Gaining an Edge in Health Care Investing

The unique worry in this sector in March 2008... 'Why shouldn't I just short all of these things to zero?'... We're entering another period just like this... Gaining an edge in health care investing... An example from Obamacare in 2012... Elizabeth Warren just kicked off a buying opportunity in these stocks...

'Why shouldn't I just short all of these things to zero?'

It was a cool and cloudy day in late March 2008 in midtown Manhattan. It was not a particularly nice day to be in the city. But I (Thomas Carroll) had a full day of meetings with our best clients talking about 2007 results and the outlook for 2008.

I settled into a drab conference room to wait for my meeting to begin.

I was a 38-year-old Wall Street health care analyst with eight years under my belt...

Health care had been a great sector to cover, and I was feeling more confident than ever. From 2000 to 2007, the stocks I covered had been doing great. One of my favorite stocks, UnitedHealth (UNH), was up 776%.

But the tone in the room was far from jubilant...

A few weeks before, many health care companies began reporting their 2007 year-end results and making comments about 2008 expectations. They were starting to sound warnings about troubling signs, like falling interest rates and a weakening economic outlook.

Aside from the mounting factors that were about to spark the financial market meltdown, health care investing had its own unique worry – health care reform.

Senior management at UnitedHealth had made comments about uncertainty going into the 2008 presidential election. Health care reform was on the table, but the plans were ambiguous at best. The market noticed, and shares of UnitedHealth were down about 40% in the past few months despite operating cash flow approaching $7 billion for the year.

It just didn't make sense.

Soon, the hedge-fund manager I was waiting for hurried in. He sat at the opposite end of the table, his hair out of place and shirt somewhat untucked. And he looked frustrated.

"You need to tell me one thing today," he said as he looked directly at me. "Why shouldn't I just short all of these things to zero?"

I had no response. This was new territory for me as an analyst.

At that moment, I knew that health care security analysis was about to go from a multiyear, fundamental evaluation to a month-by-month trading exercise.

Regardless of revenue, earnings, or cash flows, the stocks were going to trade on health care reform headlines and evolving health system expectations.

Be prepared. We're about to enter another period like 2008...

Health care is again a top issue for voters heading into the 2020 presidential election. A recent Politico writer referred to health care as "arguably the top issue in the Democratic primary and potentially a deciding issue in the general election, too."

The cast of characters vying for President Donald Trump's job are numerous. They all have a "solution."

The most widely discussed solution – "Medicare for All" – would completely upend the current system and put everyone into a government-run, single-payer program.

More moderate approaches call for re-establishing and bolstering the Affordable Care Act ("ACA," better known as Obamacare). The ACA remains law, even though Trump and the courts have removed a number of its checks and balances.

At the other end of the spectrum, Trump has expressed his desire to scrap the ACA completely.

The details of these so-called solutions will create volatility in health care stocks just like they did a decade ago. As these health care reform proposals gain traction, there will be perceived winners and losers. The shares of these companies will behave accordingly.

We can profit from this.

As a health care analyst for 18 years, I've seen this movie before. We've seen it multiple times over the past 10 years... and most important, we've learned from it.

In today's Digest, I'm going to share thoughts on the reform themes now on the table... how prior reform efforts moved health care stocks... and where we can look to profit over the next year.

As these health care reform proposals gain traction, shares of the perceived winners will shoot higher... and the perceived losers will nosedive.

What has created all this great trading opportunity?

At its heart is the crazy U.S. health care system.

The system's failings are well-documented. If you've ever had an inpatient hospital stay, you know exactly what I'm talking about. (You might recall my 30-hour ordeal in a Delaware hospital, which I detailed in the March 15 Digest.) We are all customers of this incredibly frustrating system.

The system is disjointed. It has few checks and balances. It is the most expensive system in the world. But it doesn't bring us outsized benefits for all that money...

For the 50 years between 1966 and 2016, health care costs grew at an average rate of 8.9% per year. That's much higher than inflation's long-term average of 3.2%.

Patients rely on "third parties" – employers, insurance companies, or the government – to cover costs. That has led to massive price inflation in health care.

Thanks to all that spending, health care represented about 18% of the U.S.'s total gross domestic product ("GDP") in 2018. That equates to more than $3.5 trillion, which is similar to the total GDPs of India, France, the U.K., or Germany. In 2000, health care was a little more than 13% of total U.S. GDP. In 1960, it was just 5%.

The government's interest in 'doing something' about health care dates back to 1912...

That's when President Theodore Roosevelt included health insurance in his campaign platform. But it wasn't until 1965 that President Lyndon Johnson signed into law the first comprehensive health care coverage for aged and poor Americans – Medicare and Medicaid.

Since then the Clinton, Bush, and Obama administrations have tried different approaches to expand coverage to as many people as possible. Despite their successes and failures, all of these efforts have succeeded in doing one thing – creating massive uncertainty.

The constant scrutiny and debate surrounding the sector has made health care stocks very sensitive to proposed government changes. So many institutional investors totally steer clear of them.

And that makes health care great for investing... It's complicated, but if you understand health care, it gives you an edge.

Let's go back and look at an example from Obamacare...

On June 28, 2012, the Supreme Court issued a critical ruling on the future of the ACA.

Leading up to the ruling, experts watching the industry knew the result was binary... either the law stays or it goes. There was no splitting the baby. All of the potential winners and losers from this complex new law hung in the balance.

Unlike the other branches of our federal government, the Supreme Court is tight as a drum. Information does not leak out early. So while we as investors had our own opinions about what would happen, the best we could do was place our bets... and wait.

Keep in mind, that regardless of the rancor and politicking that surrounded the ACA's passage and subsequent efforts to limit or reverse it... by 2012, most health care experts generally thought the law had been good for the industry. It increased the number of people paying into the insurance markets and seeking out care.

Insurance companies liked the ACA because it forced people to buy health care coverage, which generated lots of new revenue. Insurers who work with Medicaid beneficiaries – Medicaid managed-care organizations ("MCOs") – were particularly grateful, since the law dramatically expanded the Medicaid rolls.

Hospitals also liked the law because with fewer uninsured patients walking into their emergency rooms, the amount of bad debts on their books would drop.

And the makers of medical devices and prescription drugs also looked forward to expanded markets for their products.

So how did health care stocks react to all of this?

Take a look at the following table... It shows what the market was thinking around the time of the decision. We look at four different trading periods before and after the ruling...

• Column 1 shows how you did if you bought health care stocks a year before the ruling, and sold three months before the ruling, just as media attention was focusing on the case,

• Column 2 illustrates buying three months before the ruling and selling two weeks before,

• Column 3 shows what happened if you bought one year before the ruling, but got cold feet and sold just two weeks before the ruling (combination of the first two), and

• Column 4 describes the stout-hearted who bought two weeks before the ruling and held on for a year.

Owning health care stocks in the year prior to the decision was mostly profitable if you sold before the financial media began to talk up the pending announcement. Doing so earned you 14%, on average.

But this changed quickly...

Health care stocks declined 18% in the three months prior to the ruling. Investors began to get skittish. Pundits began to suggest that the court would find the ACA unconstitutional. The benchmark S&P 500 Index fell, too... but only about 5%. Health care underperformed the index by 13 percentage points.

In total, owning these segments the entire year before the ruling proved unprofitable, but they got killed in the three months leading up to the decision.

But if you were a contrarian (as I was), you bought this weakness as the ruling approached...

My team and I understood every last detail of the ACA and fully believed the court would uphold it. It was a lonely position.

My CEO at the time called me after reading our thoughts on the ACA. He told me I was wrong. He said the ACA was a socialist program... it would raise expenses for all of us... there's no way it could be constitutional.

When the court ruled the ACA could stand, the stocks ripped higher.

Buying the sector in the weeks ahead of the ruling, during the moment of maximum fear, proved to be the best timing. Doing this and holding for a year provided great returns. The average of our groupings returned 62% versus the S&P 500's return of 21%.

For the record, my old CEO never called me back... never congratulated our team on our winning trade... or offered our group any support.

But the point is, if you really understand the impact policymaking can have on an industry... and the guts to make a contrarian call... you can profit.

This is about to happen again...

So what are the trading opportunities that will emerge in the next year?

We've actually seen some already. My friend and colleague, Stansberry NewsWire editor C. Scott Garliss, wrote about our warnings that early talk about the next health care reform would pressure many health care stocks that were flying high at the start of 2019.

In late February, the "Medicare for All Act" was introduced in the U.S. House of Representatives. The bill would eliminate private health insurance.

And major health care stocks began to sell off almost immediately... just as we had warned.

Insurance firm Anthem (ANTM) sold off about 23% in the weeks that followed. UnitedHealth dropped about 18% – a lot for a company with a $250 billion-plus market cap. Hospital companies HCA Healthcare (HCA) and Universal Health Services (UHS) fell 17% and 9%, respectively.

In the early stages of new policy discussions, indiscriminate selling like this often occurs... This is akin to the old saying, "sell now and ask questions later." It seems the health care reform uncertainty surrounding the 2020 election has begun.

We have a new opportunity for the next couple months. We have already seen some a reversal of the Medicare for All trading. And this could now mean an upside opportunity in these stocks...

You see, Elizabeth Warren just gave us another policy trading datapoint...

Last Friday, the Democratic presidential hopeful softened her stance on Medicare for All. Major financial news sources went live with this mid-afternoon.

Once again, stocks reacted immediately...

UnitedHealth was trading at about $260 per share around 2 p.m. Over the next two hours of trading left in the day, the stock rose to around $270 a share. That's a two-hour gain of nearly 4%.

Anthem was trading at about $284 a share in the middle of the afternoon. It closed the same day at almost $298 a share – a 5% end-of-day pop.

We don't think this move is over...

The latest commentary about Medicare for All will continue to soften fears for the next couple of months. The market will say "Medicare for All is crazy"... "It will never happen"... "Warren is even stepping back"... "Maybe we should look at these health care stocks again."

We believe health care services stocks could rise further into year end. If these stocks trade where they did prior to when the Medicare for All bill passed, they could rise 3% to 27% (11%, on average) in our view. Here is a small sample...

As the Democratic candidates continue to debate the future of health care, indiscriminate trading will get more focused. Keep an eye on this sector...

We expect we'll find more opportunities like these.

And no... we should not short all of these stocks to zero.

New 52-week highs (as of 11/20/19): Fidelity Select Medical Technology and Devices Portfolio (FSMEX), Pan American Silver (PAAS), ResMed (RMD), and ALPS Medical Breakthroughs Fund (SBIO).

In today's mailbag, several readers said they couldn't attend our special crypto event last night with Crypto Capital editor Eric Wade and Dr. Ron Paul. Fortunately, we're offering a free replay for the next few days. You can watch it right here. And two others shared praise for our recent work. As always, you can send your questions and comments to feedback@stansberryresearch.com.

"I loved Justin [Brill]'s November 18 article ("Checking In on the 'Melt Up'"). I have sold most of my equity positions and put half of my money in gold and silver coins. The remainder I am waiting patiently for the next correction to reenter the equities market. So I guess I am not one of the complacent investors. I hope we can count on Justin to give us another excellent article when the Complacency Indicator indicates it is time to jump back in. Thank you, Justin." – Paid-up subscriber James B.

"To all the writers at Stansberry: Thank you for all the time and effort you put in your work. For me, this has been a several year reading and learning process. This a big day for me, little for you. Porter has been telling us about bonds for a long time, and as he said I thought they were too hard to understand.

"Today I read the letter about the [recommended bond in the Stansberry's Credit Opportunities newsletter], and for some reason it finally made sense, [so] I went and bought the bond! I can't believe it! I am so excited. Progress is being made. So for all the writers, thank you and keep it up! I look forward to more progress in the future." – Paid-up Stansberry Alliance member Scott L.

Good investing,

Thomas Carroll
Baltimore, Maryland
November 21, 2019