by Jason Norris, CFASenior Vice President of Research
Comfortably Numb This week, the Supreme Court heard arguments on the constitutionality of the Patient Protection and Affordable Care Act (PPACA) of 2010. The main issue that 26 states brought to the court was regarding the individual mandate. The fundamental question was whether or not Congress can require individuals to purchase a product. If it is determined that this mandate is unconstitutional, the question remains as to whether the entire act is unconstitutional, or if this provision is “severable?” While it is difficult to handicap Supreme Court hearings, there are many indications that the individual mandate will be found unconstitutional. The questioning by the Justices led us to believe that they were troubled with the argument that Congress could force individuals to purchase insurance—including coverage they may not feel they need. Also, there is the concern about the slippery slope this may create regarding the authority Congress has to mandate a specific action.
Many are speculating whether or not the rest of the PPACA can continue forward. Will Justice’s feel comfortable in striking down some provisions, while enabling others? The key provision to be addressed is the guaranteed issue of coverage, which forces insurance companies to accept all applicants at the same rate. This provision would be detrimental to the health insurers, thus we believe it will be struck down along with the individual mandate. If this occurs, the Court must decide if they have the ability to make policy decisions by upholding some provisions and striking down others—or will these actions alter the PPACA so much that it essentially eliminates the intention of the law?
With the belief that the guaranteed-issuance provision will be struck down in some sense led to a rally in the HMO stocks this week. We reduced some exposure to this area the last few months due to the uncertainty; however, we still remain overweight the industry and view their fundamentals as strong.
Money for Nothing Corporations issued over $1.16 trillion of debt in the first three months of 2012, which is the largest amount on record. With rates at historic lows and tight corporate bond spreads, companies have come to the markets to raise cash. What they are doing with all this cash remains to be seen. Corporations have been building their cash hoards over the last few years. We have seen some pick up in capital spending as well as dividends, but companies are still cautious due to economic … and political uncertainty.
Who’s Buying all the Debt? With the federal government over $15 trillion in debt coupled with records amounts of corporate bond issuance—why are interest rates still low? Investors who continue to be skittish of equities are willing to park their money in low-yielding instruments rather than take any equity risk. Even with stocks up over 12 percent for the first three months of 2012, investors redeemed close $30 billion inU.S.equity funds and invested over $72 billion in taxable bond funds. There has not been a lack of supply of dollars to soak up all the debt coming to market, which has kept rates low.
Our Takeaway for the Quarter Strong corporate earnings and balance sheets, low valuations and plenty of funds on the sidelines support our confidence in equities.