Fed Chairman Jerome Powell confirmed that his Fed remains independent of the White House.
President Donald Trump has berated the Fed for even considering raising rates. Yet that’s exactly what Powell and the Federal Open Market Committee voted to do at last week’s monetary policy meeting. The stock market fell on the news that Powell was not wearing his Santa outfit.
Interestingly, the 10-year Treasury bond yield fell, signaling that the Bond Vigilantes are leaving it to the Dow Vigilantes to punish the Fed for its Grinch-like decision. In my opinion, by proceeding with yesterday’s rate hike and suggesting that two more are on the way for 2019, the odds that there will be no rate hikes in 2019 have increased. That’s confirmed by the reaction in the bond market.
I still don’t expect a recession in 2019, but slower economic growth and possibly even lower inflation should dissuade the Fed from hiking rates in 2019. While the outlook for earnings growth remains challenging, as Joe and I have been discussing since late October, we are sticking with our target for the S&P 500 of 3100 by the end of next year based on our view that the economy will continue to grow in 2020.
Strategy: Mnuchin vs HFTs. As I previously reported, I attended a White House lunch of the President’s top economic advisers on Wednesday (12/12). While I can’t disclose who was there, I was pleased to read a 12/18 Bloomberg article titled “Mnuchin Blames Volcker Rule, High-Speed Trading for Volatility.” This was one of the four issues I brought up in my presentation. I didn’t mention the Volcker Rule. But I did opine that high-frequency trading (HFTs) may account for some of the volatility in the stock market this year, and I advocated for restoring the Securities and Exchange Commission’s uptick rule, which Melissa and I discussed in the 12/12 Morning Briefing.
The Bloomberg article mentioned the HFT issue, but not the uptick rule. The article noted: “U.S. Treasury Secretary Steven Mnuchin blamed volatility in equity markets partly on high-speed trading and the effect of the Volcker Rule, adding that he planned to conduct an inter-agency review of market structure. … Mnuchin said he will ask the Financial Stability Oversight Council, which he heads, to study stock market volatility. While he has not ‘pre-judged’ what exactly is behind the sharp moves before a review is complete, Mnuchin said problems with market structure ‘may be one of the reasons.’”
Health Care: Wounded by the Courts, I. When we were sitting down for Thanksgiving dinner, the S&P 500 Health Care sector was outperforming other sectors in the index ytd. Since then, the sector’s ytd gain has been halved to 4.3%. Headlines out of the judicial system calling into question the legitimacy of the Affordable Care Act (ACA) sent shares of some of the largest companies in the sector tumbling. The best-performing sector ytd is one of the worst-performing sectors so far in December.
Here’s the dismal performance derby for the S&P 500 sectors in December through Tuesday’s close: Utilities (-2.0%), Real Estate (-4.3), Communications Services (-4.9), Tech (-6.4), Consumer Staples (-6.9), Consumer Discretionary (-7.1), Materials (-7.5), S&P 500 (-7.8), Industrials (-8.8), Health Care (-9.1), Energy (-10.2), and Financials (-11.7) (Fig. 1).
Ytd results for the S&P 500 sectors look a bit better: Health Care (4.3%), Utilities (2.9), Consumer Discretionary (1.0), Tech (0.7), Real Estate (-2.0), S&P 500 (-4.8), Consumer Staples (-8.7), Industrials (-13.0), Communication Services (-14.2), Financials (-14.9), Materials (-16.7), and Energy (-18.1) (Fig. 2).
Let’s examine what’s dimming the performance of the top-performing sector as the year comes to a close:
(1) Obamacare drama. Last Friday, a US district judge ruled that the ACA is unconstitutional because it requires Americans to obtain medical insurance. The ruling upheld a lawsuit brought by 20 Republican states. The ACA will remain in place if the Democrats appeal the decision, as is expected.
The ruling may put Republicans in a difficult situation because the ACA has grown in popularity. There are about 11.8 million Americans enrolled in Obamacare insurance plans.
“Senior Republicans are divided over whether to continue their push to repeal the act, or whether to move instead towards more moderate bipartisan action to change its terms. While the party has campaigned heavily to repeal the act in the past, the law has gained in popularity over recent years, and is now supported by more Americans than oppose it,” a 12/16 FT article reported.
President Trump has called for Congress to pass a new health care law that would protect those with pre-existing conditions. Republican Senator Susan Collins wants to see the ACA’s requirement to purchase health care struck down even though Congress has eliminated the penalty for failing to take out insurance. Meanwhile, some Democrats would like the law strengthened and turned into Medicare for all.
(2) From best to worst. The ACA has been a boon for health care companies as more patients had health insurance, sought care, and could pay for the care they received. In the wake of the judge’s ruling, the S&P 500 Health Care sector’s stock price index tumbled 6.2%. The sector was dragged down by many of its industries, including Health Care Distributors (-9.0%), Health Care Facilities (-8.4), Pharmaceuticals (-7.5), and Managed Health Care (-7.5) (Fig. 3). They were each among the worst-performing industries we track.
The S&P 500 Health Care sector contains numerous industries with above-market earnings growth expected for 2019, but they also have above-market forward P/Es. Here are the Health Care industries expected to see faster earnings growth next year than the 8.1% forecasted for the S&P 500 as a whole, along with their 2019 earnings growth forecasts and forward P/Es: Managed Health Care (14.0%, 17.1), Life Sciences (11.3, 23.8), Technology (9.2, 20.9), Health Care Equipment (9.2, 22.1), and Health Care Supplies (9.0, 24.8). The sector’s forward P/E of 15.7 is dragged down by the Pharmaceuticals industry, which has a forward P/E of 15.6. Pharmaceuticals is expected to grow earnings by 3.4% in 2019 versus the sector’s 7.1% expected earnings growth (Fig. 4 and Fig. 5).
Consumer Staples: Wounded by the Courts, II. Despite its involvement with all things health related, CVS Health is actually a member of the S&P 500 Drug Retail industry, which is part of the Consumer Staples sector. It too took one on the chin after a federal judge’s ruling.
US District Judge Richard Leon questioned the Justice Department’s decision to allow CVS Health’s acquisition of Aetna. The federal judge noted that the American Medical Association objected to the merger, stating it would substantially reduce competition in health care to the detriment of patients.
Judge Leon initially threatened to halt the integration of the two companies while he considers the deal’s implications, a 12/3 WSJ article reported. The decision was highly unusual because judges typically rubber-stamp agreements between the Justice Department and two companies involved in a deal.
CVS has offered to maintain control over the pricing of its products and services for its insurance customers and said the two companies wouldn’t exchange competitively sensitive information, a 12/18 WSJ article reported. The federal judge agreed to CVS’s offer and suggested bringing in an outside monitor to ensure that the offer was upheld. His review of the acquisition could take “at least several months.” Ironically, this is the same judge that stopped the Department of Justice from preventing the merger of AT&T and Time Warner.
CVS shares are down 13.3% since the judge’s first ruling on 12/3. The stock’s performance has weighed on the S&P 500 Drug Retail stock price index, which is down 10.9% so far in December and up 6.9% ytd (Fig. 6). The S&P 500 Drug Retail industry, which also includes Walgreens Boots Alliance, is expected to grow revenues by 4.6% and earnings by 8.6% in 2019 (Fig. 7 and Fig. 8). The industry’s forward P/E at 12.3 is near the low end of its two-decade range (Fig. 9).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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