George Hosfield, CFA, discusses Ferguson Wellman's quarterly strategy titled, "Inflation's Flame Flickers," which addresses the narrow market leadership, the impact of higher interest rates on inflation and how assets are priced at this stage of the economic cycle.
George Hosfield, CFA, discusses the firm's quarterly strategy titled "Stalemate," which highlights the Fed's ongoing battle to tame inflation along with our views on the health of the banking industry and capital market expectations for the balance of the year.
Director and Chief Investment Officer George Hosfield, CFA, discusses the Fed raising interest rates, peaking inflation and our view on equities and volatility across all asset classes in our Investment Strategy titled, “Balancing Act.”
While the broad market finished the holiday-shortened week positive, healthcare investors weren’t as fortunate. Continued chatter regarding “Medicare for All” as well as a Health and Human Services proposal to ban drug rebates for Medicare are weighing on the sector.
by Shawn Narancich, CFA
Executive Vice President of Research
Don’t Look Back!
As investors question the underlying strength of the U.S. economy, stocks are consolidating gains and bonds are defying Wall Street expectations for yields to rise. Like drivers gawking at a car wreck as they drive past, market participants once again revisited the surprisingly poor economic start to a 2014 that most thought would bring faster economic growth instead of the worst quarterly performance since the depths of the Great Recession. Reasons for the 2.9 percent contraction in first quarter U.S. GDP have been widely discussed, but the cold, inclement weather and late Easter don’t negate the math of such a poor start to the year, and its impact on full year estimates that economists are now scrambling to reduce.
Back on Track
Relatively healthy payroll growth, rising retail sales, and healthy manufacturing indicators bely the wreckage of first quarter GDP, but this week’s surprisingly poor May personal consumption numbers prolong the debate about how strong the economy really is. Few indicators are as simple as they first seem and this number is no exception, being dampened by accounting for the Affordable Care Act that economists first thought would boost healthcare spending. As it turns out, this component of consumer spending actually fell in May, and with the Fed’s preferred inflation measure ratcheting up to 1.8 percent year-over-year, real consumption spending used to compute the GDP number actually dropped sequentially. So what’s an investor to believe? Notwithstanding the disappointing May number, we expect Q2 consumption spending to increase at a faster pace and look for better capital spending and housing investment to produce GDP growth somewhere in the 3-4 percent range. If achieved, this level of growth will be the best in a couple years and should go a ways toward allaying concerns about the pace of economic expansion. In this environment, we expect bond yields to rise.
Clear as Condensate?
The U.S. energy industry was jolted this week by surprise news that the Commerce Department has granted approval for two energy companies to begin exporting very light crude oil known as condensate. The U.S. energy renaissance has boosted domestic oil production by over 70 percent since the lows of 2008 and, owing to the nature of unconventional development, an increasing amount of the liftings are of the clear variety. The challenge for U.S. refiners has been to revamp their capital intensive facilities to accommodate this light production after years of gearing up for heavier Mexican and South American imports. The reaction on Wall Street was dramatic, as stocks of oil producers rallied and refining stocks tanked. If the first government approvals this week turn out to be a harbinger of additional exports to come, benchmark WTI oil prices should increase relative to the global benchmark Brent. Accordingly, the producers would realize higher prices at the expense of the refiners, which have benefited greatly from the discount at which they buy U.S. light crude. Only time will tell whether additional export approvals are granted, but the risk for refining investors is not only that their feedstock costs increase, but that investments made in recent years to process lighter grade crudes fail to pay off.
Our Takeaways from the Week
by Jason Norris, CFA
Executive Vice President of Research
I Want a New Drug
We have seen a major resurgence in the healthcare space with regard to R&D and stock performance. In 2013, with the broad market up over 30 percent, the healthcare sector returned close to 45 percent and was the second best-performing sector. This year, in a flat, sideways-trending market, healthcare has been the best performing sector. We believe the sector gives investors a great mix of growth as well as stability and income. The worst of the drug patent cliff and generic substitution is behind us. We saw this transition peak in 2011 and 2012 with the likes of Lipitor, Plavix, Viagra and Singular coming “off patent.” This total was roughly $90 billion of revenue for big pharma companies. With this event sunseting, big pharma has cut costs, spun off divisions and made acquisitions to “right size” their lines of business. We anticipate the emerging pipelines from big pharma to more-than-offset the loss of revenue that will occur in 2016 and 2017. This reemergence is driven by diabetes, oncology and anti-clotting drugs.
Another space displaying strong R&D performance is biotech. In 2013, Biogen Idec launched its revolutionary multiple sclerosis drug and this year we have seen Gilead’s hepatitis C treatment (Sovaldi) come to market. The growth opportunities for this type of drug are great. For example, six months ago, Gilead was estimated to sale $2 billion of Sovaldi in 2014. Now expectations have risen around $7 to $10 billion. The R&D efforts in drug development around the world continue to break new ground.
Cover Me
The end of March will mark the conclusion of the first open-enrollment season of the Affordable Care Act (ACA). While the rollout was far from perfect, there is still quite a bit of uncertainty of its effects on the healthcare sector. We believe, relative to investing, most of the uncertainty has been diminished. The taxes that were implemented on the drug makers and medical device manufacturers have already taken effect. It is anticipated that the remaining uncertainties will affect hospital and insurance markets. As we have seen some adverse selection in the enrollment, the overall costs to the plans may see steep increases. While there is a clause in the ACA to reimburse insurance providers for their losses, we have heard “rumblings” from Congress to repeal this provision. While that is highly unlikely, it still creates uncertainty.
Finish What You Started
On Wednesday, the Federal Reserve continued to reduce their monthly bond purchases and gave all indications that they want this program to wrap up by year end. The Fed did state, however, that they will continue to remain “accommodative” while the economy muddles along. The major change was the removal to the 6.5 percent unemployment-rate threshold. We anticipated this because of the issues around labor participation can distort the rate. We do believe that the Fed funds rate will be anchored at 0.25 percent well into 2015.
Come Monday
On Monday, April 7, the NCAA will crown a men’s college basketball champion. For those lucky enough to still have a viable bracket, you are moving closer to winning $1 billion from Warren Buffet, providing you continue to have the perfect picks. The odds of this are 1-in-9 quintillion (yes that’s 19 zeros). Let’s hope that in the last couple days, worker productivity did not fall too much as fans tried to follow all the games.
Our Takeaways for the Week
