"Healthcare Care Inflation At Lowest Rate in 50 Years"

Ezra Klein of the Washington Post is out this afternoon with a short note about the unexpected slowdown in the rate of growth in healthcare spending.

Klein writes that this chart published by the Council of Economic Advisers (CEA) illustrates the good news on health care costs:

http://www.washingtonpost.com/blogs/wonkblog/wp/2013/11/20/this-chart-is-amazing-news-for-our-health-cost-problem/?wpisrc=nl_wnkpm

I went to the CEA site and they offered up another chart that illustrated the dramatic changes going on in health care spending:

2013/11/20/new-report-council-economic-advisers-recent-slowdown-health-care-cost-growth-and-rol

Now, to be sure, the CEA is part of the White House, so it is probably not the most unbiased source.

But on the other hand, it is hard to argue with the data.

Here's  an excerpt from what Jason Furman of the CEA wrote in his note accompanying the charts:

..Health care price inflation is at its lowest rate in 50 years: Measured using personal consumption expenditure price indices, inflation for health care goods and services is currently running at just 1 percent on a year-over-year basis, the lowest level since January 1962.  (Health care inflation measured using the medical CPI is lower than at any time since September 1972.)

..The slowdown in health care cost growth is not due solely to the Great Recession; something has changed: The fact that the health cost slowdown has persisted so long even as the economy is recovering, the fact that it is reflected in health care prices – not just utilization or coverage, and the fact that it has also shown up in Medicare – which is more insulated from economic trends, all imply that the current slowdown is the result of more than just the recession and its aftermath.  Rather, the slowdown appears to reflect “structural” changes in the United States health care system, a conclusion consistent with a substantial body of recent research.

http://www.whitehouse.gov/blog/2013/11/20/new-report-council-economic-advisers-recent-slowdown-health-care-cost-growth-and-rol

More fuel for the deflationary camp?

More Talk on Health Care

My wife and I had the chance to hear from one of the prominent experts in the health care field last night.

Arthur Garson is the former dean of the University of Virginia (UVA) medical school.  He remains active in the field as an advisor to a number of global health care initiatives, including the World Bank.  Dr. Garson has also co-authored a book on health care in the U.S. titled "Health Care Half Truths: Too Many Myths Not Enough Reality".


Dr. Garson was speaking at an event here in Boston sponsored by the UVA Club of Boston.  My daughter is a second year student at UVA.

I can't do justice to all of the remarks that Dr. Garson made over the course of his hour-long presentation, but I thought he made a number of points that you might find interesting:

• On Obamacare:  the costs of the new program are clear but the savings are not.  Dr. Garson believes that the program does not address some of the fundamental issues in our health care system, and so is skeptical of its longer-term success.
• On Our Health-Care System:  any way you measure it, our system does not stack up well versus a number of other health care systems throughout the world. We need to make fundamental changes;
• On Medical vs. Health Care:  Dr. Garson believes it is important to make the distinction.  The quality of medical treatment varies widely across the U.S.  Boston hospitals are among the finest in the world, according to Dr. Garson, but other areas come up short (including New York City, surprisingly).  Health care - which encompasses the quality of life - is poor by a number of measures, including teenage pregnancy rates; teen suicide rates; infant mortality; and fatalities due to gun violence;
• On Waste in Our Health Care System:  Most agree that hundreds of billions are wasted each year, yet the solutions are not easy.  Physicians often perform too many tests, but the reasons can vary (fear of lawsuits is one commonly-cited reason, but often it is just the doctor's style);
•  Medicare:  Dr. Garson noted that no single factor has contributed more to the growth in medical spending than Medicare.  As an example, he noted that a patient with back pain is six times as likely to have spinal surgery in Miami (with a large elderly population) than Seattle.  While medicare reimbursement rates are often the subject of complaints, the volumes often make up for lower margins;
• Doctor payments:  our medical system encourages doctors to do more procedures since they are paid by the number of procedures.  Paying doctors on a salary rather than a fee-for-service would be a much better way to contain costs;
• End of Life Care:  Most cite the fact that 40% of a typical patient's health care spending occurs in the last year of their life.  Problem is, since there is no way of knowing your final date.  Dr. Garson cited the example of his two parents who were both diagnosed with lung cancer within weeks of each other. One died within three months, while the other died three years later.

Dr. Garson said that he and his co-author were working on a new version of his book, which should be coming out soon.  If you are at all interested this complex topic, it might be worth a read.

Taking the Pulse of Health Care Stocks

Even after yesterday's sell-off, investors in health care stocks (pharmaceutical, medical device and biotech) have enjoyed gains far in excess of the S&P 500 over the last 12 months.

In one respect, such strong outperformance is a little unusual, since health care is usually viewed as a defensive sector.

But we live in unusual times, and health care stocks have refused to follow the traditional script. Given the high dividend yields available on the big pharma stocks, and the anticipation of a surge in demand for health care with the passage of Obamacare, investors have flocked to the group, and the stocks have reacted accordingly.

Yesterday I had the chance to hear from Tim Anderson, who follows global pharmaceutical stocks for Bernstein. 

Tim - who is a doctor by training, and still is licensed to practice medicine - is one of the better analysts in the space, so I was looking forward to his thoughts.

In the 15 years that Tim has been following the group he has been largely neutral to bearish on his stocks, which turned out to be the correct call.

However, about 18 months ago he turned more optimistic as the two biggest negatives for pharma stocks over the past decade - lagging R&D productivity and large patent expirations - have gradually subsided.

In Tim's view, performance of pharma stocks is directly tied to the new drugs in their pipelines.  There seems to be more evidence that all of the major pharma companies have made significant gains in their R&D efforts, and new drugs with possible large revenue potential seem likely over the next few years.

Tim continues to like many of the pharma stocks he follows, but he is more favorable to European stocks (e.g. Novartis, Sanofi, Roche) than U.S. stocks since he anticipates better growth rates from the European companies.  Valuations are also slightly more attractive among the European group.  Still, he feels positive on both domestic and foreign companies.


Many investors have worried that pharma companies will experience more downward pressure on drug pricing as government influence in the health care system becomes more pervasive.  However, Tim finds this has not been the case.

Tim feels that his group will continue to act well so long as valuations relative to other "defensive" sector remains favorable, and dividend yield continues to be a focus of investors.

Taking the Pulse On Pharmaceutical Stocks

Two years ago, in March 2011, I headed over to the Merrill Lynch offices here in Boston to hear Gregg Gilbert.

After covering the specialty pharmaceutical stocks for nearly a decade, Gregg had just initiated coverage of the major pharmaceutical group. Gregg had started his career at Merrill following stocks like Pfizer; Merck; and Eli Lilly, so was already familiar with the companies.

His message that day was simple:  Buy these stocks.

His comments were along the lines as follows:

When I stopped covering this group in 2000, all of the stocks were trading a P/E multiples in the high 20's or low 30's, and dividend yields were relatively puny - around 1%. Every meeting I attended was crowded - pharmaceutical stocks were popular with both growth and value managers.

Now, 11 years later, no one likes this group.  Most are convinced that major pharmaceutical companies are dinosaurs, with bloated bureaucracies and meager new product pipelines.  Multiples today are in the single digits, and dividend yields are near 4%.  

But I am telling you now:  This is a tremendous opportunity.  While all of my companies have issues, they are just being priced too cheaply. Buy today, and you will be richly rewarded.

Over the years I have probably attended hundreds of analyst meetings, but only rarely have I heard an analyst speak so forcefully (and rationally) about the stocks he follows.

Yesterday I headed back over to Merrill's offices to hear Gregg again.  Like the meeting two years ago, there were few in attendance, although the poor weather yesterday probably had something to do with the small audience.

But there was no denying that Gregg Gilbert had been right on the money two years ago. 

As the above chart shows, major pharmaceutical stocks have been big winners.  Lilly, for example, is up +60% since March 2011, while the S&P 500 is up +20%.  Lilly also paid investors a 5% dividend yield, which even further increases its outperformance over the the last two years.

Yesterday I reminded Gregg of his prescient call on pharma stocks, and he was understandably pleased that I remembered.

So, I asked, what about now? Are the stocks still attractive?

Gregg characterized his views today as "bullish" as opposed to the "wildly bullish" feelings he had earlier. 

The valuation of most of the stocks (except for Bristol Myers, which trades at premium multiple and that he rates a neutral) are closer to the overall market. Dividend yields remain above the market, yet the gap has narrowed considerably due to the strong relative performance of the stocks.

Unlike other pharmaceutical analysts, Gregg does not base his recommendations solely on new product pipelines.  Drug development is still too uncertain, and success rates relatively low, to buy a stock on new drugs. He likes to find companies with innovative R&D and strong managements trading at cheap valuations.

And most pharmaceutical stocks today still fit the bill.