No. 23: Is Inflation Transitory?, Healthcare, Investors Are Pretty Smart
I recently watched another Buffett video where he talks about baseball to describe investing.
“You don’t have to swing at every pitch”, he says.
While I agree with this, I also think it’s important to take swings at some things – while removing forces from my life which compel me to over-swing.
What makes me get agitated to take a swing at an investment? It used to be when I wanted to seem “contrarian” or believe that I was seeing things differently from other people – like some sort of smart guy. Thankfully I’ve had my head handed to me enough times to know that I’m no smarter than anyone else.
At other times it was boredom, frustration, or just simply reading too much into short term information that pushed me to take random swings at investments. If I had instead owned a house or farm that I couldn’t transact daily, I might have been better off.
The best investment decisions of mine have been made when I was rather happy with life, which allowed calm – with no external forces prompting me to take a swing. Of course, there’s no such thing as an emotionless decision – so accepting that I’m making decisions using a cocktail of hormones is part of the game anyway.
Some people simply like taking a swing at everything. To some extent I am wired this way. I like doing things every day and am not content to sit and wait for enlightenment. But if I can take this action bias away from my main investment portfolio, either through games or sports, or through new ideas with zero downside, then I’ve mitigated my downside by taking the risks of those actions away from my portfolio.
Is Inflation Transitory?
I’ll save you some time – the short answer is nobody knows.
But I’ve collected articles about a few different product categories to describe the interesting inflationary and deflationary forces at play.
Diapers
Diapers are an interesting category. This Bloomberg article describes how P&G and Kimberly Clark, together with over 80% of US diaper market share have raised prices by around 14% over the last year. From observing other parents among family and friends, I have figured out that disposable diapers are an amazing value proposition. P&G and Kimberly Clark raising prices to offset their raw material pressures will probably not affect sales too much – as I see very limited options for substitute products. But are there potential deflationary counterweights that could enter the picture over time?
Attractive diaper margins will incentivize new businesses to enter the picture and, over time, reduce pricing power of the incumbents. Or they will incentivize retailers to find new routes to market which lower distribution costs to consumers. New consumers use the new channel to relieve their wallets - and maybe the P&G/Kimberley Clark duo might not be present in this new market segment. On the other hand, the other consequence would be that less people choose to have children, seeing the growing costs as too much to bear on a limited income.
Of course, all these reactions ignore the root cause of the price hikes, which was supply chain and raw material inflation. It is almost certain that companies will be investing behind their supply chains in the coming years to drop their cost structure. So, while we see inflationary forces in the short term, it’s not clear to me that these would be permanent in any way.
Semiconductors
Semiconductors show me a very different view of inflation. This article shows how TSMC, a major contract manufacturer of chips, is basically raising prices across the board. It is also the largest player in the industry worldwide. What’s interesting about this is that the industry was built upon how much it could drop prices to customers in the electronics industry to grow revenue. The semiconductor industry was hyper competitive to the point of being suicidal. The downturns were brutal and would see many players in different sub-sectors be knocked out or acquired on the cheap.
Today the landscape looks different. Massive capital outlays are required to build new fabs to manufacture chips. There is a skills and process knowledge gap which stops copying from competitors. In addition, in the latest leading edge fabs, massive amounts of power, water, and expensive machinery are needed to make it all work. These recent price increases don’t reflect monopoly power as much as they do a genuine input shortage. I don’t, unlike diapers, see a route to deflation in the cost structure of leading-edge semiconductor fabs.
However, the deflationary forces from semiconductors can be seen in their end-use applications.
The electronics industry has driven huge amounts of deflation across many sectors. Entire factories have been automated using a few semiconductors, computers, and robots, driving down manufacturing overhead.
Computing power has driven deflation through increased speed of communication, E-commerce, education, and generally abstracting away repetitive tasks.
The recent mRNA vaccines were made in only a couple of weeks – not by shortcuts in safety standards, but by the 1,000,000X improvement in computing power over the past two decades, which allowed the virus to be sequenced much faster than in previous years.
Lest we forget, AI will drive huge productivity gains over time - on a scale that’s largely un-comprehendible.
Any finally, even Capital Buddha acts as a deflationary force in its own small way, sharing information cheaply through computing infrastructure allowing me to reach a global audience for free.
But again, overall inflation is somewhat unknowable. Some inflation will translate through to our home grocery bills and costs. But other parts of the rising cost contribute towards infrastructure of the future – which will drive further deflation from productivity over time. I’m curious to review this note in 10 years to see how things played out.
Investors are Pretty Smart
I listened to this Value Hive Podcast with Dan Mc Murtrie, which was my favorite podcast of 2021 so far. Dan believes that institutional investors are not stupid. There might be very rational reasons why they don’t buy or sell stocks which have nothing to do with valuation. For example, owning China stocks during the regulatory crackdown in Beijing might increase career risk for investors who hold. Ordinary clients of the investor might get spooked, reading the latest negative FT articles about China. If the investor held Chinese stocks and got the bet wrong, against the warnings of their clients, they would be unceremoniously fired. Similarly, I spoke to investment managers whose clients benchmark them against indexes. Any meaningful deviation from the index for any meaningful period resulted in clients taking their money away – unless of course, all deviation was to the upside every year. Choosing anything meaningfully different than the overall market becomes difficult in an institutional environment. In fact, I would say that contrarian, or even outright common sense decisions carry outsized career risk to the institutional investor with little to no skin in the game.
In summary, it’s important to understand the players and incentives in the market before calling excessive stock market behavior “random” or “manic-depressive”. Dan explains it better though - so I’d really recommend listening to this one.
Healthcare
The US spends more than most other OECD countries on healthcare but get worse outcomes. This book was an amazing exploration of different healthcare systems across the globe. Well worth a read for those who are interested in the topic.
Training of US doctors and nurses is world class. Some of the best doctors and nurses are developed in the US. However, financing of the US healthcare system is the major problem. US healthcare is largely private for the non-disabled, working population. Therefore, many must purchase a private health insurance policy – of which there are many providers. Individuals typically get insurance through their employer. Employers can drive volume discounts with insurers, as well as dangle cheap health insurance as an attractive way to recruit employees.
Here we see some cracks in the system already. US insurers face some natural churn in policy holders – e.g., if someone changes jobs, they will likely change their insurer. This means that US insurers as a group have no incentive to invest in preventative health, only for their client to switch to another insurance provider who might reap the benefits. This means that basic preventative health campaigns don’t get spread to the wider population. This means that the population is unhealthier, as compared to countries with single-payer healthcare systems where the government ultimately pays the bill, and therefore has every incentive to invest behind inexpensive preventative healthcare.
The other part of a private healthcare system is that insurance providers spend a lot of time and energy denying claims from customers. The average US claims department (though they won’t necessarily admit this) have incentives to reduce the insurance claims made by customers. Which means that patients are denied access to funding, under a policy that they have dutifully paid for, precisely when they need coverage for a health condition.
The other shameful aspect of the US healthcare system is the correlation between being employed and having healthcare coverage. People who have a small health issue, who need time off work, might get their employment terminated, which means that their insurance also disappears. The book I mentioned earlier described a situation where a 32-year-old woman died because of a small issue that was treatable. The only issue was that when she took extended medical leave her employment contract was terminated. Americans can access disability healthcare benefits, but these are difficult to obtain in a reasonable timeframe. And some of these benefits are means-tested, which means that if you have access to a relative who is above the income threshold (even if they’re only just above the poverty line) then you will be denied access. Households barely scratching out a living can be bankrupted by healthcare costs. This system stops upward social mobility in its tracks.
Finally, US healthcare costs interferes with overall US competitiveness. The country spends just under 20% of GDP on healthcare, that’s twice the ratio of most other developed countries. In my view this would be ok if it got better healthcare outcomes for society – but most indicators (explained by the book) show that they don’t, apart from the training of physicians and surgeons.
This hits home particularly hard as I have direct family in the US – and I want the country to see a 1st world single-payer health finance model soon. Along with this, there are countless stories from acquaintances who have been left high and dry by the US healthcare system – when solving the problem would have been simple and humane.
It’s astounding that even though the US has seen international healthcare models working better and cheaper, it has not changed. Powerful vested interests probably benefit immensely from the status quo. Making a significant change would probably require Democrat majorities in both the House and the Senate. But once it is made, it will free up 10% of GDP, alongside better healthcare outcomes. It’s a prize that’s definitely worth going after.