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Two Healthcare Sectors the Stock Market Got Wrong on Election Day 2012

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How various sectors in the Health Care Industry fared under the PP-ACA legislation?

[A SPECIAL R&D REPORT FOR THE ME-P]

By David K. Luke MIM, MS-PFP, CMP™ [Certified Medical Planner™]

Website: http://www.networthadvice.com

David K. LukeThere has been a lot of speculation since the words “Affordable Care Act” were first whispered years ago on how the various sectors in the Health Care Industry would fare under such legislation. I proposed that a good indicator would be to look at the performance of the individual health care sector stocks on the first trading day after the election.

(See With Obama Election Win, “Mr. Market” Weighs in on the ACA Equity Winners and Losers by David K. Luke on November 16, 2012).

Link: With Obama Election Win “Mr. Market” Weighs in on the ACA Equity Winners and Losers

The day after Pres. Obama’s reelection on Wednesday, November 7, 2012 the stock market was down over 2% as measured by the S&P 500 and the Dow Jones Industrial Average (DJIA). The common reason given was increased doubt that the impending “fiscal cliff” issue, which was splitting the House and the Senate, would be resolved. There was however, another big concern on investor’s mind: the future of the Affordable Care Act. While the election was close when measured by the popular vote with President Obama earning 51.06% versus Mitt Romney with 47.20%, the electoral vote showed a hands-down Obama victory with 332 versus 206 votes. Investors voted with their pocketbooks with that first trading session following the election showing certain healthcare sectors up in price, other healthcare sectors with moderate returns, and certain healthcare sectors down in price.

Disparate Health Care Sector Returns

It is interesting to look back now over a year and a half later and see how accurate those investor votes were on that first day of realization that health care reform was continuing forward at a much faster pace now that President Obama would be serving a second term. Keeping in mind that the day was a very negative day as a whole in the stock market, a number of healthcare sectors were up in price. This group includes Hospital Stocks and Medicaid HMOs. Note the phenomenal one-day returns (in a down 2% market!) on the sample stocks in these two groups:

Hospital Stocks

  • Health Management Associates (HMA) +7.3%
  • HCA Holdings Inc. (HCA) +9.4%
  • Community Health Systems Inc. (CYH) +6.0%
  • Tenet Healthcare Corp. (THC) +9.6%

Medicaid HMOs

  • Molina Healthcare Inc. (MOH) +4.6%
  • Centene Corp. (CNC) +10.1%
  • WellCare Health Plans Inc. (WCG) +4.4%

Such positive returns on a big down day in the market indicates investors assessing these healthcare sectors being good investments under an Obama presidency and a positive outlook for the implementation of the Affordable Care Act. The other up sector on that day was the Drug Wholesalers, up almost 1% on that negative day. (See “Selected Health Care Performance” Chart – below).

The market had a tepid response to the Pharmacy Benefit sector, as well as the Generic Pharmacy, Testing Labs, and Big Pharma. In my sample group, these sectors were down -.4%, -7%, -1.7%, and -1.4% respectively. It is important to note however that these sectors while slightly positive or barely negative still performed better than the general market that day.

Two Sectors

But, the two healthcare sectors that the stock market severely punished with the voting of substantially more sellers than buyers by investors on that first post-election day were the Medical Device Companies (down 2.5% in the sample group) and the Medicare Part D Companies (down 4.7% in the sample group). The thought at the time was that Medical Device Companies, facing an impending medical device excise tax of 2.3% on the sale of most medical devices in the United States, would be devastated, and that Medicare Part D Companies would face severe profit constraints with tighter-fisted government regulations imposed by the ACA.

***

Stock_Market

***

The Retro-Specto-Scope

In hindsight, investors were correct on two out of the three predictions based on stock market prices on the various healthcare sectors. Hospital Stocks, Medicaid HMOs, and Drug Wholesalers, the leading sectors indicated to be winners with the impending implementation of the ACA, are up 69.8%, 63.6% and 76.5% respectively in the sample groups since November 7, 2012. This remarkable and closely parallel return for these three sectors seemed to prove that the stock market on November 7, 2012 correctly picked the three winning health care sectors! The S&P 500 index for the same time is up 32.02%, a nice return for 1 ½ years but about half the return of these apparently huge benefactors of the ACA. The healthcare sectors that investors felt less positive about (but more positive than the general stock market) on that first postelection day were Pharmacy Benefit Companies, Generic Pharmacy Companies, Testing Labs, and Big Pharma. These four health care sectors are up 43.8%, 40.5%, 6.4%, and 20.5% respectively. Again, in terms of ranking the sectors, these four sectors performed in line based on the comparative returns of the other healthcare sectors.

Wisdom of Crowds

Amazingly, it appears that the emotional Mr. Market predicated quite accurately on Wednesday, November 7, 2012, in one day of trading, not just which health sectors would be good investments for the near future, but the actually ranking of the future performance of the sectors! It seems as though the stock market, as one large voting machine, precisely dissected the over 20,000 pages + of resulting legislation created from the original 906 pages (pdf here) of the PPACA law and distilled it down to profits and losses with the resulting winners and losers in the health care industry in one trading session.

Two [2] Big Misses

Investors however were way off on their concerns about Medical Device Companies and Medicare Part D Companies. The two sample groups were up 71.3% and 66.4% in the time of November 7, 2012 to May 19, 2014 respectively, more than double the S&P 500 for the same period, and in line with the best performing sectors! This is spite of the fact that stock sample of these two groups were the two worst performers on post-election day trading. What happened?

***

Bear + A Falling Stock Chart

***

The “Medical Device Excise Tax” Fable and the “Private Insurers Will Control Costs” Fairy Tale

Wall Street has sharpened their pencils in the last year and a half and realized they have gravely underestimated the profit potential of the Medical Device makers and the Managed Care Health Insurers, in spite of the ACA. Based on stock price performance of the sample group of major players in the past 18 months, fewer sectors look as profitable as the Medical Device Industry and the Medicare Part D Industry. What happened?

The Medical Device industry states that the tax will cost the US “tens of thousands of jobs” and that those jobs will be shipped overseas. A number of issues that are involved here however refute these claims (http://www.factcheck.org/2013/10/boehner-and-the-medical-device-tax/. It appears that any targeted reductions were not related to the implementation of the tax, which became effective January 1, 2013, in spite of heavy protest by the industry. Medical technology continues to have a bright future regardless of the tax.

The notion that the “Affordable” Care Act will help reign in the rampant cost increases of Medicare’s “Part D” program seem to be elusive. Private insurers have done a poor job of keeping drug prices down, especially when compared to the discounts the government gets for Medicaid. Medicare Part D companies wield significant influence on Capitol Hill, and impending steeper discounts look unlikely.

Everybody Wins, Except …

Before the ACA implementation, about 85% of Americans had health insurance. Currently with an additional 7 million Americans with health insurance thanks to Obamacare, an additional 2.2% of Americans now have coverage, or about 87% of all Americans. How can such a slight increase in new health care consumers be responsible for such large anticipated profits in the health care sector? It cannot. Wall Street is telling us that the new health law is not about new customers, but about increased profit margins for the health care industry. I can draw three conclusions:

  1. The Affordable Care Act may not be so affordable for health consumers
  2. Most companies in the Health Care Industry stand to gain financially with ACA. There is one sure loser with ACA: The physician, who can only look forward to increased workloads and mpending Medicare SGR pay cuts.

THE CHART [Research and Development]

Selected Health Care Sector Stock Performance Random Sampling of Publically Traded Companies From President Obama Re-election Date to Present

Chart

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With Obama Election Win “Mr. Market” Weighs in on the ACA Equity Winners and Losers

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The Wisdom of Crowds

By David K. Luke MIM, Certified Medical Planner™

Website: www.networthadvice.com

The first trading session following the election on Wednesday, November 7, 2012 gave us some clues on how different sectors of the health care market may be affected by the ACA, as Obama’s win confirms that health reform marches forward. “Mr. Market” has spoken.

“Mr. Market”

For those that may be unaware, “Mr. Market” was Benjamin Graham’s term for the stock market in explaining fluctuations. Graham is the father of value investing and Warren Buffet’s most influential mentor. According to Graham, Mr. Market is emotionally unstable but doesn’t mind being slighted. If Mr. Market’s quotes are ignored, he will be back again tomorrow with a new quote.

So, the point is that successful investors do not place themselves in emotional whirlwinds often created by the market. This first post-election trading session was such a whirlwind. Large groups of people (such as those that voted with their pocketbook in this telling stock market session) are smarter than an elite few, or so goes the premise of James Surowiecki’s Wisdom of the Crowds.

Now; what did we learn from the combined investing public wisdom about the future of healthcare companies profitability with ACA?

Keep in mind the overall market was down 2.4% on the day as measured by both the Dow Jones Industrial Average and the Standard & Poor 500. The biggest concern of the day was investor worry about the so called “fiscal cliff” and the debate over billions in spending and tax increases. Considering the total market on November 7th, health care stocks performed as a group better than the averages, but Mr. Market definitely parsed health care stocks by sector from “great” to “dreadful” based on the implications of impending health care reform:

Great:

Hospital Stocks

  • Health Management Associates (HMA) +7.3%
  • HCA Holdings Inc. (HCA) +9.4%
  • Community Health Systems Inc. (CYH) +6.0%
  • Tenet Healthcare Corp. (THC) +9.6%

Yes, there were stocks that went up stridently on the big down day. Not surprisingly, hospital stocks are expected to benefit from the estimated 30 million Americans who will line up for insurance coverage beginning in 2014, increasing profits and decreasing bad debts.

Medicaid HMOs

  • Molina Healthcare Inc. (MOH) +4.6%
  • Centene Corp. (CNC) +10.1%
  • WellCare Health Plans Inc. (WCG) +4.4%

Health insurers that typically focus heavily on Medicaid are up in line with ACA provisions to expand care for the poor. Mr. Market tips his hat to Centene Corporation, which has been successful in procuring multi-line coverage contracts with States including long-term care, vision, dental, behavioral health, CHIP and disability.

Good:

Drug Wholesalers

  • McKesson (MCK) +1.3%
  • Cardinal Health (CAH) +.5%
  • AmerisourceBergen (ABC) +1.0%

Growth in prescription drug spending means increased revenues for the drug wholesalers, so ACA should be a positive for this group. But because a majority of wholesaler profits come from generic drugs, and because wholesalers are indirectly affected by changes in pharmacies, pricing pressures will keep the wholesalers in check.

Fair:

Pharmacy Benefit Mangers

  • Express Scripts (ESRX) -0.4%
  • CVS Caremark Corp (CVS) -0.4%

As an intermediary between the payor and everyone else in the health-care system, PBMs process prescriptions for groups such as insurance companies and corporations and use their large size to drive down prices. These companies are incentivized to cut costs and have been thought to benefit greatly from ACA, and will expand prescription drug insurance plans sold through health insurance exchanges starting in 2014.

Generic Pharmaceuticals

  • Teva Pharmaceutical Industries Ltd ADR (TEVA) -0.7%
  • Mylan Inc (MYL) -0.8%
  • Dr. Reddy’s Labs (RDY) -0.6%

Health care reform is good for generic drugs with anticipated increased dispensing of drugs in general.  With more funds spent on Medicaid, the ACA will certainly be generic oriented and should fare better than the name-brand drugs. Pricing pressures are expected over the longer term however.

Testing Laboratories

  • Quest Diagnostics (DGX) -1.5%
  • Laboratory Corp of America (LH) -1.9%

More patients you would think would mean more medical tests. In a recent Gallup survey, physicians attributed 34 percent of overall healthcare costs to defensive medicine (think diagnostic blood tests/invasive biopsies, etc). ACA may curb this expensive part of medicine and appears to have very negative implications going forward as Labs will have intense pressure to reduce rates. However, these larger labs held up better than the market averages suggesting that lab work isn’t going away with ACA.

Big Pharmaceutical Companies

  • Pfizer Inc.  (PFE) -2.2%
  • GlaxoSmithKline PLC (GSK) -0.8%
  • Eli Lily & Co. (LLY) -1.2%

The name-brand large Pharmaceutical companies have agreed to rebate Uncle Sam on Medicaid purchases and must give the elderly discounts. But there will be a lot more of us taking drugs too.

I’ve ranked these 4 health care sectors “fair” considering that broader stock market averages were down 2.4% for the day and Mr. Market was kinder to this group with only a slight negative. Likewise, it appears that he is anointing this group as a benefactor of upcoming reforms.

Not Good:

Medical Device Companies

  • Medtronic Inc. (MDT) -3.0%
  • Stryker Corporation (SYK) -1.6%
  • Boston Scientific Corp. (BSX) -3.6%
  • Zimmer Holdings Inc. (ZMH) -1.8%

The 2.3% excise tax on revenue of medical-device companies is looking more inevitable, in spite of industry lobbying group efforts.

Dreadful:

Medicare Part D Companies

  • Humana Inc. (HUM) -7.9%
  • WellPoint (WLP) -5.5%
  • Cigna Corp. (CI) -0.7%

Even though managed-care companies should gain millions of new customers thanks to the ACA, profit margins are expected to decline significantly.  Mr. Market went easy on Cigna, perhaps because of the company’s focus on self-insured large employers.

Currently

Currently it is unclear how the increased revenue generated from more patients will affect the increased margins to the various sectors of the healthcare market. Also, too much weight should not be placed on this one day action by the market. One thing is clear however, and that is how Mr. Market and the market at large feels at first blush towards the impending implementation of the ACA based on the November 7, 2012 trading of the respective stocks.

Assessment

Remember: Mr. Market is temperamental and can change his mind anytime!

About the Author:

David K. Luke MIM, a Certified Medical Planner™, focuses on helping physicians, medical professionals, and successful retirees with financial planning, investment and risk management. He directs physicians through their complex planning needs, helping them foster a better medical practice and lifestyle. David is a fee-only financial planner.

Disclosure:

Percentage changes in price of stocks represent published change in price from closing price November 6, 2012 to closing price November 7, 2012. Stocks listed here are not considered to be past, present or future recommendations to buy or sell securities and is for educational purposes only. This information should NOT be considered as investment recommendations or advice but rather summary comments and opinions on the health care market by David K. Luke, MIM CMP™, who is entirely responsible for the contents of this article.

Link: www.CertifiedMedicalPlanner.org

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