Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.
Editor's Note: Below is a brief excerpt and chart from today's Early Look written by Hedgeye Senior Macro analyst Darius Dale. Click here to learn more.
“… over the rest of the year, say, two or maybe three rate increases this year, maybe one or two more next year, so three or four next year, I think that’s still about right.”
-John C. Williams, President of the San Francisco Fed
Wait, what? The Fed is going to hike rates 4-7 times by the end of calendar 2017? Seems ambitious…
Back to the Global Macro Grind…
I don’t know about you, but it’s becoming a real grind keeping up with the torrent of forward-looking commentary out of regional Fed heads.
If you include the aforementioned speech which Williams delivered over the weekend at an event hosted by the Council on Foreign Relations, as well as Boston Fed President Eric Rosengren’s comments to the FT on Sunday evening, yesterday saw three different Fed heads pipe up with [hawkish] commentary regarding the outlook for domestic monetary policy:
Having to react to the increasingly well-publicized opinions of the various regional Fed heads has become a daily occurrence. In fact, having to incorporate 2-3 such views into one’s investment mosaic on any given day has effectively become par for the course.
Part of me thinks this current spate of hawkish commentary is all part of a sinister plan to float hawkish trial balloons into the market, just so that they can be counteracted via dovish rhetoric – likely from Federal Reserve chairwoman Janet Yellen herself. This would effectively amount to monetary easing, on the margin, as expectations for near-term tightening are diminished.
Another part of me thinks they honestly have no idea what they are doing. And I don’t mean that in a disrespectful manner; these are obviously all very brilliant economists who are all at/near the top of their profession. Rather, I honestly think there’s just a lot of uncertainty associated with forecasting economic activity and pinpointing where we are within #TheCycle itself.
Moreover, the confluence of said uncertainty and their insistence upon thinking out loud becomes quite the intoxicating concoction when spiked with a dose of “modeling to desired (as opposed to probable) outcomes”. While we were pleased to see one of our chief competitors follow in our Superforecasting footsteps yesterday, we can rest assured that the models employed by the Fed remain as linear as they come.
Do the economic outlooks expressed by each of the aforementioned Fed heads and their counterparts incorporate some degree of hopium? Of course they do – almost by default. While it’s sad that the world’s most important economic policymaking institution has a zero percent lifetime batting average in forecasting cyclical downturns, I’m definitely of the view that they really can’t afford to.
Imagine if the Janet Yellen dropped the “r-word” during a prepared speech at a $10,000 chicken dinner, specifically suggesting that her model(s) was forecasting one to commence within 3-6 months? The reflexive impact that would have on investor, consumer and business confidence would likely and perfectly perpetuate that outcome. As such, it makes sense why the Fed is serially overly optimistic in their forecasts for both growth and inflation – they don’t really have a choice.
But just because they don’t have a choice doesn’t mean their forecasts are going to be proven accurate on an intermediate-term basis. On growth specifically, each year of this expansion has seen the FOMC’s intra-year forecasts for annual real GDP growth surprised to the downside, with an average maximum intra-year tracking error of 92bps (on a number that has ranged from +1.5% to +2.5%, nonetheless).
Moreover, according to our model, 2016E is shaping up to be not much different. Their +2.2% forecast compares to our current estimate of +1.5%, effectively implying 70bps of downside surprise risk to their number if our estimate is proven accurate. For reference, Bloomberg consensus is splitting the distance at +1.8%, which itself is down from +2.5% at the start of the year.
What gives us such confidence in having a growth forecast that divergent from the perceived wisdoms of macroeconomics?
For starters, the data itself helps:
The market continues to back our bear case as well on a trending basis:
All told, we think investors will continue to do well to fade what we view as inappropriately hawkish commentary out of various Federal Reserve officials. Fight the Fed by tactically taking advantage of intermittent back-ups in rates and sharp sell-offs in defensive style factors to increase your allocation to these [winning] factor exposures.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 1.68-1.87% (bearish)
SPX 2029-2058 (bearish)
RUT 1090-1120 (bearish)
NASDAQ 4 (bearish)
Nikkei 16311-16795 (bearish)
DAX 9 (bearish)
VIX 14.16-16.94 (bullish)
USD 94.04-95.98 (bullish)
EUR/USD 1.11-1.13 (bearish)
YEN 108.01-110.55 (bullish)
Oil (WTI) 46.23-49.91 (bullish)
Gold 1 (bullish)
Copper 2.02-2.10 (bearish)
Keep your head on a swivel,
Takeaway: Obama Administration punts Part B Drug Demo to next administration who probably won't have any better luck.
Update: Late yesterday afternoon, one of the Capitol Hill newspapers, Inside Health Policy, reported basically what we did, reaching pretty much the same conclusion. In the report, CMS issued a statement: “We have not announced a change in timing and we continue to review comments." CMS claims that the date of March 2019 was simply the latest date they could finalized the proposed rule without starting over. According to IHP, "A CMS official told IHP that 'Final Action' on the White House Office of Management and Budget's website in this case reflects the statutory deadline for a final rule, not the expected time to issue a final rule. IHP goes on to point out: "However, the statutory deadline and the final action dates listed in the agenda for many rules are not the same." We would add that IHP reported on Friday a delay to rules related to the 340b drug program based on the new schedule listed in the recent Unified Agenda.
We share IHP's skepticism and think the proposal has problems - real problems not just political problems - with oncologists, rural providers, non-profit hospitals, patient advocates and others. Time will tell.
Drug prices have become a white hot political issue this year and for good reason. In October, 2015, a Kaiser Family Foundation tracking poll found that respondents felt affordability of prescription drugs was a top health care priority. In a March report from the Health and Human Services Office of the Assistant Secretary for Planning and Evaluation (ASPE), the research arm of the department, estimated that in 2015, Americans spent $328 billion on retail (drugs sold at outlets that serve patients like Walgreens and CVS) and $128 billion on non-retail (drugs dispensed through physicians offices). Drugs accounted for 16.7 percent of all health care spending in 2015.
The ASPE found that, after a period of slow growth from 2008 to 2013, retail and non-retail drug spending dramatically increased in 2014. Chart 1 illustrates recent drug spending and projections from the HHS Office of the Actuary.
A driver of the increased spending appears - though there is some conflicting data - to be increased costs associated with the use of specialty drugs. ASPE estimated that 30 percent of the increase in drug spending in recent years is attributable to escalating prices. Other factors include an increase in prescriptions per person, general population growth and economy-wide inflation.
These facts took human form in late 2015 when the tone deaf Martin Shkreli, former CEO of Turing Pharmaceuticals, created a stir by raising the price of Daraprim, a drug for which Turing had recently acquired the manufacturing license, and earned him the title of "most hated man in America." The drug industry's standing in the court of public opinion was further eroded by the bad behavior of Valeant Pharmaceuticals (VRX) and a spate of tax inversion deals. The combination of a real and dramatic increase in drug costs and the convenient arrival of a boogie man, forced the issue onto the 2016 Presidential campaign platforms. In October 2015, Senator Bernie Sanders released his plan for combating the increase in drug costs and was quickly followed by Secretary Hilary Clinton. Donald Trump appears to also be considering ways that drug prices can be controlled.
The confluence of events and the predictable political response had quite a few people wondering if the time was right for federal intervention to control drug prices. Some of those people were at the Center for Medicare and Medicaid Innovation and the White House. In early March, the Obama Administration, out of the blue, proposed the Part B Drug Demonstration. The proposal had not previously appeared on the Obama administration's regulatory agenda suggesting that they were exploiing a political opportunity so in the waning years of their administration they could claim some credit for reform of drug prices.
We were not among those who saw federal intervention in the drug price issue as viable. The reimbursement system for drugs is too complicated and too connected to the payment systems for physicians and hospitals to be easily altered. Furthermore, the drug industry lobby's power and effectiveness in Washington is legendary. Our money was on Pharma and on Friday the Obama administration offered pretty compelling evidence that the Part B Drug Demo was not moving forward anytime soon. The Spring 2016 Unifed Agenda - a "honey-do" list of regulatory activities in the coming months - includes the Part B Drug Demo but with a finalization date of March 2019. Since the Demo cannot move forward until the rule is finalized, it would appear, assuming there has not been a clerical error, the project will be backburnered until the next Administration. The next President can proceed or abandon the whole thing.
What Are Part B Drugs?
Medicare pays for prescription drugs obtained from retail pharmacies through the privately administered Part D plans. Drugs administered in physicians’ offices and Hospital Outpatient Departments (HOPDs) (e.g. chemotherapy infusions) are reimbursed through direct payment to doctors and hospitals via Medicare Part B. Many of these Part B drugs are what the ASPE referred to as "non-retail" drugs. The Medicare payments to doctors and hospitals are comprised of both reimbursement for the drug itself and payment for the administration of the drug either through the physician fee schedule or the Hospital Outpatient Prospective Payment System (OPPS). It should be noted that reimbursement for services on the HOPD schedule is considerably higher – 20 to 30 percent in some cases- than the physicians fee schedule.
Medicare reimburses for Part B drugs by inflating the Average Sales Price from manufacturers to wholesalers by 6 percent. This formula takes into account all rebates and discounts offered by the manufacturer but not “prompt pay” discounts that are not typically passed on to the provider. Part B drug reimbursement has been subject to sequestration for the last several years and that is scheduled to continue until 2024. The impact of sequestration on reimbursement is -1.6 percent so that the effective reimbursement is ASP plus 4.4 percent.
The Part B Drug Demonstration
The Part B Drug Demonstration would be a five-year, mandatory program with two phases that would significantly upend Medicare Part B payments. Phase one of this experiment, as it is often called due to the inclusion of a control group, would have begun in Fall 2016. The current reimbursement system of Average Sales Price (ASP) of the drug plus 6 percent would be replaced by ASP plus 2.5 percent (0.9 percent after sequestration) plus a $16.80 flat fee. All physicians and Hospital Outpatient Departments (HOPD) would be required to participate. However, roughly half would be part of a control group.
Phase two of the Part B Drug Payment Model would have begun in early 2017 and layered on top of the phase one payment method a veritable smorgasbord of Value-based Purchasing (VBP) payment tools. CMS has provided relatively few details on phase two. They do propose that the VBP could include:
The Part B Drug Demonstration model would consist of four populations:
If the details of phase one seem a bit arbitrary and those of phase two rather vague, you are not alone. Aside from a MedPAC study last year where the 2.5 percent add-on was presented as merely an illustrative example, and chosen because it was higher than the 1-2 percent reportedly given to wholesalers, there does not seem to be much research to support its use.
Phase one also fails to even address the problem identified by CMS. In the studies released in conjunction with the Part B proposal, CMS characterizes the problem as one where providers have little incentive to prescribe lower cost, but equally or more effective drugs when they are available. As noted above, a big part of spending increases are attributable to specialty drugs. There is not yet an agreed upon definition of a specialty drug but most people agree they usually are manufactured or produced by a single company implying there are no alternatives. Yet the phase one proposal makes no distinction between reimbursement for drugs with comparably effective alternatives and those without. Given the history of Medicare, where reimbursement cuts are inevitably met with margin protection through higher utilization, the phase one proposal could actually create incentives for increased prescriptions for drugs without alternatives.
Phase two of the proposal is significantly more nuanced but treading dangerously close to charging Medicare with a role in determining cost effectiveness of drugs – a dog whistle for patient advocates and often used as code for rationing of care. This phase does include opportunity to tailor incentives for providers. However for things like indications-based reimbursement, CMS would need to rely on some scientific knowledge-base that is undisputed. There is a significant lack of detail and specifics on how exactly, CMS would measure things like effectiveness and outcomes making phase two look unready for prime time.
In short, phase one appears to be more complete than phase two but arbitrary and an oversimplified response to an extraordinarily complex problem. Phase two is less defined but equally inadequate in addressing the multi-faceted and complex nature of Medicare Part B drug spending.
The Part B Drug model is budget neutral – meaning CMS anticipates paying the same amount of money, in aggregate, to physicians and HOPDs as they would had the program not been implemented. As such, some practice areas will see an increase in payments for Part B drugs, while others will see a decline. Anesthesiologists, for example, will see an increase in Part B drug reimbursement while oncologists will see a decrease. This result is not a surprise since drugs administered by oncologists, ophthalmologists and rheumatologists usually make the list of Top 25 drugs for Medicare spend.
Topping the list of most Medicare dollars spent is Roche's Rituxan to treat certain cancers and Lucentis to treat Macular degeneration.
CMS claims - and we have no reason to dispute it - that there are many oncologists for whom half their income is derived from the drugs the prescribe. The finding appears to be their sole justification for structuring the program in such a way as to alter provider compensation.
The Implications. The near term implications for physicians and patients was significant and the source of much of the opposition to the program. While the Obama Administration was able to keep its party on the reservation for a hearing last week on the Demo, members of both parties raised objections. Opinions ranged from Republican calls for a complete withdrawal to requests from Democrats to downsize the project. In these days of a divided Washington, it is tough to find such consensus.
Driving the debate was the Pharma who understood this Demo for what it was: a political response to a very complicated and difficult problem. Political reactions call for more politics not less. Pharma put together a coalition of physicians, hospitals and patients to be the face of the opposition who effectively pointed out the many flaws of the program. After a week of floating trial balloons suggesting a much smaller Demo was in the offing, the Obama Administration released the Spring 2016 regulatory agenda. Finalization of the Part B Drug Demo is now scheduled for March of 2019.
The delay is good news for Pharma who apparently still has what it takes to protect their interests. Because of that, efforts by the next President to "do something about drug prices" will not be easy. Pharma's success in beating back this threat however, did rest solely on their lobbying prowess. The fact is that federal drug reimbursement policy has created a web of interests that are tough to unwind. Part B drug reimbursement is an element of physician compensation and not simply a cost recovery system. Non-profit hospitals that increasingly derive significant portions of their annual revenue from the 340b drug discount program want to avoid any disruption of the current system of reimbursement. Had Pharma failed at blocking the Part B Drug Demo, interests favoring drug price regulation would have had the toehold they needed for additional intervention. In political terms, the Pharma lobby would have suffered a loss that would have called into question their ability to defend the industry, a weakness that would have been exploited by supporters of price controls.
Any changes to how the federal government reimburses and controls drug prices will be a hard fought fight and it doesn't look like anyone is spoiling for that just yet.
Takeaway: Role Reversal, Trump and the Tennessean; Reid's Veep Suggestion...
ROLE REVERSAL: While Donald Trump and the Republican Party are moving quickly to unite and get their act together, Hillary Clinton and the Democrats are looking to minimize the damage inflicted by Bernie Sanders’ escalating attacks. A little more than a month ago, the Republicans looked as if they were headed for a contested convention and, if Sanders remains true to his words, it will be the Democrats who are in for a long, hot summer. One bit of solace for the Democrats – when they finally united behind one candidate in ’08, they quickly rode a wave that took them right into the White House. Could the same happen for Hillary, or will she remain scarred from the Bern?
TRUMP AND THE TENNESSEAN TALK: Trump has been criticized in the media and his former primary opponents for being on the wrong side of a number of foreign policy issues – so he met with Foreign Relations Chairman Senator Bob Corker (TN) yesterday in an effort to burnish his image here and to “get know each other” – or did he have something else in mind? Hmmm…Corker says there is no reason we should think he is being considered for Trump’s Veep, but Washington tends to disagree. We’ll take Corker’s own advice and just let that “chill.”
REID’S NOT-SO-SUBTLE VEEP SUGGESTION: Senate Majority Leader Harry Reid warned Clinton she should not pick a senator from a Republican-controlled state as her Veep. The Democrats are in a heated battle to regain control of Senate majority this election cycle and if she chooses a Democratic senator on the ticket, this would pave an easy path for the Republican governor of the state to appoint a Republican to fill the senate seat, ultimately forcing Democrats to win an extra seat to reclaim the majority. Democrats would need a net gain of five seats to win the Senate back outright, but would only need four if they were able to retain the White House; Senators Elizabeth Warren (MA), Sherrod Brown (OH), and Cory Booker (NJ) might want to file away their resumes.
STAYING AFLOAT: Speaker Paul Ryan and Treasury Secretary Jack Lew struck a tentative deal on the Puerto Rico debt crisis with House Natural Resources Chairman Rob Bishop and now the task of shepherding the bill through the House begins in earnest tomorrow. The ‘‘Puerto Rico Oversight, Management, and Economic Stability Act” or PROMESA will be considered by the Natural Resources Committee and is expected to pass out of Committee - we expect a full floor vote in the House in mid-June. That is, unless Bernie Sanders’ opposition to the legislation garners enough support on the left to sink the bill…
WATCH IT BERN: After Bernie Sanders was told to cool his jets by the Democratic establishment and Party Chair Debbie Wasserman Shultz, he went along to endorse her primary opponent, Tim Canova, a former Capitol Hill staffer, anti-establishment candidate and stalwart Sanders supporter. Although the rallies and events are still packed to the brim, Sanders ties to his adopted party are likely to be burned when he returns to the Senate.
EVADING THE HOUSE: IRS Commissioner John Koskinen said thanks, but no thanks, to a “misconduct” hearing request by House Oversight Chairman Jason Chaffetz. House Republicans plan to lay out their case to impeach Koskinen for allegedly failing to comply with a congressional subpoena. Lawmakers summoned Koskinen to the Hill to answer questions from Chaffetz and his oversight panel regarding accusations that he failed to preserve documents lawmakers requested for its probe of the IRS tea party scandal - and that he was less than truthful when asked about erased back up tapes containing copies of emails belonging to former IRS official, Lois Lerner.
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