will allow Greece to fail, what incentive do countries have to act any differently? Without any hell to keep me honest, why shouldn’t I lead a sintastic life?
For the most part, the market seems to have moved on, which I find very interesting. This reminds me of early 2007 when people were saying, “Yeah, this subprime stuff is a problem, but it’s contained.” Maybe subprime mortgage backed securities technically were contained and the actual damage from them wasn’t that bad. The real disaster was what they represented: an entire industry loaded with shoddy, semi-fraudulent practices and too many bad assets on their books.
The problem today is not so much what is happening in Greece per se but what Greece represents. It represents a rampant global culture of excessive borrowing and unsustainable spending.
Your faithful Draconian has been on this pretty much since the get-go. But for whatever reason, I feel like I don’t have any right to toot my own horn here. I’m sure that any of you guys that picked up a copy of This Time is Different upon our recommendation saw that this prediction was a no-brainer. The point is that this time is never different. Stories like Greece always end the same way and have for the last 700 years. This will end in currency devaluation or straight up default. Seriously: who in their right mind would bet otherwise?
Again, Ken Rogoff has it right. The bailout precedent in Europe has now been officially set and the question to ask now is who will be next. Spanish, Portuguese, and Irish bond yields are all on the move upward amidst talk that the EU will need to broaden its bailout package. Portugal also got downgraded by S&P on Tuesday. Spain got downgraded on Wednesday. Remember that bond yields go up because the thing behind them is perceived as being more risky. I know you guys are all starving for yield in this environment, but don’t forget that bonds with big yields have big yields for a reason.
These other shaky European countries are no different from Greece, not in any way that matters. They have all borrowed heaps of money and made promises to their people that simply are not possible to deliver.
If you still think that Greece doesn’t matter, doesn’t affect your life in any tangible way, consider California. Or the U.S. as a whole.
How are we any different?
We are bigger, that’s for sure. But our budget and debt pictures look eerily similar. That’s why I continue to think that Japan offers a reasonable set of expectations, at least as long as we continue to follow the economic template that they laid down in the 90’s and continue to make the exact same mistakes.
No, U.S. stocks didn’t bubble the way Japanese stocks did. But Japan’s economic problems have made life legitimately difficult for its stock market.
At some point, our economic problems will make life difficult again for the stock market.
Up we go
But right now things in the U.S. look OK. Seriously! We’ve succeeded at kicking many our problems down the road so let’s take a break for a week and focus on the here and now.
This recovery is for real.
Since last summer we’ve been saying that the recession would be technically marked over after last July but that it wouldn’t feel like it was over for most of us. The other part of our view, and the reason for feeling so “blah” about things, is that unemployment will remain elevated for a long time, a lot longer than the administration and more optimistic voices are forecasting.
I’ve shown this chart before and it should qualify why we think the halcyon days of 5% unemployment are a long way away:
Get used to unemployment between 9 and 10%. As we muddle through the next decade this will have a profound effect on a lot of things, from politics and public policy to housing and the performance of the stock market. The theme of this decade will be “the job situation” and what to do about it.
But as for the economy right now, it’s doing fine. Given the trillions of dollars that the government has spent on bailouts and stimulus this should come as no surprise. I suppose all of us who grew up reading something other than Keynes in our econ classes have learned a pretty big lesson: never underestimate the power of government spending. Uncle Sam has indeed stepped right in for the American Consumer and done an admirable job of it. You are correct to wonder what happens when he stops spending and shifts that burden back to the rest of us. But let’s worry about that later.
The Three Amigos
To get a clear, unbiased read on the current state of the economy we call on our friends, the Three Amigos!
As you can see, when used in conjunction with one another, these three amigos do a darn fine job predicting the beginning and ends of recessions (which are highlighted in blue).
What exactly are these amigos? Glad you asked, El Guapo.
Capacity utilization – This is basically the percentage of total industrial capacity that the economy is using. It measures how much slack is out there, system-wide. For example, let’s say you own a microbrewery that can produce 100 gallons of beer per day. If the economy is rocking and people are feeling groovy, you’ll make as much as you can, all 100 gallons per day. Everybody loves your tasty beer and wants to buy more. When the economy slows down and your customers cut back their spending (or switch to Budweiser, blech!), you’ll reduce production to 75 gallons per day. The last thing you want is too much beer sitting around… or do you?? Maybe a brewery was a bad example.
Anyway, we’re using about 73% of our capacity right now. We use more of our capacity when the economy is good, less when it sucks. It’s definitely improving, but still a long way from normal. You’ll also notice from the chart that this one has an eerie knack for almost perfectly calling the end of recessions.
Junk Bond Yields – High yields mean investors are unwilling to loan money to shakier businesses because they’re concerned they might fail. Recessions are almost always preceded by rising junk bond yields and recoveries are almost always preceded by falling rates. When investors perceive the economy turning the corner, they’re more willing to loan money to these businesses. This amigo usually reacts early; bond investors are a skittish bunch. Keep your eyes peeled for a spike in yields and then watch if it’s confirmed by the other indicators in the months to come. It could mean a new round of economic trouble.
ISM Purchasing Manager’s Index – This amigo basically measures the health of the manufacturing sector. It looks at things like new orders, inventory levels, deliveries, unemployment, and total output. The Institute of Supply Management gathers all this data then waves it’s magic wand and produces a single number. If it’s above 50, it means the manufacturing sector is expanding. A reading below 50 means it’s contracting. In my opinion this is one of the most honest bits of economic data out there and it’s used to reliably predict a whole bunch of stuff, from stock prices to inflation.
After looking at that chart again, it would seem pretty obvious that the recession is long over, wouldn’t it?
Well, the NBER may call an end to the recession last summer and they may not. It usually takes them a year or two after the end of a recession before officially labeling it as such. They actually did meet earlier this month and said there still wasn’t enough data to conclusively show that the recession was over. Who knows what they’ll decide. Right now, the industry scuttle is that our estimate of summer 2009 may have been a little optimistic. To my knowledge that is a Draconian first.
The good news is that what the NBER says doesn’t matter. The NBER stands for National Bureau of Economic Research. Does that sound like a group of people whose opinions matter? No. It does not.
What does matter is that it is very clear that things are heading in the right direction and have been since about last summer.
Thank you, Three Amigos!
The big “but”
What also matters is how you feel. In fact, that probably matters most of all.
Just how do you feel?
Well, I’ll tell you how you feel:
Today:
- You feel worse than you did during the worst of the 2001 recession. (Much worse)
- You feel worse than you did during the technical bottom of the 1990-1991 recession.
- You feel worse than you did immediately after 9/11.
- Today, almost a full year into economic recovery, you barely feel better than you did during worst of the 1970s!
This popular, though not particularly useful, index of consumer sentiment is published by the University of Michigan. Big Blue calls up a bunch of people every month and asks them questions about three things:
- How they view their prospects for their own financial situation.
- How they view the prospects for the economy over the near term.
- How they view the prospects for the economy over the long term.
Then they feed all that stuff into Microsoft Excel. At the very bottom of one of the tabs is a tiny cell that contains a number. That number is the University of Michigan Consumer Sentiment Index. Last month it was 69.5. In January 2000 it was 112.
Man, what were we all smoking?
The Draconian’s promise to you
Look: the economy is improving and the market is going up. One of the hardest things that traders have to deal with is a market that runs totally opposite to their investment thesis. Their thesis may even be right, but markets do crazy things for crazy reasons. That’s my way of saying that the market can remain irrational longer than you can remain solvent.
Betting against this thing over the last year has proved deadly. We stopped directionally betting against the market on a tactical basis very early last summer, but we’re short-term traders. I’m not sure if I’ve got the stones to short the market right here and wait a few years to see it through, even though I think that could eventually be a great trade.
So right now you can either (a) trade along with the markets or (b) wait for the condition to reverse. It’s impossible to pick tops and bottoms and when you truly understand that the objective is to figure out where the market is going from here, you get a sense of how difficult this whole trading thing really is.
But what does the average investor do? The guy who doesn’t do a lot of trading but needs to invest in something and is concerned about the economy at large?
Over the weekend I was talking to a good friend of mine and she said that after reading one of our recent newsletters she just had the urge to sell everything. Unfortunately, I’m the writer you guys are stuck with here and the bad news is that my mindset is one that really doesn’t see what’s so bad about holding a lot of cash. I spend less than I make and have no psychological qualms about stockpiling a lot of the excess. I like cash! Why do I want to trade it for things that I think are less valuable? If I’m confident of one thing it’s that someday all that cash will come in handy.
But I recognize that this places me in a certain minority. More important is that my job is to be:
- Entertaining
- Informative
- Useful
So I am going to make an effort in the coming months to spend more time talking about investments that I like and less time talking about investments that I hate. It’s tough, because I have a natural proclivity for things that are a good value or offer fair yields, and the present environment is one of poor value and unfair yields. I’ll have to work extra hard, but I promise to do my best. I think it will be most useful for you if I do. Be warned: our entertainment quotient may take a hit, not that it was that great to begin with.
Listen up, here comes the “useful”
You’ve heard me mention over and over that I believe the next decade is going to be a tough one. It will be a decade of sacrifice for one and all and that sacrifice will take different forms depending on how much money you make. Amidst all that will be a thematic objective to rebuild the middle class. Median household income – after rising steadily through the post-war years into the 1970s where it chopped around awhile before rising steadily again – has been stuck at a plateau for well over a decade. The middle class is probably starting to really feel aware of this, and this feeling will intensify in the years to come. Politics will, of course, play a huge role.
So I like companies that will benefit from this ideological push to bolster the middle. Companies like Coca Cola, McDonald’s, Nike, and Toyota. Disney is a favorite of mine here.
I like companies that dominate industries and are an inseparable part of our lives. Companies like Exxon, Johnson & Johnson, and Microsoft. Google, too, I suppose.
The bad news is that these are super-boring companies. There isn’t a ton of upside in these names. But when it comes to long term investments in the stock market, I know that capital preservation trumps all, so I like boring.
Dividend stocks are pretty boring too, and as a category, I’m a fan. We wrote about this last year, in “Dividend Bonanza,” where I listed 6 important things to understand before looking at dividend stocks. I also ran some screens and came up with a few specific companies to take a look at.
With so much government spending still to come, I like infrastructure plays, power companies, utilities. That sort of thing.
Oh, and healthcare too. We talked about how to make money off healthcare reform a couple of weeks ago.
I like high quality corporate debt, particularly if it’s shorter term in nature. VFSTX is one of my favorite ways to get that and a core holding in my wife’s IRA. MBDFX is another good one. Don’t expect either of those to repeat last year’s performance. The long-term picture for bonds is pretty ugly, one where rates could slowly rise and rise which will make life tough for bond investors. One of the last things in the world I want right now is long term debt unless it’s in the form of TIPS, which are risk free and offer guaranteed inflation protection.
Most investors I know are pretty hung up on past performance, and the stuff that’s performed the best in the last year is the junkiest stuff. I have no reason to believe that won’t continue until the next reckoning where all that junk will be (predictably) eviscerated once again. If you are a thrill seeker and want to chase that, go right ahead. Just be aware of the risks associated with chasing hot assets.
Me? I’ll take quality. Just as I was about to click “Publish” for this issue, I stumbled across Jeremy Grantham’s latest quarterly missive. Grantham is another of my investment heroes and I’m tickled to discover that we have apparently come to the same conclusions for totally different reasons. His reasons, however, are far more convincing than mine. Probably because he’s a much smarter dude, smart enough to oversee $100 billion. You can read his letter here. Print it out and save it for when you’ve got 15-30 minutes to really focus.
And finally, you might be wondering how long can the market can keep partying on. I am too. Check out Doug Kass’ list of 20 signs that could indicate a market top. This one is a quick read, but still very interesting and helpful.
Stay tuned in to the events in Europe. I know it was lost amidst the hoopla of the public Goldman flogging, but this is incredibly important. It’s where all the other answers lie.
There won’t be any technical jargon or tricky concepts in this week’s letter. Mom, you should be able to get through this one no sweat. Stay focused, though, because today we’re going to talk about the single most important lesson for investing success.
I’m not kidding! Read on…
You can’t always get what you want
I’ve only been working in finance for about a decade, so I don’t have the amount of hands on experience that my elder peers in this industry do. But a decade is long enough to learn a thing or two, and certainly long enough to understand that while I’ll spend the rest of my life in this business, I will die knowing far, far less about the markets than that which I was yet to learn. Maybe you feel the same way about your own profession.
Since childhood, when I read off commodity prices from the Wall Street Journal and my dad plotted each little point in his black chart book, I’ve wanted knowledge from the markets. But over the years an odd thing happened: the more I learned, the more I realized there was to learn, and the deeper that want for knowledge became. It was like drinking sea water. Somewhere along the way I passed out. When I woke up, Mick Jagger’s voice was strutting out of my speakers.
You can’t always get what you want
But if you try sometimes
You just might find…
You just might find
You get what you need
-The Rolling Stones
(Listen for free here)
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It’s very rare that anybody gets what they want out of the markets. In my experience, what they usually want is money. But sometimes the want goes a little deeper. There are people who want to trade the markets because it’s exciting, or to fit in at the club, or because that’s where the action is. Every once in a while I’ll come across someone who just wants to feel plugged in, something that makes him feel a little sexier at home and with his friends. As with so many of our desires, it seems to always be about a deep want to be loved by others. It just manifests on the surface as lust for money.
Instead, what investors ultimately get – unless they’re really lucky, which, trust me, is one of the least appreciated factors amongst amateur investors – is something they didn’t want at all. Usually they get losses. They wind up getting burned. And instead of feeling excited and sophisticated, they feel ashamed or riddled with anxiety.
Will their family still love them if they lose half their retirement savings? How about their friends at the club? It’s a touchy subject. There’s a reason we are quick to boast about that bank stock we bought that doubled in value, but keep those countless stories of loss behind lock and key. Listening to your friends, you’d think only winners come back from Vegas. We Nevadans know that’s not the case.
The reality is that amateur traders who actively play in the markets tend not to do so well over time. This fact is a perfectly reasonable thing to assume and requires no convincing; skill and success are correlated everywhere one looks. Most of these amateurs that go into the markets are even perfectly reasonable individuals, yet despite this knowledge they are not dissuaded. They plunge in head first, confident of success. Why they do it, I am not sure. Apparently they want something very badly.
It’s not always tears and frustration from the start. A lot of times these amateurs meet with early gains. Anybody who simply bought stocks in the last year is probably feeling like a pro. Your shifty brother in law was also a pro, day-trading dot-com stocks back in 1999. But he doesn’t day-trade anymore, does he?
Most of the time these early gains are parlayed into eventual losses, or at best, mediocre gains. I wish it wasn’t this way, that it wasn’t so much like a Discovery Channel documentary where the powerful lion eats the defenseless wildebeest, but it is. More often than not, amateur money ultimately gets taken by professional firms like ours and the traders we invest in through our fund of funds.
Now, lions aren’t invincible, and I’ve seen my fair share of professional traders gunned down over the years. In nearly every occasion they had it coming, taking too much risk or being too lazy in the savannah sun. Lions (and firms like ours) may have advantages, but it’s still a dangerous, wild world. One of my lifelong dreams is to visit South Africa and Botswana. I want to stand on the edge of the bush and see if I feel that same flutter in my stomach – that mixed feeling of excitement and dread – that I get when I come into the office every day, turn on Bloomberg, and start hunting for trades.
And this certainly isn’t to say that novices can’t become pros. They can. But like any other endeavor, it requires years of hard work and lots of self-discovery. Investors should not expect that simply watching Cramer or attending a VectorVest seminar will transform them into a pro. I’ve spent my entire career in finance and I still consider myself a cautious young cub. Ten years from now I doubt much will have changed.
Reading our insignificant little newsletter isn’t going to make you a pro, either. Our goal here at The Draconian is simply to help you avoid some rookie mistakes, to keep the big picture in mind and not get swept up in the emotion of it all. If we can give you a tool here and there that helps you be a better investor, all the better. But I really don’t expect any of that to stick, certainly not every week.
Honestly, the best I can hope for is that we make you think.
I keep a wide perspective on here and talk about all sorts of seemingly random stuff, from sine waves and black holes to Korean cinema and The Rolling Stones. This stuff is all connected, all part of the same tapestry. Thinking about the same old things in new ways makes this interconnectedness more clear.
You get what you need
OK, so investors don’t always get what they want. But I’ve found they usually get what they need.
And just what is it that investors need?
It varies, but nine times out of ten what they need is an education. It’s tough to learn about the markets if you aren’t in them, and the bad news is that it’s a hard knock life. This is a business where one learns by doing, and occasionally, the independent-minded amateur will learn enough to get by on their own.
Usually they’ll learn enough to stay away, that the markets are not for them and should be left to the professionals. And this is a perfectly noble lesson to learn. It saves them from a lot of pain further down the road. Last spring I built a garden box for the backyard. It came out ugly and uneven but I was quite fond of it nonetheless. However, the valuable lesson was that spending a ton of money on fancy materials or quitting my job to become a woodworker was a bad idea. If I ever need a nice garden box it will be far cheaper for me to just buy one. Or I’ll have to ask Kyle, who’s much more handy with a saw than I.
A big part of the education that some amateurs get is humility. I cannot tell you how many gigantic egos I’ve seen come into the markets, egos that were inflated by tremendous success elsewhere in life. These individuals assume that the skills that powered their earlier success will translate to the markets. If there’s one thing the markets are good at, it is crushing egos. These intolerable folk need reality checks and I’ve found that the market is quite good at giving it to them. It’s not what they wanted, but even these big egos will occasionally admit it was what they needed.
Sometimes the need goes a little deeper. There are some people who absolutely thrive on competition and what these folks need is a worthy opponent. I’ve found that guys like this understand defeat much better than others. When their portfolio gets battered by the market, they wipe the blood from their lips, learn what lessons they can, and hop right back into the ring. These are the guys who make and lose fortunes over their lives and keep pushing ahead, undeterred. Every fighter needs something to fight.
Other individuals harbor a bottomless love of puzzles and live to work out solutions to problems. I am most fascinated by these folk. They are cerebral little buggers and I enjoy listening to them talk about the markets. These are the rare birds like Richard Russell and John Mauldin. Their approach and commentary is far less dogmatic than what comes out of the major investment houses, and I think that’s because they understand that the whole thing is a work in progress. They seem to know that they’ll spend their entire lives trying to solve the puzzle of the markets and won’t ever get there. No bother. What they live for is the process.
To a certain extent, I can relate to these guys. Every once in a while my wife and I will buy a puzzle and empty it out on the coffee table. I enjoy sorting the pieces and my excitement peaks as the edges begin to emerge and seemingly-unrelated big blocks of pieces are joined together. She loves the sense of accomplishment at the end, dropping the last few pieces into place. She’ll even leave the completed puzzle on the table for weeks until my pestering to tear it apart grows too obnoxious for her to bear.
And then there are those people that need a vast, intricate social network. These natural extraverts need to be around and connected to others to feel alive. This network of people and activity gives them the fuel they need to get through the day. True, these networks are found elsewhere, but the markets are global. No other networks are as big and complex. Maybe these individuals originally come into the markets because they want to make some money, and whether they do or do not, they wind up staying because it feels like home.
Herein lies the secret
We’ve never done it before, but each one of you who have read this far into the newsletter has a homework assignment. Yes. This is the first Draconian Homework Assignment. I know I should probably reward and thank you for reading this far. Sorry about that. You get homework instead. We don’t call ourselves The Draconian for nothin’.
But you might enjoy it: I want you to go home today and think about what you want from the markets, what you want from your investments. It’s probably a very simple want, right? I want them to go up! But is it really that simple? Is sending your child to college what you really want? Is it a new BMW? Hopefully it’s not next month’s rent. Reflect on your past experiences as an investor – professional or amateur – and think about whether you got what you wanted or how often your wants were satisfied.
Then go a little deeper and think about what it was you really needed. It was probably an education, and given the recent past, you probably got a good one. Be proud of that. Even if it involved losing money. Or maybe it was something else? What need was it that ultimately got fulfilled? Or are you not even sure what it was you needed? Are you still figuring it out?
The first and most important step to take as an investor doesn’t involve investing at all. It is a journey of self-discovery. Take an honest look inside yourself and try to come to terms with what you find. It isn’t always pretty. We tell our investors that the more they understand about who they are as individuals, the better investors they’ll make.
There’s a reason for this. Someone who understands who they are will make investments that suit that their personality. And when they have investments that suit their personality they will relate to them on a more intimate level. They’ll make better decisions and will be more apt to do the right thing at the right time. They’ll also sleep better at night. Like sleeping in a bed that was designed exactly for them.
That might sound really nice, but out in the real world it’s the minority case. A more common example is the guy who is in truth rather risk averse but buys an equity index fund anyway. Maybe his broker or Jim Cramer or Niles Wealthypants down at the club told him to. When the stock market has a nasty correction, as it does with disturbing regularity, this guy panics and makes an emotional decision.
In the world of investing, emotional decisions are the worst kinds of decisions to make. Why did he buy that index fund in the first place? Did that commitment to “being in it for the long run” wind up being half-assed? Or did he think he’d be able to identify the top and sell? Little did he know, he would have been much better off finding a different investment altogether.
This weekend, spend some quality time thinking about wants and needs. The weather looks like it will be pretty nice here in Reno, so go out in the backyard, lay down in the hammock, and take a little journey inside. Rock out with some Rolling Stones if you have to. I’m sure there’s at least one or two of you aging hippies out there, so go on ahead and light up a bowl and see what sort of deep realizations of self you come to. You have my blessing. Write that stuff down though, in case you forget.
What I need
As for me, I was sort of forced to do all this long ago. I needed an edge over my more-experienced peers and thought this kind of alternative approach could help me survive out on the savannah. It did. It gave me the right psychology to approach the market and helped me make decisions that were appropriate for me. I discovered that I’m a value hound and I’m obsessed with framing return in the context of risk. I like stuff that offers the best bang for the buck. I share this with you not because I think you’re interested, but because you need to understand the perspective behind the rickety pulpit that this commentary is delivered from.
I gravitate towards things like hedge funds that tend to offer better returns and lower drawdowns, or investments like TIPS that may only return a couple percent but carry zero risk and give me guaranteed protection against inflation. I pass on the stock market, and get my equity exposure through more resilient stocks that offer good dividends and “alternatively managed” mutual funds like Hussman (HSGFX). Or I’ll get it through our own trading.
Good bang for the buck doesn’t always mean cheap. It means that the relationship of benefit and cost is appropriately balanced. I love my Toyota 4Runner, which cost over twice as much as a Suzuki Grand Vitara (JD Power’s worst in class). Despite being more expensive, I thought it was a much better value. Would I get a similar increase in quality by paying twice as much again and driving away with a Range Rover? I didn’t think so. Econ wonks know this territory as the “efficient frontier.” I look for investments that seek maximum return for a given level of risk, or alternatively, minimize risk given an expected rate of return.
Every once in a while an investor will call and tell me that my old man was the same way. Naturally, I smile and wonder if that sort of thing is genetic. Or maybe it was subconsciously built between the two of us at the kitchen table, poring over the Wall Street Journal and recording the relevant bits in that black chart book.
It’s tough to know for sure. I suppose that’s part of the knowledge that I want, and I’ve accepted that I may never get it.
At this point you might be wondering what it is that I need from the markets.
I think I just need a way to feel connected to my past.
This week we’re simply going to run through the major markets one by one. As we’ve been discussing some of the lesser-talked-about aspects of healthcare reform the markets have moved around a little bit. We’ll break it down and take a look at what might lie ahead.
But first, thanks to everyone that has downloaded our our new iPhone app! We’ve had over 200 downloads so far, and a few more trickle through every day. My programming skills are pretty mediocre, so the app is nothing fancy. But it does a clean job formatting the newsletter and makes it really easy to read while you’re on the go. Go download it if you haven’t yet.
Also, I was recently honored with the opportunity to write a guest post for Alex Lawrence’s The Entrepreneur’s Blog. Alex does a nice job over there and if you own a small business or are interested in entrepreneurship, his blog should be part of your regular reading. Alex is a Partner with Funding Universe, a hub for matching entrepreneurs with investors and banks. If you’re a startup in search of funding or if you’re an investor looking for fresh opportunity, it’s worth checking out. Their platform is really cool and they’ve facilitated a ton of deals.
Anyway, you can read my article right here.
Alex was kind enough to let me write about anything of my choosing, and so I told our own little story of entrepreneurialism, the story of how we survived the financial crisis and founded a brand new business in the process. It’s an honest look inside our company. Those of you small businesses and entrepreneurs might find it even sounds a lot like your own experiences.
Crude Oil
This is probably one of the biggest bits of news in the last few weeks.
We talked about it a few weeks ago, right here, if you missed it. We outlined a little seasonal energy strategy, and provided some history on how March, April, and May tend to be good months for energy commodities and energy stocks. Hopefully you didn’t ignore that history. Crude oil has gone straight up since late March.
Why?
A lot of it does have to do with these natural seasonal forces. But underneath that is what could be a new round of brewing global speculation. I saw a good chart from the NYMEX earlier this week showing a new high in speculative positions in crude oil.
One of the real experts in this sector is Stephen Schork, publisher of the highly-respected and ridiculously-expensive “Schork Report”, and over the last several months I’ve been listening him detail the very bearish fundamentals for crude oil. There’s a ton of supply at present. Inventories have risen pretty much every week and there are tankers full of oil that are literally parked out on the ocean because there isn’t enough room to store it onshore. Despite all that, last week he said that we could get to $95 before we know it and that there’s “a reasonable chance of hitting $110 by the end of June.”
It seems as though Wall Street may have taken control of the crude oil market once again, with a new round of speculators driving prices higher. When interest rates are so low, investors are forced to put their money somewhere, and so pension plans and hedge funds and bank trading desks all pile into the energy markets, as sure a bet as any for long-term price appreciation. We’ve seen this movie before. But does it go back to $145/barrel? Who knows.
Schork did make another interesting point. Last year, Exxon lost a millions of dollars per day trying to refine $70 oil. They couldn’t do it. None of the big refiners could take $70 oil and turn it into a profit. Knowing that, it’s hard to see any kind future for crude below those levels. Coincidentally, the market traded down to $70 twice in the last six months and bounced sharply off of that level. $70 was also basically the midpoint of where it traded all through last summer. As we look forward, that should be a very stable floor.
So with the future fundamentals of constrained supply and growing demand, and increased speculation at present, the world seems tilted towards higher energy prices. A few weeks ago I pointed out $80-85 as a very important level in crude oil. If this thing keeps moving up, it could get ugly in a hurry. We’re already on the threshold of the point at which demand destruction could start to take place. And if that starts taking place here in the U.S., it’ll take place in Europe and China as well.
What does all this mean for you?
The obvious effect is that higher crude oil prices translate to higher energy prices throughout the entire chain. It’ll cost you more to drive your car, to fly the family to Disneyland, and cruise up the coast in your yacht.
In aggregate, this is a drag on consumption and a drag on the global economy. It won’t take much higher prices to effectively knock out all the effect of the government stimulus measures. This is another one of those secular headwinds that Mohammed El-Erian is always talking about.
Bonds: the beginning of the end…of low rates
Bond yields have jumped up in the last few weeks, finally breaking out of their 3-month range. That’s bad news for bond prices, of course. Here’s a chart of the 10-year yield.
Two weeks ago we had a shockingly bad 2yr treasury auction. That was followed up by an awful 5yr auction. And then a lousy 7yr auction. You might be wondering what kind of person watches the action in Treasury bond auctions. The answer is: really dorky people watch treasury bond auctions. That’s me, and I thought these terrible auctions qualified as “big news that nobody is talking about.” Loyal readers know that’s my favorite kind of news.
Could it be that demand for US Treasuries has finally tapped out? Now that the Fed has officially stopped injecting money into the banking system via quantitative easing and its trillion dollar Mortgage Backed Security purchase program, does the world finally have enough Treasury bonds?
You guys remember how quantitative easing works, right?
Mr. Bernanke has bought over $1 trillion of mortgage-backed debt in the last year, a lot of which undoubtedly qualifies as “stinky.” As the Fed buys this stuff from banks and big investors, they give them actual money in return. The dollars just magically show up in their bank accounts and their dodgy debt disappears. In the past year, these banks and such have had to do something with all these magic new dollars. As you guys all know, cash doesn’t yield anything right now, so this money has to go somewhere.
In the last year these banks have purchased a whole lot of Treasury bonds. It makes a lot of sense that now that the Fed has stopped exchanging real money for stinky debt, these banks aren’t in such a rush to buy new stuff. Or maybe they’re just buying crude oil instead.
A couple weeks ago Bill Gross was on CNBC and he said that bonds may have seen their best days. This is pretty remarkable. Bill Gross and “bonds” are synonymous and for him to talk against his what his firm built its reputation on is a little startling. It’s sort of like Steve Jobs telling everybody to stop buying iPods.
I know nobody listens to Alan Greenspan anymore, but in a recent interview he too expressed great concern about the United States’ fiscal situation, and said that rising treasury yields are the “canary in the coalmine.” Incidentally, he also endorsed the idea of a VAT, a federal tax on consumption, as a short-term fix for the current fiscal problems. We’ve been discussing for a while on here. It was one of our 10 Predictions for 2010 – not that we’d actually get one, but that the debate would heat up. On my Bloomberg podcasts, I’ve started to notice at least one or two of the interviewees per week talk about this as well.
Yeah, I know Bernanke and the rest of the Fed (except inflation-fighting, cult-hero Tom Hoenig!) is on record stating that rates will remain low for a long time. As long as necessary. But that’s the rate that they have control over, the Fed Funds rate. Any rates set by the market are going to have some powerful winds lifting them up, especially now that the Fed has stopped it’s purchase program, which for all of last year acted to keep those updrafts at bay.
What does this mean for you?
Obviously, it’s bad news if you already own a bunch of government bonds. Rising rates mean falling prices. So maybe now it’s time to cycle into something else. You can follow Bill Gross into countries who are in a better fiscal situation than we are, ones that aren’t so highly levered like Germany, Australia, or Canada. Or you can take a little more risk in the corporate space.
I still like TIPS for the inflation protection that they’ll give you over the next 10-20 years. Now is probably a good time to mention that the latest TIPS auction was an absolute barn-burner. 3.43 bid-to-cover! That basically means that there were over three times as many bids as there were bonds. The guy on Bloomberg said it was the best auction since 1997. Perhaps a few others out there are starting to tool up for long-term inflation protection as well.
Rising rates are also bad news if you own a house or want to buy a house. Higher rates mean higher monthly mortgage payments, which is the thing that really controls how much money buyers can spend on a house. When mortgages get more expensive, home prices tend to fall. If you have an adjustable rate mortgage or are carrying credit card balances, it means that the interest expense associated with that is about to get bigger. That’ll hurt your cash flow.
If you’re one of those responsible folks who have been listening to us over the last year, saving your money, paying down your debt, and cleaning up your household balance sheet, you are about to enter an environment where you’ll be rewarded. You will have shielded yourself from the damage of rising rates and you’ll have cash available to jump on the great deals to come in the bond space. And other spaces too.
For example…
Stocks: Overbought & Overvalued
Stocks right now are overbought and overvalued, but that condition won’t last forever. I don’t like to buy things that are expensive and if they are things that fluctuate in value (like stocks) I am happy just being patient until they get cheap again. Don’t worry, they will get cheap again. The history of the stock market is one where it moves in big cycles from “expensive” to “cheap” and back again. When stocks do get cheap I’ll go shopping. Until then, I’m avoiding the risk and saving myself the heartburn.
The trend right now in stocks has clearly been “up”, and I understand how tough it is to not chase performance. As counter-intuitive as it may seem, chasing performance is bad. I’ve got a stack of white papers in my drawer showing that it’s not a very good investment strategy. Just because something has been going up doesn’t mean it’ll keep going up.
Regular readers will remember this chart, one of my all-time favorites:
That came from this newsletter, Long Term Investors: What to Expect, which goes into detail about exactly what that chart means. Basically, it relates the present valuation of the market (whether the market expensive or cheap) to the future 10-year return. The chart should make it pretty clear that when you buy an expensive market you don’t make as much money over the long run as you do if you buy it when it’s cheap. This might even be one of the only true things one can say about the stock market.
Back in December we were at 20.4. Today we’re at 21.7. On a historical basis, that’s very expensive.
With the exception of the bubble 90’s, the stock market has never had a positive 10-year return that began from valuation levels like the present. That’s not to say that stocks will go down over the next decade. They could go up. These are crazy times! We addressed that possibility in that newsletter last December and our analysis shows that, all things considered, stocks are priced to deliver returns that should average 2-4% per year for the next 10 years or so. Not too exciting, especially considering you can get the same yield from risk free Treasuries without all the volatility
You might be wondering: when will I buy stocks again?
That’s a good question! Thank you for asking. I’ll always buy specific names here and there, even in an environment like this one. Right now I like companies with good balance sheets that pay juicy dividends. Companies like that didn’t rally the way the junky stuff did in 2009, but should the market get spooked again, solid companies do a better job hanging in there than the junky ones. I’ll get a little more aggressive and allocate a higher percentage of my total portfolio to stocks when that red line in the chart gets back in the 10-15 range.
But if that red line ever gets below 10, I am going to load the freakin’ boat with domestic equities. It will be a long-term trade, and the bad news is that it’s the kind trade that most investors get only one shot to make in their entire careers. It’s like buying stocks in 1908 or 1933 or 1947 or 1982. I wasn’t in the business in 1982, so I’m still waiting for my chance. It will come, but I can tell you right now that it won’t be an easy trade to make. The world will feel like it’s ending and people will hate stocks with a violent passion. Stocks will sell for 8 or 9 times the previous decade’s earnings and everybody in the world will think they should be selling at 4 or 5x. It’ll take serious cojones.
I know this all might sound like common sense to most of you, that investors should buy cheap markets and avoid expensive ones. But every day I listen to all sorts of smart people who believe that investors who buy an expensive stock market will be rewarded. True, many of these people manage mutual funds or professionally advise clients on which stocks to buy, so they don’t get paid if people don’t buy stock or invest in their funds.
As some of you may know, our real business is managing a family of hedge funds. We house all our proprietary trading inside our Draco Fund, and we have an interesting fee structure, one that is becoming scarce in the hedge fund sector and doesn’t even exist at all in the land of mutual funds. We only get paid if we make money for our investors. Since we’re not a big firm that can go out and raise a ton of fresh capital if our fund blows up, it also shackles the level of risk we take with the money we manage. We can’t bet the farm, Lehman-style, and are actually forced to be prudent.
So what this compensation structure means is that we have direct financial incentive to make money as often as we can and not lose it. It’s how we maximize our paychecks over the long-run, and coincidentally, this happens when we put forth the best investment product we can, one that makes good money over the long-run without too much risk.
We believe that there should be more investments out there structured in this fashion. Most funds are set up in such a way that the manager gets paid more money when the fund gets bigger. No surprise, these managers spend a lot of money on advertising and telling everybody how awesome they think their fund is, even if the fund is so crappy they won’t put their own money in it! You may have heard that almost half of all equity mutual funds report zero manager ownership. It gets even worse with international equity and bond funds. These guys should be ashamed of themselves. It’s like that commercial where the salesman from Other Insurance Company is shopping in the Progressive Insurance store. What do these mutual fund managers have against their own products?!
Anyway, you have more important things to do this week than listen to me rant about mutual fund managers. If you want to continue that discussion you can hit me up at Feedback@TheDraconian.com or learn more about how much these guys invest in their own funds from articles like this one. I’ll spoil the punch line, though: the best fund families also report the highest level of manager ownership (Oakmark, First Eagle, Dodge & Cox, T. Rowe Price, Royce) while the worst fund families report the lowest level of manager ownership (Wells Fargo Advantage, BlackRock, Schwab, Goldman Sachs, AIG).
Surpriiise, surprise!
Somebody get Ken Feinberg on the phone.
This week we’re going to conclude our conversation on healthcare. If you missed the first part, you can catch up right here. As is our custom at The Draconian, we’re going to try and look at things from a few different perspectives than those being discussed elsewhere. We’ll also see what sort of investment implications all this might have. Today is April Fool’s day, but I doubt this week’s newsletter is going to make you laugh, especially if you’re a doctor.
But first, let’s have some fun! Imagine the following scenario…
It’s spring, so you’re at the car wash.
It’s been a while since your baby’s last scrub-down so you treat her to the “SuperWash” with tire dressing and even a floor mat shampoo. You hand your keys to the attendant and pay your $26.50 or whatever. Behind the register and through the window you see your car scoot past on the automatic track, covered in foamy bubbles.
Times are tough, so you steel your resolve and ignore all the tchochkes and impulse-buy stuff hanging on the rack. You take a deep breath as you walk towards the waiting room where you discover that the weird lady with gigantic sunglasses and the tiny dog has grabbed the last newspaper. Unless you get a kick out of thumbing through local real estate mags, it could be a boring 20 minutes. Eek. What to do?
Good thing you downloaded the FREE Draconian iPhone app!
Now you can put your downtime to productive use and learn about the markets while you wait!
It’s 100% free. Who doesn’t love free apps? Especially free apps that can make you money. Or at least help you sound smart at your next cocktail party.
Here’s an interesting story: I finished programming the app two weeks ago and submitted it to Apple. About 48 hours later they approved it and on Saturday night it was available to download. I didn’t really tell anybody about it; I just sent my coworkers an e-mail letting them know we were live and I made a post on my personal Facebook page where I don’t even have that many friends.
In the first week, we had 49 downloads. In the second week, we had another 103 downloads, including 8 from Great Britain, 7 from China, 2 from Denmark, and about two dozen others from country codes I don’t recognize. We even got a download from Mexico! Our website traffic has more than doubled since the launch of this thing. All this happened with virtually no advertising on my part. Where did all these people come from? I have no idea. I don’t have any friends in Mexico.
I’m a little late to the party and still ridiculously inexperienced in this area, but if you’re looking for a way to spread the word about your business or your website, make an iPhone app. I know this isn’t a newsletter about how to grow and market your small business, but I’ll let you know how this goes for us.
Whoah, what?
You don’t have an iPhone?
I thought everybody had an iPhone. Lucky for you we’re available everywhere else:
OK, that’s enough shameless self-promotion for one issue.
A doctor’s plight
One of the highest-value things I consume is my subscription to Bloomberg’s On the Economy and Surveillance radio programs. It costs $99/year, which might seem like a lot to pay for a radio product, but it’s worth every cent, both as intellectual entertainment and macro-investing usefulness.
CNBC may be dramatic and fast-paced, and have a lot of viewers, but they should be ashamed of themselves when it comes to the quality of their perspectives. Every conversation is about “buy this” or “sell that” and the markets are much grayer than the black & white opinions found on CNBC. Bloomberg Radio operates in a totally different league. The problem is that it costs a lot of money and requires you to do a fair amount of thinking for yourself.
Be warned: investors who’d rather not do the heavy thinking will be happier just listening to Jim Cramer. Here at The Draconian we are advocates of finding an investing style that works for you. If you’re happy with CNBC and Cramer, by all means, keep watching them. But if you feel like taking off the water wings and think you’d be more satisfied hanging out in the intellectual deep end, you can check out Tom Keene On Demand here. This is a guy who wears a bow tie and isn’t afraid to talk about Gaussian distributions and regression functions. You probably know right away if that’s the sort of thing you can get down with.
Anyway, the episodes air throughout the week, but what I usually do is put them all on my iPhone and listen to them on the weekend while walking the dog or working in the backyard. I guess the real selling point is the great interviews with all sorts of economic and investing heavyweights, but also “off the beaten path” interviews like a recent one with Dr. Nathan Schatzman, an anesthesiologist in Chattanooga, Tennessee.
Patients, insurers, and drug companies have dominated the conversation about healthcare reform. But what of those who actually provide and direct the services to patients? The doctors. How does this affect them?
A Cruel Joke
I wish I could give you guys a straight link to this particular Bloomberg interview with Dr. Schatzman. In the meantime, just send me an email at Feedback@TheDraconian.com and I can hook you up. I did play it for my wife, who practices as a Gyn-Onc surgical PA, and she said it totally passed muster, accurately summing up the realities of what a lot of doctors are dealing with right now.
As I mentioned last week, this Healthcare reform act is a pretty big bill. It does a lot of things. But one of the things that this healthcare legislation does not address is a scheduled 21% cut in the payouts physicians receive from Medicare. This cut takes effect today, April 1st. In basic terms, what this means is that if a Medicare patient comes in for a visit that normally pays out $100, the doctor will now only receive $79 from Medicare.
For doctors, this is no laughing matter. But for the rest of us, it might be easier to put it into context with an example and Dr. Schatzman gave an excellent one:
Most physicians are technically small businesses and a typical family practice office’s revenues might be around $500,000 per year. All the expenses associated with that (staff, rent, malpractice insurance, etc.) are probably somewhere around 60-75%. Dr. Example takes home around $160,000 at the end of the year. Assuming a 60% base of Medicare patients, after this cut goes through he’ll take home $95,000. That’s quite a pay cut.
OK, so what? This reduces Medicare “costs” and maybe you just don’t care how much your doctor gets paid. “Times are tough,” you tell him. “Buck up! Trade in that BMW for a Toyota.” You still got your annual checkup and can’t see how any of this affects you.
But what would you do if you were a doctor? Would you work twice as many hours in the week? Would you just raise the cost of an office visit? Would you perform more procedures of debatable necessity? If you were older, would you just retire? If you were in medical school, would you give up on trying to make it as a general practitioner and instead pursue a more lucrative specialty? Seriously, you have some hefty student loans to repay!
Consider a world where various physicians respond in those very sensible ways. What happens to patients when there are fewer doctors or doctors who are working longer hours and charging more for more procedures? Patient care suffers. I’m certainly not trying to scare anybody here; odds are, those shifts would be gradual. But it will take a little longer for you to get an appointment and when you do get to see your doc, he’ll spend less time with you. What if your doctor stops seeing Medicare patients altogether?
As you can see, this doesn’t just affect doctors and the cars they can afford to drive. This affects the rest of us too.
What’s really going to happen
My guess is that somebody is going to blink. Rational minds will prevail. Congress is set to reconvene on April 12th and the scuttle is that they’ll retroactively reverse this cut and kick it back down the road before any doctors get affected. So nobody panic. Unless Jim Bunning gets in the way again. Then: panic.
The bottom line is that this is a long-term problem, and continually pushing back the date that this 21% SGR cut takes place is a short-term tactic. What’s needed here is a long-term fix. I sincerely hope that the U.S. government doesn’t actually believe that simply reducing the amount Medicare reimburses doctors is a legitimate solution for controlling costs. That’s crazy talk. But hopefully this will give them time to legislate a real fix, one that doesn’t involve a simple reduction of reimbursement rates.
That being said, they’ve been dragging their feet on a real fix for a long time. Here’s why: when the Congressional Budget Office calculates the long-term budget for Medicare it assumes that this 21% actually happens. A fix to permanently get rid of this SGR adjustment would add several hundred billion dollars to Medicare’s deficit over the long run. Quite the bind! On the one hand, they can let the cut go through and deal with the social consequences discussed above. On the other hand, they can fix it once and for all and abandon the accounting sleight-of-hand that makes Medicare look a whole lot more sustainable than it actually is.
Quite simply, we have promised our people more than we can deliver. Rather than dealing with these problems, we’ve chosen to perpetuate the illusion. To cover our ears and hum.
Add this to the list of really important problems that this recent healthcare legislation fails to address.
Another thing nobody is talking about
Going back to that Bloomberg interview with Dr. Schatzman, he made what I thought was a simply beautiful point.
There is no doubt that this is all a gigantic political victory for Obama, and it might even be a great piece of legislation because it extends coverage to so many people. That’s a good thing. But this bill has only addressed one side of the ledger. We’ve increased the number of insured but haven’t increased net coverage. Read that sentence again. Go on, I’ll still be here.
Demand for health services has immediately gone up. With more people insured, more people will use health services more frequently. But the supply of health services has stayed the same! Rewind to your Econ 101 class and think of “healthcare” as a good like any other, like guns or butter. We have increased the demand for healthcare and haven’t increased the supply.
What happens in situations where demand increases relative to supply? Anyone, anyone? Bueller? Bueller? What happens is prices go up. This is no joke.
I’m sort of embarrassed that those supply & demand dynamics didn’t occur to me earlier. But that’s why I listen to Bloomberg Radio. I know there are plenty of nuances that affect supply and demand in health care, so it’s unclear exactly what effect this shift will have on each of us specifically. Still, this is a macro perspective that nobody is talking about.
Conversations with doctors
I’ve spent the last two weeks talking to different doctors about this healthcare thing. Some are fresh out of med school and launching their practices anew. Others have been around a while and have a steady base of patients. What they had to say was jaw-droppingly interesting. If you’d like to read some of their direct comments, you can do so right here. I think you’ll find what they had to say both fascinating and refreshingly honest.
From our conversations emerged some common themes:
- The importance of a healthy society cannot be understated. Whether you think that people should be covered as a right or whether you just want to keep costs down, we should all agree that a more-healthy population is strictly preferable to less-healthy one. This is so, so important for the century to come. For both social and economic reasons. I am a libertarian cynic at my core, and while I might want to live in a world full of responsible people who take care of themselves and make responsible decisions and stay out of each other’s business, the world I do live in isn’t like that. Americans, sadly, need a whole lot of nannying.
- Simply reducing the amount that Medicare pays physicians is a completely insane strategy for controlling Medicare’s long term costs. That would work just fine in a country like Japan or Great Britain, where the cost of procedures and the salaries of physicians are also set by the government. But in a system like ours, where the government sets what the insurance pays out and the market sets what this stuff costs, it is fundamentally broken methodology. We have to deal with all the problems of free markets but don’t get any of the benefits. I’m surprised so few others see this. Anybody who does wins a big piece of the puzzle of why healthcare costs have risen so dramatically relative to other sectors in the economy.
- I am sympathetic to doctors’ plights. It is very expensive to become one, and it’s getting more difficult to justify the costs of doing so. This is a move in the wrong direction. Doctors need better incentives to become doctors, especially lower-paid GP’s, and especially with the 30 million newly insured who are going to need care.
- Most of these doctors told me that they never went into healthcare for the money and did so for patient care. And I believe them. I believe them because if they were just in it for the money, they would have gone to Wall Street, where the rewards are much greater and the costs (both absolute and opportunity costs) are much lower. Plus, you get bailouts when you screw up.
- Despite what may be virtuous and noble ideals, a doctor’s office is still a small business, and the economics of all this stuff does matter. In many other countries, doctors are employees of the state. If we want to treat doctors as private enterprise, it’s important we have a system that supports them as such.
- It’s also important that they are protected against the most litigious society the world has ever known. Malpractice lawsuits seem to be a serious concern amongst many of the doctors I talked to, and it’s a big expense to guard against them. I personally know a couple of gynecologists around town who used to be obstetricians as well, but don’t do it anymore strictly to avoid the liability headaches. On top of that, it’s a lot easier and safer for a doctor to just not fight a patient demanding a particular drug or test, and order up things that he, as a doctor, believes are unnecessary. It’s not always easy to connect the dots, but unnecessary procedures and ridiculous lawsuits from angry or greedy patients carry significant social costs.
Again, if you want to read some of these doctors’ unedited comments, you can click here. Thanks to all those who offered their honest and heartfelt opinions.
I’ve talked to a lot of other people in the last few weeks about healthcare reform. From college kids to elderly on Medicare. As far as I can tell, the mainstream conversation boils down to a simple, ideological difference: There are people that believe that healthcare is a right and should be provided for all of our nation’s citizens, and there are people that don’t think the total costs of doing so are justified. The core debate really is that simple.
Honestly, I’m not very interested in that debate. There’s little either side can learn from the other, which I think is what explains the contentiousness. And partisan politics only exacerbates the difficulty we have communicating about areas where we actually can have a productive conversation.
There are so many more dimensions to “healthcare reform” that are so much more interesting. And more relevant to each of us.
So how do I make money off all this?
Given the macro perspective that we’ve outlined in this issue, one where the demand for healthcare is rising relative to the static supply, and one where Medicare’s long-term budget is either shrouded by accounting fictions or must be addressed with significant economic consequences, I think we can draw a few investment conclusions:
- Any way you slice it, the recent bill amounts to a pretty big entitlement, which means you have to like long-dated government debt a little less than you did back in January. I’m not sure I want to loan the government money for 30 years and only get 4.5% to show for it. I’m not even convinced that will break me even after inflation over that span.
- While there might not be any inflation on the immediate horizon, the condition isn’t likely to persist forever. Inflation sensitive assets may be boring for a year or two, but allocating to them now will prevent any anxiety from missing out on the inflation-trade that many see to come.
- Higher taxes are in our future, and in a vacuum, higher taxes are a drag on consumption. That’s usually bad news for stocks, especially discretionary stocks, the first place people go when they have to curb their spending.
- With more demand and lagging supply, healthcare, as a sector, is likely to become a bigger and bigger portion of the economy and stocks in that sector will probably outperform the market over the long-run.
- Supporting sectors like technology will probably also outperform the market over the next few secular cycles.
- Parents, if you’ve got kids in school, steer them towards a career in medicine. Invest in their futures. At least then they won’t have to worry about the joblessness that the rest of us are so afraid of.
Pretty basic stuff. We outlined some other strategies in our popular 10 Predictions for 2010 piece and this one too. Or you can just subscribe and stay in the loop every week.
No, this long-term macro stuff isn’t as exciting as day-trading financial stocks, but we think it’ll get you through the next decade with a lot less heartburn. Less heartburn is a good thing.
Our nation has enough health concerns as it is.
