Valeant, Turing and drug price increases

I make no secret of the fact that I’m not an expert on healthcare companies.  In fact, I get my healthcare exposure through specialized mutual funds rather than selecting stocks myself.

So I’ve been taken aback by recent press furor over the hedge fund practice of encouraging the acquisition of sleepy drug companies with the aim of jacking up the price of key drugs owned by the target.  The case of Martin Shkreli (who looks like he should be in middle school) and his company Turing Pharmaceuticals, which acquired a drug that had been selling for $13.50 a dose and raising the price to $750 became a flash point for social concern–especially after Mr. Shkreli made the rounds of financial TV shows visibly gloating over his “achievement” and the attention it brought him.  What could he have been thinking?

That performance has drawn negative attention to Valeant, a serial acquirer whose playbook also includes a liberal dose of the same price increase tactic.

My quick and imperfect look at Valeant suggests that the company’s mind-bogglingly high 50% + return on equity last year was fueled mostly by financial leverage.  But it’s possible that as much as a third of its 16% return on capital is due to raising prices on acquired drugs (the company’s disclosure doesn’t make it easy to get a good figure).  So without tons of borrowing and the price hike maneuver it seems to be a pretty pedestrian operation to me.  Remember, though, I’m no healthcare expert.

As to Valeant, which has lost about a third of its market cap since Hillary Clinton’s tweet objecting to “outrageous price gouging” by pharma firms, I don’t think it’s the details–or lack of them–in its financial disclosure that’s the issue.


I firmly believe that Americans are unwilling to allow entities to make unusually high profits from taking advantage of the medical problems of others.  Sure, we’ll pay for revolutionary new drugs, but we won’t stand for large price hikes for mature ones.  We think it’s unfair   …and won’t tolerate it.

I don’t mean to be making an ethical judgment, although I do personally think this is an unconscionable practice.  As a nation we put up with gun violence, we tolerate the Motor Vehicle Bureau and decades of lousy cars from GM.  New Yorkers are ok with Mayor DeBlasio’s opposition to charter schools in poor neighborhoods.   On the other hand, they wouldn’t put up with his efforts to quash Uber or to remove the pedestrian mall in Times Square (installed by the predecessor he satanizes).


My point?  I find it interesting/astonishing that the prominent hedge funds that back Valeant are so detached from mainstream American culture that they think “outrageous price gouging” is socially acceptable.  It’s not.


what comes after a double bottom?

A double bottom marks a significant reversal in market direction.   There are two possibilities:

–after a bear market, meaning a nine-month to year+-long market decline caused by a recession.  (This is not the situation we’re in now.)  The market typically bottoms six months or so in advance of what government statistics will eventually say was the low point for the economy.  It does so partly on valuation, partly because the first anecdotal signs that the worst is over are beginning to be seen.

The market then begins its typical sawtooth pattern of upward movement, forming what technicians call a channel.  This is an upward sloping corridor whose ceiling is formed by progressive market highs and whose floor is similarly formed by progressive lows.  Initially, the slope can be quite steep.  Day to day, the market makes progress by bouncing along between floor and ceiling.

–after a correction, meaning a decline of, say, 5% to 10% in market value that occurs over several weeks and which, in effect, adjust market values back from stretched to the upside to levels where potential buyers see the potential for reasonable gains over a twelve month period.  (This is our current situation, in my view.)

Generally speaking, the same upward channel forms.  But the slope may be very shallow.  In fact, until new, positive, economic information emerges, there may not be much of a slope at all, so that stocks move more sideways than up.  Nevertheless, in the case that the channel is almost completely horizontal, periodic successful testing of the bottom established at the end of the correction reinforces the idea that downside risk is limited.

double bottom

As regular readers may have discerned, I have a complicated view of the value of technical analysis, which is the attempt to derive useful investment information from studying the volume and price trends of individual securities and/or entire markets.

In the US of the 1920s, technical analysis was king.  That’s because there were no real standards for reporting of financial results by companies (some of which switched accounting standards the way most people do shirts to show themselves to the best advantage) at that time.  Nor were there legal bars to prevent syndicates of wealthy investors from creating artificial enthusiasm by manipulating individual names up and down in bucket shop fashion.  Basically, technical analysis was all there was.  In my view, subsequent legislation mandating minimum auditing and disclosure standards, and outlawing syndicate activity, have rendered much technical work obsolete.

By the way, I also find much of technical analysis to be useless/incomprehensible.  Take head-and-shoulders movements as an example   …or the Dow Theory.  But my main objection remains that technical analysis is a century-old tool that has been superceded by fundamental analysis of audited and SEC reported financial results.  It’s like riding a bicycle in a NASCAR race.

Nevertheless, even fundamental analysts fall back on technicals in times of panic, which is, after all, completely about sentiment with no room in fear-gripped minds for fundamentals.  And there are a few indicators that I think are very helpful in gauging sentiment.

One of these is a double (sometimes triple) bottom.

what a double bottom is

The idea is to figure out the index level where selling that is driving down a market/stock either exhausts itself or meets potentially strong resistance from buyers.

bottom occurs when downward movement stops and reverses itself.  Often this happens on higher than normal volume.  Sometimes the final down period is marked by a steeper than normal decline.  The level of the low may also be closely related to a prior significant low.  At times, however, none of these confirming signals are present.  The important thing is that the marke/stock stops falling and begins rising again.

Four to six weeks later–not any sooner, but occasionally even later than six weeks–the market/stock stops rising and declines again to the vicinity of the prior low.  If the market/stock then reverses course and begins rising a second time, it is said to have tested and confirmed the prior low.  In most cases, this double bottom signals the end to the down phase.

Sometimes, the market repeats this process and forms a triple bottom.


From a psychological point of view, the fact that the market/stock falls to a significant low but repeatedly fails to break through that low creates and strengthens the belief that this is a point where significant resistance to further decline will occur.  The more the low is successfully tested, the stronger this conviction grows.

relevance for now?

The S&P 500 made a low of 1867 on August 25th.  This is very close to the closing low of 1862 (intraday:  1820) on October 15, 2014–and another low (1816) on April 11, 2014.  The index reversed course on all these occasions, this time reaching 2020 on September 17th.  The S&P then declined to 1882 on September 28th.  The market then reversed course again and has been rising since.

So far this looks like a classic double bottom–the first low, the four-week interval, the confirmation of the first low, all linked to prior significant lows.  We’ll only know for sure as we see trading unfold over the next few weeks.

In the present case, the formation of a firm bottom for the market would also be evidence in favor of the idea that investors are willing to separate clearly the (weak) commodities-related sectors from the (strong) rest of the market and are not prone to let the former infect the latter.



will the poor performance of Energy, Materials and Industrial sectors derail the S&P 500?

In the course of doing a performance attribution for the S&P 500 year-to-date last week, I noted that the S&P 500 ex Energy, Materials and Industrials, is pretty close to flat so far this year on a total return basis.

But is it correct to conclude that the “healthy” sectors of the S&P will continue to be relatively immune to the economic illness caused by the price collapse of global mining commodities?   …or will they eventually be dragged down if, as I expect, commodity weakness continues for an extended period of time.

This isn’t as silly a question as it might seem at first.

In the early 1990s I was asked by the board of the company I worked for to present my views on the stock market in Japan at that time.  I created a presentation that divided the Topix index, which was trading at about 70x earnings, into three parts:

–highly speculative property-related companies that were trading at around 500x earnings and made up 10% of the market

–export-oriented industrials, such as the autos or tech companies like Canon, which were trading at 15-20x earnings and made up 30% of the market, and

–everything else, which made up 60% of the market and traded at around 25x.

I said what I believed:  that, while the index might do poorly as the speculatives came back to earth and the bulk of the market went sideways, the export-oriented stocks were cheap and would go up significantly in price–not only in yen but in dollars, too.  My model was the behavior of the US market throughout the second half of the 1970s, when former speculative favorites, the Nifty Fifty, were crushed while everything else went up.

An aside: a famous finance academic on the board, who made it clear he had not sought the opinion of a mere “practitioner” like me, objected that the low dividend yields of Japanese stock proved they remained wildly overvalued.  A little embarrassed (for him), I had to explain that Japanese tax laws did not provide the same preference for dividend income that the IRS did. In fact, dividend income was subject to income tax at an extremely high rate (up to 90%) in Japan.  Because of this, taxable investors (the majority at that time) had a very strong preference for (untaxed) capital gains.  Companies tended to make negligible cash payouts and to use stock dividends as a substitute.

Embarrassingly (for me), it turned out that my reasonable analysis was completely wrong.  Yes, the exporters were cheap, but for the next decade they significantly underperformed similar-quality companies elsewhere in the world.  In this case, the general economic funk that engulfed the Japanese economy hurt the stocks of all firms listed there.  There was no escape.

my thoughts

Thee aren’t a whole lot of relevant examples of this kind of situation to generalize from.  (Another might be the worldwide collapse in the price of mining commodities and of commodities stocks from 1982-86, which did not impede the upward progress of global stock markets from mid-1982 on.)

My hunch is that the contamination of “good” stocks in 1990s Japan is more a function of the continuing economic malaise in that country than of anything else.  What’s somewhat troubling is that the US today is very similar demographically to Japan back then, when lack of workforce growth was a significant contributor to Japan’s stagnation.  We have the same woes of extremely low interest rates and an impotent legislative arm tied to the status quo and unwilling to use fiscal policy to bolster the economy–another set of lead weights dragging Japan down.


At the end of the day, I’d argue that the US is inherently a much more dynamic country than others in the developed world.  Also, I see the commodities collapse as much more like an external shock than a sign of weakness in the domestic economy in the way the property collapse in Japan was.  So I see the chances that commodities/commodity stock softness will cripple the rest of the US stock market as low.  But there are enough similarities between us today and Japan 25 years ago to make me vaguely uneasy.




the jobs report and last Friday’s trading

I had decided last week to write today about what happens in an overall market when one or two significant sectors are performing poorly and have weak future prospects.  Is the rest of the market indifferent to the laggards?   or do the weak sectors work to sap the strength of sectors where business is good and the outlook favorable?  This is potentially important, given the miserable performance of the Energy, Materials and Industrials sectors–and the likelihood of no positive news for these areas of the stock market for a considerable time to come.

After I saw the sharp negative reaction of the market to the so-so Employment Situation report released Friday morning, I decided to push that post back until tomorrow and write about Friday’s market action instead.


There’s been  lot of discussion recently about the role of computerized trading in influencing the day-to-day, or hour-to-hour, direction of stocks on Wall Street.  Understanding what effect this trading is having on stocks is the first step in the stock market’s judo-like process of beginning to use the momentum of such trading against itself.  For investors like us with long holding periods in mind, one might argue that day-to-day volatility has little significance.  Even so, it seems to me it’s important to be able to read the signals the market is sending    …alao, understanding the rhythms of daily trading can be some help in determining the timing purchases and sales we may be thinking about for strategic reasons.


Last Friday, stock index futures fell immediately on the Labor Department release of the monthly ES report.  Stocks fell sharply at the open, an hour later.  Equities remained depressed for about an hour, before beginning a steady ascent through the rest of the day.  The S&P 500 closed on its high.  This is a particularly positive sign, since professional traders tend not to want to hold positions over the weekend if they have even the slightest worries.

On the surface, the ES report isn’t encouraging reading.  The economy gained 142,000 jobs last month.  That was substantially below the average gain for the past year, and it was much less that the 200,000 new positions that economists had estimated.  More than that, the two previous months’ estimated job gains were both revised down.  All of this was emphasized in media reports that were available a minute or two after the 8:30am edt release of the information.

Several important factors weren’t mentioned, however:

–economists’ estimates of +200,000 new jobs were, as usual, very close to the average monthly gain in jobs over the past year, leading me to conclude that getting this figure right is not their highest priority

–that’s understandable.  The Labor Department says that the monthly job figures from its Establishment survey are correct to within +/- 100,000, meaning a “miss” of 50,000 or so jobs contains no statistically significant information

–we’ve seen outlier months occasionally over the past several years.  In each case, job gains have soon returned to trend

–the latest JOLT (Job Openings and Labor Turnover) Survey from the Labor Department shows that the country has 5.7 million unfilled jobs at present, a figure 25% higher than at the previous economic peak in 2007.  This is also an all-time high for the JOLT tally, which makes it hard for me to believe that the September jobs report heralds a significant downshift in US economic activity.

How do I read Friday trading?

I think computers programmed to read news services pushed the market down, both in pre-market futures trading and in the first hour of actual stock trading, as well.  Human traders (smarter computers?) waited for the downward momentum to exhaust itself and, recognizing that this initial move was a mistake, then began buying.

Although I think my analysis is correct–Friday’s trading pattern was very unusual–I also find it very odd that someone (actually lots of someones) would be content to trade on a government report + questionable sentiment indicators.  But maybe that’s the world we’re in today.   If anything, it argues for higher day-today volatility.  It also suggests that there’s money to be made for those with better-than-newspaper knowledge, a trading temperament and time to watch the market closely.





a tale of two markets …or three …or one?

In yesterday’s Keeping ScoreI outlined the performance by sector of the S&P 500 component sectors over the past one and three months.  Here’s the same information for 2015 to date, through the end of September:


Consumer discretionary          +2.9%

Staples          -2.9%

Healthcare          -3.3%

IT          -4.1%

S&P 500 (adjusted, as described below)          -4.3%


S&P 500          -6.8%

Telecom          -7.4%

Financials          -8.4%

Utilities          -8.4%


Industrials          -11.2%

Materials          -11.2%

Energy          -23.1% (ouch!!!).


Index performance falls pretty neatly into three categories:

–relative stars, which are clustered around/above the adjusted S&P 500.  These are, generally speaking, sectors with primarily a US/EU focus and which do well when economies are expanding and consumers are feeling good.  But they don’t depend on rip-roaring commodities-oriented, basic industry-based economic expansion.

–non-descripts, clustered around the index

–clunkers, either basic materials or the Industrial sector which serves basic industry (and also makes lawn mowers and other stuff for consumers)

my adjustment to the S&P

Energy (currently 6.9% of the S&P), Industrials (10.1%) and Materials (2,8%) make up about 20 percent of the S&P by market capitalization.  The three account for half the index’s losses so far this year, however.  The -4.3% return of the adjusted index is the aggregate performance of the other 80% of the S&P through the end of September.  Figure that a holder of those sectors has collected a dividend of around 2% and the total return of the adjusted index looks more like treading water than a catastrophe.

my thoughts

Of the clunkers, the simple story for Materials and Energy is that commodity producers are invariably their own worst enemies.  In good times, they plow their cash flow back into creating new capacity that ultimately floods the market with output and destroys pricing.  The most maladroit borrow the funds needed to shoot themselves in the foot.  Like the biblical seven years of famine following the seven years of plenty, we’re in the early stages of a long downturn.

Industrials are a little more complicated.  Many don’t make gigantic turbines or stamping or cutting machines that would fit comfortably in Soviet propaganda art.  Instead, they make paint, lamps, gardening equipment–any of the stuff consumers buy in a Home Depot.  I haven’t looked at the sector carefully enough to know whether some of the members are being punished unfairly (I suspect not, though, so I’m in no rush to find out.)


On a nine-month view, though, all the fear that seems to be pulsing through Wall Street seems misplaced.


why three markets?

Recent problems with Healthcare don’t reveal themselves in this performance analysis.  The straightforward explanation is that the current swoon is about valuation, and represents simply giveback of earlier outperformance.  Although/because I hold a lot of a healthcare mutual fund run by a super-competent former colleague, I don’t pay enough attention to this sector to have a strong opinion.  I do think, however, that Americans don’t take kindly to firms that make extortionate profits from the misery of others.  Recent revelations that acquisitive drug firms, spurred on by hedge fund backers, have aggressively raised the prices of drugs they’ve bought is probably inviting political backlash.  In any event, I think Healthcare will go its own way.


is this a stable situation?

In other words, will Wall Street simply shrug off the woes of the clunkers by shifting into other sectors, which has been the case so far?  Or will the problems of the 20% eventually drag down the rest?

To me, the answer isn’t obvious.


More on  Monday.






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