We spend $1.8 trillion on healthcare, or 15% of our GDP. Other leading nations spend no more than 10%. Yet 15% of our population is without health insurance and our life expectancy is no better than our peers. Despite the growth of large drug companies, HMOs and hospital chains, medicine remains the isolated work of individual doctors. Heart disease, stroke, and cancer are a huge portion of medical costs, yet there is very little money spent to detect disease before it becomes life threatening.
That is all about to change according to Andy Kessler, a former Wall Street technology analyst and successful hedge fund manager. He has visited numerous medical researchers in Silicon Valley and learned of excitinig discoveries which he believes will allow a doctor's knowledge to be transferred into the memory of medical devices. He observes in his book, The End of Medicine, the "scale" that microchips have brought to computers, finance, and telecommunications will soon benefit healthcare.
Excerpts from his book are summarized in this newsletter.
"Although they can't say one particular weather event is caused by global warming, many scientists are now making the connection between global warming, rising sea temperatures, and the strength of flooding."
Tom Brokaw, "Global Warming: What You Need to Know," Discovery Channel, July 16, 2006
The bad news is it looks like global warming is for real, and that greenhouse gases are the primary cause. Despite the significant changes we have seen in the climate over the last two decades, it was not until recently scientists have said global warming might be the cause.
The good news is, in our opinion, help is on the way thanks to advances in technology plus the surge in oil prices.
In this newsletter, we contrast a gloomy view on global warming as expressed by Daniel Schrag, followed by Ray Kurzweil's upbeat forecast that technological advances are coming to the rescue.
Two Topics: Investment Strategy Conference at the University of Dayton and Bullish Factors About the Economy and the Market
Spring 2006
Investment Strategy Conference at the University of Dayton
There were two interesting economic/investment panels at an economic conference held at the University of Dayton on March 30, 2006. Over 1,500 graduate students, faculty, and investment professionals attended the event. Both were moderated by Dr. Bob Froehlich, Chairman of Investor Strategy, Deutsche Asset Management. The first panel consisted of three economists, Dr. Ed Yardeni, Chief Investment Strategy, Oak Associates; Dr. William Dudley, Chief U.S. Economist, Goldman Sachs; and Diane Swonk, Chief Economist, Mesirow Financial. Panelists in the second session included Richard Bernstein, Chief Strategist at Merrill Lynch; Elaine Garzarelli, Quantitative Analyst at her own firm, Garzarelli Capital,; and Jim Rogers, former Hedge Fund Manager and popular commentator. Yardeni, Swonk, and Garzarelli were very bullish on the outlook. The other three were bearish. Well, that's what makes a market. The first half of the newsletter summarized their remarks.
Bullish Factors About the Economy and the Market
In the second half of the newsletter, Mr. Todd discusses bullish factors about the economy and the market.
The following is an excerpt of a speech given by Bosworth M. Todd to the
Louisville Rotary Club on January 5, 2006:
Although all of us are exposed to a wealth of economic and market information daily, making sound decisions is not getting any easier.
Steve Hanke, Economics Professor at John Hopkins University, recently said in Forbes Magazine, all investors should be warned about the 95% rule which states that about 95% of what you read is either wrong or irrelevant. Beniot B. Mandelbrot, a well-known Yale economics professor, recently said: "The whole world of economics is enormously more complex than the world of physics. Therefore, the teaching of business schools, including Yale's, is unrealistic. Even though economics is a very old subject, it has not truly come to grips with the main difficulty, which is the inordinate practical importance of a few extreme events."
Certainly, our economy has been fortunate to weather some extreme events in recent years. Martin Wolf, of the Financial Times, recently stated that during Alan Greenspan's 18 years as Chairman of the Federal Reserve, we enjoyed a low and stable inflation, suffering along two shallow recessions. This stability has occurred despite the stock market crash in 1987, a big downturn in real estate in the late 1980s, a series of international financial crises in the 1990s, a three-year bear market after 2000, several wars, and 9/11.
Ben Bernanke will have his hands full when he takes the reigns as Chairman of the Federal Reserve Board in January. Alan Greenspan is a tough act to follow, as Martin Wolf pointed out in a recent Financial Times article stating, "Alan Greenspan is the preeminent central banker of our era. During his eighteen years as Chairman of the Federal Reserve, we have enjoyed a low and stable inflation and suffered only two shallow recessions." Wolf goes on to say, "this stability has occurred despite a stock market crash in 1987, a big downturn in real estate in the late 1980s, a series of international financial crises in the 1990s, a three-year bear market after 2000, several wars, and a terrorist attack in the U.S."
In many respects, Bernanke's job should be easier than that of either of his two predecessors. Low inflation is now worldwide. Lessons learned from the excesses of the 1970s, when inflation reached 12%, certainly helped. The weakening of trade union power, particularly in the U.S., and the reduced tariffs on foreign goods as a result of NAFTA and GATT have contributed to the modest 2% inflation in 2005 in the core consumer price index. In fact, the ISI group now forecasts that overall inflation, as measured by the GDP price deflator, will be only about 2% in 2006.
Bernanke inherits an environment of low and stable inflation. His skills will be tested against the need to unwind the housing bubble, rebuild savings, and reduce our bloated trade deficit without triggering a damaging recession.
Two Topics: (1) Modern Portfolio Theory Revisited and
(2) Investment Implications of $70 Oil
Summer 2005
"The objectives of investment are to maximize rewards and minimize risk. Recent Nobel winners have had a profound effect on the way investors manage money. They have equipped us with new tools to reduce risk and increase portfolio return."
–Todd
Investment Advisors Quarterly Newsletter, September 2005
(1) Modern Portfolio Theory Revisited
DIVERSIFY, BUT DON'T PROCRASTINATE
The computer has given us tools to help us diversify portfolios and, thereby, reduce risk. The message we draw from Modern Portfolio Theory is this: diversify, but don't procrastinate.
The most perilous element in investing is to nurture the belief that somehow time will eliminate uncertainty - it does not. Peter Bernstein observes that the safest strategy is to view uncertainty as a constant rather than a variable. This writer was fortunate forty years ago to have worked for Van Norman, who once said, "The humility that comes with experience will prompt you to take the approach whatever you do may be wrong, so avoid extremes." It proved to be valuable advice.
Investment is unlike many other fields of endeavor. Because uncertainty is lodged in its heart, most of the victories are to the tortoises, not the hares.
ALPHA REMAINS THE HOLY GRAIL
Modern portfolio theory uses "alpha" and "beta" to describe the two basic components of return from an investment. Specifically, beta refers to the part of return tied to the performance of the overall asset class or market. A volatile stock, for example, may have a beta of 1.5, which means that a stock is expected to rise 15% for every 10% rise in the market, and vice versa. This is systematic risk or the risk related to the overall market. Unsystematic risk is the other component: the change in price of a stock due to factors peculiar to it. This is alpha. Broad diversification cannot eliminate systematic risk, but it can eliminate unsystematic risks.
(2) Investment Implications of $70 Oil
AN EXTRA $900 OUT OF YOUR POCKET
It is not just the extra $900 a year that the economist Paul Krugman estimates the recent oil shock takes out of the typical family's pocket; it is the $250 billion a year out of our economy (20 million barrels per day, or 7.2 billion barrels per year, with a $35 per barrel price jump, equals an extra $250 billion). It slows the economy. It hurts the airline industry, particularly Delta Airlines which is on the verge of bankruptcy.
GS FORECASTS OIL ABOVE $60 FOR 5 YEARS
On August 15, 2005, Goldman Sachs, one of the largest financial traders in commodities, announced they expect U.S. benchmark oil prices to remain above $60 per barrel for the rest of the decade.
ENERGY STOCKS ARE ATTRACTIVE
Certain energy stocks are still attractive despite their four year run. They have the strongest projected earnings growth over the next 12 months because of soaring energy prices. The energy sector has returned over 60% since the beginning of 2004 compared with the 10% return for the S&P 500.
CONCLUSION
In the grand sweep of things, this, too, shall pass. But it is a mystery to this writer why the Federal Reserve insists on raising short-term interest rates in the face of the braking effect of the surge in oil prices.
Perhaps we should take heart. Ray Kurzweil, inventor, says, "By 2020, we'll be able to harness solar energy to provide pretty much all the world's energy needs. We can hardly wait.
The following are Bosworth M. Todd's notes from the University
of Dayton Seminar on March 30, 2005:
THE ECONOMY
The seminar started off with a symposium on the economy with Richard Berner,
Chief Economist for Morgan Stanley; Lyle Gramley, former Federal Reserve Governor;
and our friend, Nancy Lazar at I.S.I. Some of their forecasts conflicted with
one another - nothing new there.
THE BOND MARKET
The program then shifted from the economy to the bond market with Joe Dean,
a bond manager at Citigroup; Chris Garman, Head of High Yield Bonds at Merrill
Lynch; and Francois Trahan, Chief Investment Strategist at Bear Stearns.
THE STOCK MARKET
Abby Cohen, Partner of Goldman Sachs; Al Goldman, Chief Market Strategist for
A.G. Edwards, and Gary Gordon, Chief Strategist at UBS Financial, discussed
the stock market.
CONCLUSION
We agree that since the bull market is now 29 months old, interest will shift
to the larger, high-quality, more defensive stocks. That is music to our ears.
The following is an excerpt of a speech given by Bosworth M. Todd to the
Louisville Rotary Club on January 13, 2005:
We agree with consensus expectations that the stock market should be up
slightly again this year. Our GDP growth will slow and inflation and short-term
interest rates will rise. Long-term interest rates should remain low. Liquidity
is ample, which encourages investors' appetite for risk. Stock valuations, while
not cheap, are no longer excessive. Only surprises in Iraq or emergency actions
to shore up the weak dollar threaten a cheerful outlook.
Many aspects of the economy turned out a lot different than most of us
expected. Few of us expected the price of gasoline to rise 34% last year. We
were surprised at the amount of investor enthusiasm for aggressive stocks.
Google went public at $86 a share in August and is now $195, a market value of
$53 billion, about equal to that of either DuPont or Disney. There is not much
room for error with the stock selling at nearly 80 times last year's
earnings.
Economic growth should slow down this year, but inflation will not. Real GDP
should grow about 3% and inflation should be slightly higher, 2/2% versus last
year's 2.1%. We don't predict much change in the 30-year Treasury, namely about
5% yield a year hence versus 4.8% now. The 10-year Treasury should also stay
about 4.2%. We still predict the dollar will continue to weaken slightly to
$1.40 versus the euro in 2005.
I'll conclude with what I said to you in this hotel in January 1995: "By
virtually any measure, we are better off today than we have ever been in
history. I am very bullish about the future of the United States. 1989 marked a
turning point in history. Two factors that depressed economic growth were
eliminated at that time. The first was nuclear war. It is not impossible now,
but is unlikely. Second was the threat of Communist domination. The demise of
Communism will result in a higher standard of living around the world." I remain
bullish.
"Over the past century, we have developed a civilization firmly rooted in the
promise of an endless supply of cheap oil. That promise is about to be broken,
much sooner than most people realize, possibly within this decade."
–
Except from "Out of Gas: The End of Age of Oil" by David Goodstein, Caltech
Physics Professor
The cyclical pattern in oil prices over the past decade has had particular
gyrations in the past year (up 65% before falling 20% in recent weeks). Such
dramatic changes inspire us to reflect on the challenges facing energy investors
and consumers over the next decade.
Almost a year ago, we wrote a four page internal memo summarizing several
Financial Times articles that forecasted an oil shortage, leading to
higher oil prices and an emphasis on alternative energy sources. This study
reinforced our decision to overweight oil stocks in our portfolios. (For a copy
of this memo, send an email to info@toddinvestment.com).
We are overly dependent on oil in the U.S. We now have to import two-thirds
of our consumption, yet we still only pay $2 a gallon for gasoline while Europe
pays $5.50. No wonder they drive smaller, more efficient vehicles. We represent
five percent of the world's population, yet consume one-fourth of the oil
production. However, it should be noted that the U.S., with $10.9 trillion GDP
in 2003, represents 30% of the world's $36.3 trillion GDP. We are becoming a
more efficient energy user. Higher gasoline taxes, while painful, would help
solve a number of our economic problems, including the trade deficit, the budget
deficit, and air pollution.
The New York Times recently selected "Out of Gas: The End of Age of
Oil," by David Goodstein, as one of the 100 best books of 2004. In this
newsletter, we highlight the findings in his book, including other energy
sources, such as solar, wind, coal, and nuclear.
"The largest service industry in the United States is undergoing a massive
transformation that will release both providers and consumers from the
strictures of managed care."
–
"Speech on June 4, 2004, by Professor Regina Herzlinger, an advocate of
consumer-driven healthcare"
The following is a discussion of Consumer Directed Healthcare and one of its
components, Health Savings Accounts. At a Harvard Business School reunion, Mr.
Todd heard presentations from members of the faculty. The subject of the
newsletter is the one that interested him most, given by Professor Regina
Herzlinger, who teaches a course on the healthcare industry and is the author of
a recent book entitled, "Consumer-Driven Healthcare." She pointed out that we
spend 14% of our GDP on healthcare, whereas other leading nations spend no more
than 10%. Yet our mortality rate is nowhere near the top among the leading
nations.
Our healthcare system has no choices. You get one
insurer. Innovators are penalized. There is no JD Power information
for the consumer, and there is no competition. There is substantial
inflation in health costs, and the consumer has no knowledge about the quality
of care (the mortality rate of the hospital, infection rate, etc). There
are 43 million uninsured in this country, yet 20% of them earn over $50,000 a
year. Why? The reason is the premium for an individual family policy
is $12,000, and it is not a tax deductible expense, unlike that which is
purchased through a company-insured plan. The $12,000 premium represents
30% of the estimated $38,000 after-tax income.
Professor Herzlinger believes the best solution is to provide consumers with
a choice of insurers and a choice of benefits and coverage. She compares
this solution to another consumer-driven business, automobiles, where we enjoy
lower real prices for cars along with improved quality. A vast amount of
information is made available via publications like Consumer Reports. In
other words, we should work to provide Consumer-Driven Health Plans or
CDHPs.
We conclude by summarizing a March 2004 speech by David Walker, Comptroller
General of the United States, in which he explains why entitlement reform is so
essential. Mr. Walker gave an interesting speech in Business Economics entitled
“Facing Facts about America’s True Financial Condition and Fiscal Outlook” in
which he made the following observations. The combination of entitlement
programs, demographics and rising healthcare costs create the need to make
choices that will only become more difficult the longer they are
postponed. The difficulty of making such choices is magnified by inadequate
information, unfunded commitments being an especially important example.
It is time to recognize that we are in a fiscal hole. The sooner we get
started, the better. It will allow the miracle of compounding to start
working for us rather than against us. Perhaps most important, prompt
action will help us to avoid a dangerous upward spiral of debt and
inflation. We can begin by insisting on truth and transparency in
government financial reporting.
