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Rainbows over Canyonlands - Dave Stoker

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Wednesday, August 17, 2016

Pandora’s Box

Financial Review

Pandora’s Box

DOW + 21 = 18,573
SPX + 4 = 2182
NAS + 1 = 5228
10 Y – .02 = 1.55%
OIL + .29 = 46.87
GOLD + 2.60 = 1349.40

The Federal Reserve released minutes from their July FOMC meeting. In July, with the Brexit vote over and market turmoil subsiding, the Fed seemed somewhat more open to the possibility of resuming rate hikes. Economic data has been mixed; we had a very weak report on second quarter gross domestic product and we had a very strong July jobs report. A key official, New York Fed President William Dudley,  said yesterday that a rate hike in September was possible – even if markets aren’t convinced that it’s probable.

Apparently the news of a possible rate hike in September was enough to spook the equity markets a little bit. Is a Rate Hike in September two months before an election, with this economic backdrop, possible? Doubtful. The bond market isn’t buying it. Ten-year yields have hardly budged. The currency market didn’t even shrug.

Here’s what the Fed said, quoted from the minutes: “Some other participants viewed recent economic developments as indicating that labor market conditions were at or close to those consistent with maximum employment and expected that the recent progress in reaching the Committee’s inflation objective would continue, even with further steps to gradually remove monetary policy accommodation. Given their economic outlook, they judged that another increase in the federal funds rate was or would soon be warranted, with a couple of them advocating an increase at this meeting.”

Sorry, but that is just a bit too vague to be taken seriously. If the Fed wants to raise rates in September, they need to pound the table and state very clearly that they intend to hike rates. Taken as a whole, then, Chair Janet Yellen is keeping the hawks at bay and the Fed on a course of loose monetary policy, including the current 0.25-0.5 percent range. That’s even despite some clamoring from those wanting to hike. And despite some initial chatter about “some” wanting a rate hike, following the release of the minutes the market quickly adjusted its sights.

Stocks closed higher; treasuries pared losses. Two-year Treasuries, the most sensitive to policy expectations, halted a back-to-back decline. The dollar was basically flat. The greenback has slumped more than 5 percent this year as Fed policy makers have yet to see signs that inflation is moving toward their 2 percent goal. That means the Fed is less likely to diverge from the paths of the Bank of Japan and European Central Bank, which are boosting monetary stimulus as they seek to spur flagging growth.

The minutes once again portray a Fed that can’t seem to find direction or purpose; not confident in holding steady but not ready to embrace new approaches. Fed chairwoman Janet Yellen is scheduled to speak at next week’s annual economic symposium in Jackson Hole, Wyoming. Let’s hope she actually says something.

Time now for a quick lesson in basic economics. Adverse selection is a phenomenon wherein the insurer is confronted with the probability of loss due to risk not factored in at the time of sale. This occurs in the event of an asymmetrical flow of information between the insurer and the insured. Asymmetrical information refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. Or another way of saying it; in any given deal, somebody has the upper hand.

In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to get life insurance. Or in the case of health insurance, it is a situation where “uninsured people with pre-existing conditions often face tens or even hundreds of thousands of dollars in out-of-pocket medical costs annually. If insurers charged everyone the same rate, buying coverage would be far more attractive financially for people with chronic illnesses than for healthy people.

And as healthy policyholders began dropping out of the insured pool, it would become increasingly composed of sick people, forcing insurers to raise their rates. …. But higher rates make insurance even less attractive for healthy people, causing even more of them to drop out. Before long, coverage would become too expensive for almost everyone.”

Yesterday, Aetna announced that it will withdraw from 11 of the 15 state Affordable Care Act exchanges where it sells marketplace plans; leaving some counties with only one option for healthcare, and in Pinal County – no options. Aetna cited mushrooming financial losses and structural problems with the exchange markets as causes for its retreat.

There might be more to the story. A few months ago, Aetna was looking to expand its presence in the ACA exchanges and Aetna also wanted to acquire Humana. In a letter to the US Department of Justice, Aetna CEO Mark Bertolini outlined the company’s plans to roll back much of its Obamacare business if the DOJ blocked a proposed merger with rival Humana. A company spokesman denied that participation in the exchanges was a bargaining chip in its negotiations with the DOJ, saying the decision was driven by losses.

So is this about losses or a merger battle? Is this a confessional, or extortion? It may in fact be true that Aetna can’t envision a way to make a profit in the exchanges without merging with Humana, even if it is true that its losses didn’t prevent it from seeing its earnings increase 20% in 2015.

Aetna executives and attorneys surely knew that government anti-trust lawyers would see the letter as thinly veiled extortion, even if their concerns were entirely sincere. At any rate, Aetna may have opened Pandora’s Box.

A recent report from the Kaiser Family Foundation shows that as many as two states and 650 counties are on track to have just one insurer on the Affordable Care Act exchanges next year. The entire states of Alaska and Alabama will be faced with just one choice in 2017, as well as large swaths of Kentucky, Tennessee, Mississippi, Arizona and Oklahoma. The effects of health insurance company pullouts will be to leave people uninsured.

That’s unfortunate, because it turns out that making health care available to people actually makes them healthier. A new study, published Monday in JAMA Internal Medicine, offers another way of looking at the issue. Low-income people in Arkansas and Kentucky, which expanded Medicaid insurance to everyone below a certain income threshold, appear to be healthier than their peers in Texas, which did not expand. One “solution” to health insurance behemoths threatening to pull out of the ACA exchanges would be to allow them to merge. A second “solution” is to let them hike premiums to ridiculous levels. The third solution is the Pandora’s Box, also known as the public option.

Britain’s job market is shrugging off Brexit, for now
. Data from the Office for National Statistics showed that the number of people claiming jobless benefits in the UK unexpectedly fell in July. Additionally, the UK’s unemployment rate held at a record-low 4.9%. Analysts in the coming months will continue to watch the unemployment level as one of the key indicators of how the Brexit vote is affecting the U.K. economy.

Subprime credit-card lending is making a comeback. TransUnion’s Second Quarter 2016 Industry Insights Report shows that 11% of the 10 million new customers entering the credit-card marketplace in the past year were subprime borrowers. Additionally, the data suggests subprime borrowers are seeing the biggest increase in balances, up 14% versus a year ago. Still, TransUnion’s financial services business unit, says delinquency levels are not “alarming.”

Cisco Systems is readying for job cuts. The company is expected to eliminate 14,000 jobs, or about 20% of its labor force, beginning in the next few weeks. Microsoft, HP, and Intel have all announced big jobs cuts within the past year or so.

Target reported disappointing Q2 earnings and management placed part of the blame squarely on Apple. Comparable store sales at Target overall fell by 1.1%, but Target executives noted that electronic sales decreased by double digits and “accounted for 70 basis points [0.7%] of overall comp decline.”

Even more notably, Target specifically pointed out that Apple product sales were down by “more than 20%” year-over-year and were to blame for a third of the overall plunge of electronic sales at Target. Apple’s growth has been running into a bit of trouble recently, as the astounding success of the iPhone 6 has made for tough comparisons; and many customers are probably sitting on the sidelines before the launch of the iPhone 7.

The iPhone 7 might be coming soon. That’s according to a leaked photo spotted by 9to5Mac of “reset hours” at AT&T stores for September. The website speculates that the photo shows September 9 as the date AT&T will begin advertising the iPhone 7 and September 23 as the day when the phone will go on sale.

The Treasury Department issued rules this year that thwarted several tax inversions, but one large deal that managed to get through was the $16 billion acquisition of Tyco by Johnson Controls. The last hurdle for the transaction is a vote today by both sets of shareholders. Johnson Controls shareholders are set to vote in Dallas, while Tyco’s shareholders will do so in Dublin.

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