The Patient Protection and Affordable Care Act, more commonly known as Obamacare, was signed into law nearly four years ago in March 2010. A vigorous debate has ensued in the time since between those that upheld the virtues of the law and those that adamantly opposed it. But since the beginning of October 2013, the prolonged debate over the conceptual has finally begun to transform into an examination of the concrete. And whether you have been for or against the Affordable Care Act (ACA) over the years, it is difficult to dispute the fact that the initial roll out of the program has been an utter mess. This initial outcome along with the events leading up to it provide an important lesson for stock market investors that is worth heeding as we move forward.
Before going any further, it is important to note that I do not seek to promote or refute any particular political ideology in this article, as I could argue both the merits and shortcomings of various healthcare reform proposals presented over the years from both parties including the current law in the ACA. My concern here is not the law itself, as Seeking Alpha is not the forum for such debate. Instead, my focus is on how the law has unfolded and the important behavioral implications for the stock market.
The reception to the ACA since its launch in early October has been disapproving to say the least. According to Rasmussen, 81% of voters favor repealing or changing the health care law including 50% that believe the law should be completely scrapped, the latter of which is up seven percentage points from 43% just over a month ago. Much of the negative intensity for the ACA has been sourced from the individual health insurance marketplace where the law has directly impacted so many thus far. According to Gallup, more than twice as many Americans claim the healthcare law has hurt them versus helped. And all of this fervor has come with more than two-thirds of Americans still stating the law has not yet affected them. This, of course, will change dramatically once the employer mandate begins to roll out later next year.
A primary source of consternation about the ACA among those in the individual health insurance market have been the cancellation notices along with the dramatic increases in premiums for relatively less coverage in many instances. Using my own experience in the individual insurance market as an example, I received one of the many now notorious cancellation notices along with the message that my monthly health insurance premiums would increase by +173% for a comparable ACA compliant plan. An unpleasant outcome to say the least, but such is the reality of the law for the more than 5 million that have been similarly impacted in recent months.
To many, receiving such cancellation notices was a most unpleasant surprise. After all, the President and his many Democratic supporters in Congress promised repeatedly that "if you like your health care plan, you can keep it. Period". And the associated plight of many Americans has rightfully garnered a great deal of media attention over the last two months, as a promise is a promise and it has since been broken.
But here's the thing. Those in the individual market place should have seen this coming well in advance. The information has been out there in the public domain for years. And even a cursory look past the breezy promises of politicians should have revealed that the outcome that many are now experiencing today with the health care law was inevitable.
Health care costs for many were destined to rise from the day the ACA was signed into law. The reason has always been simple - there is no free lunch. Insurance companies are private sector companies in the business of providing insurance coverage to achieve earnings and create shareholder wealth. And in a competitive marketplace, they have the incentive to provide the greatest amount of coverage at the lowest possible cost while still generating a profit for their efforts. If these insurance companies chose to not provide coverage to selected individuals, whether it is fair or not from a humanitarian standpoint (and I can speak from personal experience to this point as someone who was once denied coverage for a pre-existing condition that was highly questionable to say the least), they are opting to bypass these potentially higher risk customers because they have concluded they are too costly to cover. Thus, if the government suddenly inserts itself and demands that insurance companies must now provide coverage to those that they previously deemed too costly to cover in the past and must also provide coverage for procedures that were typically excluded in the past for similar cost reasons, insurance companies are simply going to have to charge more for coverage. Otherwise, they may no longer be profitable and may eventually need to either discontinue coverage for many of their policy holders or simply exit the insurance business altogether. Such is the outcome we are beginning to see play out today.
The inherent upward pressure on health insurance costs resulting from the ACA has been evident for years. And numerous conversations with health insurance brokers along the way confirmed as much. As recently as this past May, I confirmed with my health insurance advisor that I should expect that my premiums for comparable coverage would be going up over +100% at least. In short, I knew the dramatic cost increases were coming and I was ready once official confirmation of this fact finally arrived in my mailbox this fall. Unfortunately, many others in the individual marketplace did not see this coming, which is tragic for a variety of reasons including the fact that some are now scrambling to find coverage and are left to wait on a government website that is continuing to struggle to get up to speed.
All of this brings us back to the stock market. According to the Efficient Market Hypothesis, the stock market is efficient because share prices always fully reflect all publicly available information. Perhaps this is true. But if it is the case under this notion that markets fully reflect all publicly available information, why then were so many people in the individual health insurance marketplace taken by complete surprise when their existing policies were cancelled or their premiums were sent skyrocketing? Were market participants truly considering all publicly available information, or were they instead taking comfort in the promises of politicians and ignoring the information available to them in the process.
A similarly troubling condition has been unfolding for the stock market (SPY) over the last several years. When the stock market bottomed back in early 2009, the list of challenges facing the economy on the road to recovery was vast and complex. And achieving a healthy and sustainable rebound would require tremendous fiscal and monetary policy discipline along with the willingness to make tough decisions along the way to fully cleanse the badly polluted financial system and allow it to heal.
Unfortunately, what has unfolded in the five years since has been a litany of hollow policies that have done little to resolve many of the structural imbalances that resulted in the crisis in the first place. In fact, some conditions have actually become even worse, not better. Just as the need for health care reform was widely accepted as the debate surrounding the ACA developed, so too was the need for extraordinary policy support to resuscitate the economy from the financial crisis. As a result, the Fed's first QE program through March 2010 was both prudent and justified. But while the American Recovery and Reinvestment Act of 2009 may have been well intentioned, the sustainable multiplier effect resulting from this enormous fiscal policy stimulus proved generally disappointing beyond its initial impact. Far more damaging, however, has been the fiscal and monetary policy actions once the global economy had been pulled back from the brink in the summer of 2010. Since that time, the executive and legislative branch have made a complete hash of fiscal policy with counterproductive partisanship and an embarrassing lack of leadership on both sides of the aisle. As for monetary policy makers, they have effectively become the great enablers for politicians in Washington by feeding financial markets with enough liquidity to begin inflating new bubbles while pumping the stock market to fresh all-time highs while doing little to address underlying structural problems. The relationship between the Fed's balance sheet and the stock market over the last five years is difficult to deny.
So where does all of this leave stock investors today? Optimism is absolutely running wild on Wall Street. According to Investors Intelligence, the percentage of those surveyed that are bearish has fallen to an all-time low at less than 15%. But why exactly is this the case? Is it really due to optimism over the economic outlook? If so, why then does the Fed feel compelled to keep their foot to the floor with what was not long ago considered extraordinary policy measures? The economic recovery to this point has been sluggish at best despite an outpouring of policy support, and the catalysts to drive future growth are sorely lacking. Revenue growth remains languid and earnings growth has effectively stalled over the last two years in repeatedly falling short of expectations along the way. Profit margins are already drifting lower off of record highs, stock market valuations are now expensive relative to historical averages and downward revisions to earnings guidance outnumbered upward revisions by 8-to-1 heading into the final quarter of the year according to FactSet.
If the economic and corporate outlook is mixed at best, what then is the source of such extreme investor optimism today? Let's just be honest, it is driven almost exclusively by the fact that stock prices are going up and have been doing so relentlessly for nearly a year now. Although it is difficult for some to admit, it has little to do with anything fundamental. If it did, why then did so many investors turn bearish in the summer of 2011 when fundamental conditions were vastly better than they are today?
Instead, today's investor optimism is because stock prices are rising and little else. And this compulsion for investors to simply believe that all is good simply because the market is telling them so is a treacherous approach. For just as the evidence existed for a long time that the ACA may not shape up to be what so many hoped it would be, so too does ample evidence exist that the stock market has now floated far beyond its fair value price in an environment when new bubbles are forming and many underlying structural issues remain unresolved. Even if the economy is improving and corporate earnings are poised to accelerate, they have a long way to travel to fill the air pocket that now exists between current stock prices and actual fundamentals.
Just as we have witnessed in recent months with the ACA, at some point the stock market will arrive at a day of reckoning when it is forced to confront the realities of its challenges and shortcomings. And just as the new health care law must now fight to overcome these hurdles or otherwise succumb, so too will the stock market at some point be forced to fight and find its true equilibrium price implied not by Fed liquidity but instead by its underlying fundamentals. And while the postponement of key measures in the ACA is dragging this adjustment process, the same could be said of the Fed's persistent coddling of the stock market in putting off the inevitable corrective process.
In the end, the Affordable Care Act if it survives will be considerably better for undergoing the rigorous test it is now facing. The same will be true of the stock market once it is finally set free to face reality. In the meantime, those investors staking their market optimism purely on the hopes and promises that the Fed will simply know what to do to carry stocks through to the other side without any pain may find themselves unpleasantly surprised when the moment of truth finally arrives.
This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.