Gilead deserves a reasonable return on their investment but Gilead did not invent Sovaldi, it bought the company that did for $11 billion, which is probably why we have seen such huge prices paid for upstart Biotech firms in the past few years.  Interestingly, though, as these companies are trying to expand their sales to countries outside of the U.S., pricing of the treatments is taking a huge haircut.  While a Sovaldi pill is priced at $1,000 a day in the U.S., an entire treatment regimen of 84 of those pills costs just $900 in Egypt.  Exact same medicine, completely different pricing!  No wonder we are seeing so many mergers in the U.S. Health Insurance sector; these companies are looking for some ‘buying power’ with the Biotech companies by merging and shrinking the total number of buyers, thereby giving them more pricing power.  The ‘game’ in this sector looks to be coming to an end, at least for now, with the IBB Biotech Index now trading more than 20% below its July high.

We did find some good economic news in the past month, though, that is clearly not the consensus view.  The fall in the Canadian dollar over the past year and the fact that our economy is still highly ‘trade-oriented’ is leading to a resurgence in export growth which should help to bring the Canadian economy out of its 2-quarter downturn.  Employment levels have also been growing again despite the layoffs in Western Canada.

Lower Dollar Helping Canadian Economic Stats

Unfortunately, Canada is not looking as good as it has in the past in terms of consumer debt.  Spending has not been matched by income growth which has resulted in household debt rising to a record high of 165% of household income.  Canadians now spend an average of 14% of their after-tax income on debt servicing costs, up from 11% in 1990 when interest rates were substantially higher than they are today!

Another thing to be concerned about as the 3rd quarter earnings-reporting season approaches: Stock buybacks are inflating earnings per share at many companies, which suggests more trouble for stocks when the buyback binge eventually ends.  In recent years, many U.S. companies have used their considerable cash holdings to repurchase their own shares, rather than invest in capital assets.  The trend, which has accelerated in the past two years, means buyback programs are having a material impact on earnings per share.  Share-count reduction continued for the 6th consecutive quarter.  One in five companies reduced year-over-year share count by 4% again, thereby giving a much-needed 4% tail wind to EPS.  Buybacks have become much needed, because corporate revenue and organic earnings growth have been slowing for several quarters.  The result is that S&P500 companies have increased the share of operating earnings paid out as buybacks and dividends to more than 80% in most quarters, and 104% in the first quarter of this year.  This means that companies spent more money than they earned in the quarter, most of it via buybacks. The payout ratio fell to a still-high 98% in the second quarter.  Clearly this is a trend that has been supporting stocks and artificially inflating earnings.

Shareholders welcome these buybacks, believing they lift share prices, and they do in the short term.  But, in the longer term, the benefits of repurchase programs are open to question, especially given management’s tendency to buy at market highs rather than lows.

My intention is not to depress everyone with these economic views but to put the necessary caution flags out for all investors and to provide background to our very defensive market strategy.  Any good news?  We will soon be heading into the seasonally-strongest period of the year for stocks, from mid-October to year end.  But even that is no guarantee for better stock markets.

 

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