September 20, 2017

Stocks once again set new highs, although gains were disappointing. While most front pages discussed President Trump’s U.N. speech, the stock market was more focused on the two-day FOMC meeting that commenced yesterday, and the possibility that the Senate may yet pass a form of Obamacare Repeal and Replace.

I discussed the Fed’s meeting on Monday. There isn’t a whole lot to add. We will see the details this afternoon. There will be no interest rate increase, it will leave room for one possibly in December, and it will set the table for a very slow gradual reduction in the size of its balance sheet. By gradual, I mean perhaps $25 billion per month beginning in October. The pace isn’t carved in stone, and the Fed more than likely will vary it over time as economic growth trends change. Some months may be closer to zero, while it could go as high as $50 billion in a given month. Since no one expects the Fed to actually sell assets in the open market, at least at the beginning, the reduction will come about via the run off of maturing debt, especially concentrated on its holdings of mortgage-backed securities. $25 billion is a moderately-sized corporate offering to support an M&A deal. Clearly, that pace shouldn’t be very disruptive. The Fed has done a good job of advertising its plans. The fact that markets have risen steadily over the last two weeks demonstrates the apparent lack of concern.

Given that the Fed has been very clear about its future game plan, there should be more attention paid to the dot plots of economic forecasts. At regular intervals, FOMC members and other meeting attendees (e.g. non-voting regional bank Presidents) submit forecasts of future growth, interest rates and inflation. Their patterns are then plotted and reported. What analysts will be looking for are changes from prior forecasts. One might presume that the near-term growth outlook has improved a bit. But where the focus will be is on inflation forecasts and the long term neutral targets. In particular, economists and investors want to get a better idea of the Fed’s possible end game. Where is the neutral rate going to be in 2-3 years? Will Fed Funds get back to 3% or even higher this cycle? How do FOMC members see the shape of the yield curve going forward? There won’t be sharp answers to these questions, but rather directional responses. With that said, we have to note two facts. The Fed members have been notoriously bad forecasters of both growth and inflation for years. They have persistently overestimated growth and underestimated inflation. Second, as many as 4 (of 7) Federal Reserve seats could be vacant before year end. Chair Janet Yellen’s term ends in February. Therefore, any guidance given today can be altered meaningfully with a full complement of 4 or more new Board members.

Now on to healthcare. Senators Lindsey Graham and Bill Cassidy, both Republicans, are pushing for yet another stab to repeal and replace Obamacare. Essentially what they propose is to take well over a trillion in Medicaid reductions and give most of the money back to the states, mostly via block grants based on a formula tied primarily, but not exclusively, to population. Obviously, some states have a higher cost structure than most. Senators and Representatives from these states need to insure themselves that they won’t be squeezed to a point that they can’t fund necessary care. As has been the case to date, this bill is being rushed through. There is scheduled to be a day of hearings next week, which is one more day than some previous attempts, and it is questionable whether the CBO will get a chance to score the bill before the Senate votes.

The urgency this time is calendar related. The government’s fiscal year ends on September 30, which is next Saturday. There will be no more votes taken this week or next Friday due to the Jewish holidays. That leaves about 4 working days to get everything done by year end. That is the deadline for the Senate to use the reconciliation process to pass a bill with just 50 votes. It would then move to the House. The House would then have to vote up or down on that bill without change because if it mandated any changes, the modified bill would have to go back to the Senate, almost certainly after 9/30, and would then need a 60-vote majority. If this sounds like a bad way to legislate, it certainly is.

The bill as constructed today (and all the details haven’t been revealed yet) doesn’t have a completed transition formula to take care of the 2 years before the bill is scheduled to take effect in 2020, if passed. In the interim, premium rates on the Federal and public exchanges for individuals who are required to go in that direction to get any health insurance at all are skyrocketing as the larger insurers have backed away from selling policies on the exchanges. Because of the very shortened window, the odds this bill gets passed into law are still relatively small. But politics often trumps policy (pun half intended), and both Republicans and the President wants a “win.” Of course, if any Obamacare replacement works out to be wildly unpopular, the so-called win could be the landmine that kills Republicans in the mid-term election. Or, of course, it could be the catalyst that energizes the GOP base and leads to greater gains. Again, the odds of passage are still small, and the bill is likely to increase the number of uninsured Americans by millions. It is hard to spend dramatically less and convince people you are giving them more. Yesterday, health care stocks took a beating based on the possibility that the Graham-Cassidy bill might pass. If you want to see the odds play out day-to-day, watch the healthcare stocks, especially those companies most tied to servicing those on Medicaid.

Today Sophia Loren is 83.

James M. Meyer, CFA 610-260-2220

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