Careful What You Wish For…
So be careful what you wish for
‘Cause you just might get it
And if you get it then you just might not know
What to do wit’ it, ’cause it might just
Come back on you ten-fold
Eminem, Careful What You Wish For
There was a collective gasp on Wall Street last week as the 3rd revision of 1st quarter GDP was released. Down 2.9%! That’s quite different from the first read, of up 0.1% and just goes to show that economists aren’t just bad at predicting the future but even face significant challenges figuring out the past. The culprit in the big downward revision was centered in consumer spending and specifically, healthcare spending. The reason we got such a big revision is that economists had expected, due to the implementation of the ACA (Obamacare), a big surge in healthcare spending as the newly insured rushed to the doctor to take care of all those pre-existing conditions. Instead, the final figures actually showed a drop.
Healthcare reform has been touted as needed by just about everyone on the basis that the US spends more than any other country, as a percentage of GDP, on healthcare. Despite significant differences on the proper structure of any reform, everyone agreed (agrees) that we spend too much. Obamacare was passed on a lot of false premises but the most egregious may have been the one that said that we could increase the number of people utilizing the healthcare system while also reducing the cost. I pointed out at the time that this was logically flawed based on the simple idea of supply and demand. If you increase the demand for a product or service while holding supply constant, getting a price reduction is out of the question. The economists who expected a rise in healthcare spending in the first quarter fell victim to a similar but slightly more nuanced misunderstanding of supply and demand.
The fact is that the implementation of Obamacare, even with all the various exclusions and delays, increased the price of healthcare at the consumer level. One of the main complaints we’ve heard about the policies being offered on the exchanges is that, for most people who previously had insurance, the deductibles and out of pocket expenses are considerably higher. And people who previously had no insurance could finally get a policy, but they came with those high deductibles. The implementation also changed a lot of plans that were not in the exchanges in similar fashion. For a lot of companies, the only way they could continue to provide health insurance – after the rapid rise in cost leading up to implementation – was to shift to polices with higher deductibles. I know for a fact that is what happened at our little company.
So, yes a lot of people who previously had no insurance suddenly found themselves with policies at some point in the first quarter. And yet, they didn’t seem to use them to the degree that economists and the White House predicted. And the reason is fairly simple. For a person who couldn’t afford a policy before, the addition of coverage protects them from bankruptcy in the case of a major illness but it didn’t put anymore money in their pocket to pay for those deductibles. For people who already had plans but are now facing higher deductibles, an incentive was added to shop for lower prices. A consumer with a new higher deductible, needing say an MRI, is more likely to shop around for the best price. Add in the higher taxes and fees imposed to pay for the reform and visible healthcare prices have risen significantly.
So, Obamacare may indeed push down the cost of healthcare in aggregate but not for the reasons that were touted during the debate. It isn’t because we are utilizing ERs less and engaging in more preventive care or whatever other claims were made. No, the reason Obamacare may push down the cost of healthcare is that it raises the price of healthcare at the consumer level – through higher deductibles – introducing new incentives to spend more wisely and thereby reduces the demand for healthcare services. Patients have more skin in the game; they can’t just assume it’s the insurance company’s problem and consume infinite amounts of healthcare. If you believe we should be spending less on healthcare (or anything else for that matter) the simple answer is to raise the visible cost. First quarter GDP would seem to confirm that the laws of supply and demand are alive and well in the healthcare industry.
Despite a lousy 1st quarter GDP print, this reduction in healthcare spending is probably not a bad thing. More price conscious healthcare consumers is certainly a good thing – and by the way seems to confirm what free market types have been saying about healthcare for a long time – and should reduce what we spend – per capita – on healthcare over time. Freeing up capital currently going to healthcare for other purposes would also seem to be a good thing in the long run. It is true that we spend more than any other country on healthcare and it has surely reduced spending in other areas that might have had a more positive impact on long term growth.*
The problem is that economies – markets – are made up of people who have to make decisions and they don’t always make them as fast as the perfectly rational beings who occupy economists’ neat models. If, as a country, we spend less on healthcare that should, theoretically, increase spending in some other part of the economy. But it surely doesn’t happen overnight. Given the uncertainties surrounding the changes to the healthcare system, it should not be surprising that people are hesitating and becoming more conservative. Until they feel confident they have a handle on the cost to them of healthcare in this new system it is perfectly logical to spend less and save more. For those who can’t afford the higher deductibles, it makes sense to delay any but the most urgent care while saving for those deductibles.
The other factors that pushed down 1st quarter GDP were even more predictable than healthcare spending. Our Jeff Snider warned way back last year that, absent a surge in Christmas spending that we didn’t expect, an inventory correction was inevitable and would reduce 1st quarter GDP. Likewise the residential and non residential investment numbers. Jeff warned months ago that real estate was having problems – as reflected in the mortgage application numbers – and that companies were foregoing investment in favor of financial engineering (stock buybacks and M&A). So nothing about the 1st quarter was very surprising to us although I must admit we didn’t see a negative number that large.
But as I often say, the economy isn’t the market and the market isn’t the economy. Stocks have continued to move higher this year despite the 1st quarter drop in GDP, based primarily on the belief that most of the 1st quarter debacle was weather related and that as the weather warmed, so would the economy. And that has happened in some areas; the reports we got last week showed some improvement. Existing and new home sales were higher, the regional Fed surveys were fairly positive, jobless claims remain well behaved and consumer confidence is rising (although the expectations component was unchanged and still quite depressing).
The pertinent question though is whether these rebounds are the beginning of something that is sustainable or just one time bumps that will fade as the year progresses. I don’t like to make predictions about the future so I’ll just say that if the recent strength continues about the only market that won’t be surprised is the one for stocks. I watch the TIPS market as a guide to growth and inflation expectations and right now, the former are still waning while the latter are waxing. Not generally a positive combination for corporate profits and stock prices.
I would also add that I have become more concerned (I know, I know; you didn’t think it was possible for me to get more concerned about anything) recently about market structures. As this stock market has moved relentlessly higher, volume has been falling, indicating – to me at least – that liquidity is not sufficient should some exogenous event turn the buying into selling. Trading has shifted to ETFs, dark pools and other venues that do not have the structure of traditional exchanges; there aren’t any specialists required to step in and provide liquidity when no one else will. Even more concerning is the bond market, particularly the more speculative areas. Wall Street brokers and banks have reduced their bond inventories to a third what they were prior to the implementation of Dodd Frank and the Volcker Rule which limited the ability of these firms to take risk, to trade for their own account.
The powers that be wanted to reduce the risk of the banking system and if the risky part of the bond market goes south, banks will certainly be protected by their reduced inventory. However, if the 1st quarter was not an aberration and the economy does fall into recession, junk bonds are going to be on the sell list for most investors as defaults inevitably rise. The new rules may have accomplished their goal of reducing the risk in the banking system. But the risk hasn’t disappeared. It has just been shifted to the owner of that junk bond or bank loan ETF who won’t be able to find a buyer when they most want to sell. As the lyrics at the beginning of this say, be careful what you wish for; you just might get it.
*I have no idea what the optimal level of healthcare spending should be in an economy and neither does anyone else. For all I know we’re spending the right amount and it is the rest of the world that should be spending more. I do believe though that the market for healthcare has been distorted through third party payment – particularly by government agencies such as Medicare and Medicaid where fraud is rampant – which makes the price less visible to the end consumer.
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For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: email@example.com or 786-249-3773. You can also book an appointment using our contact form.