Tag Archives: New Deal

Transparent Reinsurance for Health

Transparent reinsurance programs could emerge as significant opportunities for healthcare providers, issuers, reinsurers, technology innovators and regulators to address health insurance.

The message is clear. Having to factor in higher costs associated with new entrants to the healthcare system gives insurance firms license to charge higher rates. If these new people were put into a reinsurance pot for three to five years with costs spread over all insurers, no one insurer would be unnecessarily burdened. After this period, costs for these entrants could be reexamined and a decision could be made on how to proceed with them, depending upon the deviation from the remaining population.

Several factors are coming into play. 

United Health Group indicates it will be leaving all but a few of the 34 states where it is offering health insurance under Obamacare.

A fresh Blue Cross Blue Shield study finds recent Obamacare entrants have higher rates of specific illnesses and used more medical services than early entrants. “Medical costs of care for the new individual market members were, on average, 19% higher than employer-based group members in 2014 and 22% higher in 2015. For example, the average monthly medical spending per member was $559 for individual enrollees versus $457 for group members in 2015,” the study found.

What emerges in conversations with economists, regulators and healthcare actuaries is a sense that properly designed, fair and transparent reinsurance could—and would—advance industry and public policy goals to continue insurance for all at affordable prices. This approach would represent tangible improvements over inefficient, incumbent systems. Information would be used by insurers and reinsurers, providers and regulators and, crucially, insureds to establish best performances for healthcare outcomes and expenses. Virtually everyone knows that state or regional reinsurance would have to be mandated, as voluntary systems could be gamed.

“The implementation of new policies, the availability of research funding, payment reform and consumer- and patient-led efforts to improve healthcare together have created an environment suitable for the successful implementation of patient-reported outcome measures in clinical practice,” fresh research in Health Affairs also indicates.

Risk analysis technologies could help issuers, reinsurers, healthcare institutions and citizens rein in the healthcare system’s enormous costs. Earlier this year, the Congressional Budget Office and Joint Committee on Taxation projected that, “in 2016, the federal subsidies, taxes and penalties associated with health insurance coverage will result in a net subsidy from the federal government of $660 billion, or 3.6% of gross domestic product (GDP). That amount is projected to rise at an average annual rate of 5.4%, reaching $1.1 trillion (or 4.1% of GDP) in 2026. For the entire 2017–2026 period, the projected net subsidy is $8.9 trillion.”

CBO/JCT published this stunning projection amid consensus that $750 billion to $1 trillion of wasted spending occurs in healthcare in the U.S. “Approximately one in three health care dollars is waste,” Consumer Reports says.

Key metrics should focus on estimates of risk using demographics and diagnoses; risk model descriptions; calculation of plan average actuarial risk; user-specified risk revealing and detailing information; drill-down capabilities clarifying research; monitoring and control; and calculation and comparison measures to address reinsurance validation.

Several major refinements yielding and relying upon granular, risk-revealing data and metrics would support more efficient reinsurance. All would, and could, update reinsurance information and address customer experience, trust and privacy concerns.

As the industry has noted, ledger technologies could play fundamental roles as blockchains. Indeed, blockchain technologies are just now being introduced in the U.K. to confirm counter party obligations for homeowners’ insurance.

“Advanced analytics are the key,” remarked John Wisniewski, associate vice president of actuary services at UPMC Health Plan. “Predictive capability that looks at the likelihood a patient admission may be coming is the information that we can give to doctors to deal with the matter. … Whoever develops algorithms for people who will be at risk—so providers can develop plans to mitigate risk—will create value for issuers, providers and members alike.”

Available technologies support the connecting of risk assessments with incentives for risk information.

Michael Erlanger, the founder and managing principal of Marketcore, said, “We cannot know what we cannot see. We cannot see what we cannot measure. These available technologies provide clarity for more efficient health insurance and reinsurance.”

Context: Three Rs: Reinsurance, Risk Corridors and Risk Adjustment

When Congress enacted the ACA, the legislation created reinsurance and risk corridors through 2016 and established risk adjustment transfer as a permanent element of health insurance. These three Rs—reinsurance, risk corridors and risk adjustment—were designed to moderate insurance industry risks, making the transition to ACA coverage and responsibilities. The Centers for Medicare and Medicaid Services (CMS) within the Department of Health and Human Services (HHS) administers the programs. All address adverse selection—that is, instances when insurers experience higher probabilities of losses due to risks not factored in at the times policies are issued. All also address risk selection, or industry preferences to insure healthier individuals and to avoid less healthy ones.

With the expiration of ACA reinsurance and risk corridors, along with mandatory reporting requirements this December, healthcare providers, issuers, reinsurers, technology innovators and regulators can now evaluate their futures, separate from CMS reporting.

Virtually all sources commend reinsurance and risk adjustment transfer as consistently as they deride risk corridors. Reinsurance has paid out well, while risk corridors have not. Risk adjustment transfer remains squarely with CMS. 

ACA numbers

While House Republican initiatives try and fail to repeal the ACA, and some news programs and pundits say it is unsustainable, approximately 20 million subscribers are enrolled in Obamacare: with 12.7 million as marketplace insureds, with others through Medicaid and as young adults on parent plans. President Obama, in March, remarked: “Last summer we learned that, for the first time ever, America’s uninsured rate has fallen below 10%. This is the lowest rate of uninsured that we’ve seen since we started keeping these records.” Subscription ratios are off the charts. Premium increases have been modest, approximately 6% for 2016, experts find. “I see no risk to the fundamental stability of the exchanges,” MIT economist Jonathan Gruber observed, noting “a big enough market for many insurers to remain in the fold.”

Transitional Reinsurance 2014-16: Vehicle for Innovation 

One of the great benefits of the ACA is eliminating pre-existing conditions and premium or coverage variables based on individual underwriting across the board. Citizens are no longer excluded from receiving adequate healthcare, whether directly or indirectly through high premiums. Prices for various plan designs go up as coverage benefits increase and as co-pays and deductibles decrease, but the relative prices of the various plans are calculated to be actuarially equivalent.

To help issuers make the transition from an era when they prided themselves on reducing or eliminating less healthy lives from the insureds they covered, to an era where all insureds are offered similar ratings, the ACA introduced reinsurance and risk corridors to cover the first three years (2014 through 2016), in addition to risk adjustment transfer, which will remain in force.

The concept is relatively simple: Require all issuers to charge a flat per-dollar, per-month, per-“qualified” insured and create a pot of money with these “reinsurance premiums” that reimburses issuers for excess claims on unhealthy lives. Issuers would be reimbursed based on established terms outlined in the ACA.

Reinsurance reimburses issuers for individual claims in excess of the attachment point, up to a limit where existing reinsurance coverage would kick in. Individuals involved with these large claims may or may not be identified in advance as high-risk. The reimbursed claim may be an acute (non-chronic) condition or an accident. The individual may otherwise be low-risk.

The important aspect is that all health insurance issuers and self-insured plans contribute. By spreading the cost over a large number of individuals, the cost per individual of this reinsurance program is small to negligible. Non-grandfathered individual market plans are eligible for payments. A state can operate a reinsurance program, or CMS does on its behalf through this year.

As a backstop, the federal government put some money in the pot through 2016—just in case the pot proved inadequate to provide full reimbursement to the issuers. In a worst-case scenario, the sum of the reinsurance premiums and the federal contribution could still be inadequate, in which case the coinsurance refund rate would be set at less than 100%.

As it turned out, 2014 reinsurance premiums proved to be more than adequate, so the refund rate was 100%, and the excess funds in the pot after reimbursement were set aside and added to the pot for 2015, just in case that proves inadequate.

Reinsurance functions on this timetable through this year:

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CMS transferred approximately $7.9 billion among 437 issuers—or 100% of filed claims for 2014, as claims were lower than expected— and it has yet to release 2015 payments. The results for 2015 are coming this summer.

From the outset, states could, and would, elect to continue reinsurance, the CMS contemplated. In 2012, the CMS indicated that “states are not prohibited from continuing a reinsurance program but may not use reinsurance contribution funds collected under the reinsurance program in calendar years 2014 through 2016 to fund the program in years after 2018.”

Subsequent clarification in 2013 did not disturb state discretion. Current regulation specifies that “a state must ensure that the applicable reinsurance entity completes all reinsurance-related activities for benefit years 2014 through 2016 and any activities required to be undertaken in subsequent periods.”

One course of action going forward from 2017 and varying from state-to-state could be mandatory reinsurance enacted through state laws. Healthcare providers, issuers, reinsurers, regulators and legislators could define the health reinsurance best suited to each state’s citizens.

Reinsurers could design and manage administration of these programs possibly at a percentage of premium cost that is less than what is charged by the federal government today. While these reinsurance programs would be mandated, they could include a component of private reinsurance. For example, reinsurers could guarantee the adequacy of per-month reinsurance premiums with provisos that if these actuarially calculated rates turned out to be inadequate in any given year or month, there will be an adjustment to account for the loss in the following year. Conversely, if those rates turn out to be too high, 90% or more is set aside in an account for use in the following year. This way, reinsurers could participate by providing a private sourced solution to adverse claims.

Risk Corridors

Risk corridors apply to issuers with Qualified Health Plans (exchange certified plans) and facilitate transfer payments. The CMS noted: “Issuers whose premiums exceed claims and other costs by more than a certain amount pay into the program, and insurers whose claims exceed premiums by a certain amount receive payments for their shortfall.” Technically, “risk corridors mean any payment adjustment system based on the ratio of allowable costs of a plan to the plan’s target amount,” as the CMS designated.

Issuer claims of $2.87 billion exceeded contributions, so the CMS transferred $362 million among issuers; that is, a 12.6% proration or a $2.5 billion shortfall in 2014.

Risk corridors are politically contentious. Sen. Marco Rubio (R-Florida) likened risk corridors to bailouts. The HHS acknowledged it will “explore other sources of funding for risk corridors payments, subject to the availability of appropriations… includ[ing] working with Congress on the necessary funding for outstanding risk corridors payments.” And, a knowledgeable analyst, Dr. David Blumenthal, noted that risk corridors are not bailouts.

Going forward, evaluations of risk corridors will demand due diligence. Several health exchanges failed from any number of factors—from too little capital for growth experienced, inadequate pricing, mismanagement or risk corridor payments.

Whether innovation can yield effective risk corridors or whether risk corridors will simply fade out as transitional 2014-2016 regulation will depend on institutional and industry participants. Risk corridors did not score unalloyed approbation among sources.

Risk Adjustment: Permanent Element of ACA

Risk adjustment remains in force and impels issuers with healthier enrollees to offset some costs of issuers with sicker ones in specific states and markets and of markets as a means toward promoting affordable health care choices by discouraging cherry picking healthier enrollees.

The HHS transferred approximately $4.6 billion for risk adjustment among issuers for 2014.

At first blush, one might postulate that risk adjustment does the job and that reinsurance and risk corridors could just as reasonably fade out. There is some logic to that argument.

On the other hand, state or regional level reinsurance could make up for risk adjustment shortfalls. In some instances, risk adjustment seems to be less friendly to issuers that take on higher-risk individuals, rather than rewarding high tech issuers and providers with back office capabilities coding claims in such a way as to tactically game risk adjustment.

Evaluating and cultivating these opportunities are timely amid the uncertainties of the presidential and congressional elections that may yield executive and legislative lawmakers intent on undoing ACA provisions, starting with risk corridors. Such legislation could produce losses for issuers and reinsurers.

Nelson A. Rockefeller Precedent

In 1954, then-Undersecretary of Health Education and Welfare Nelson A. Rockefeller proposed reinsurance as an incentive for insurers to offer more health insurance. S 3114, A Bill to Improve the Public Health by Encouraging More Extensive Use of the Voluntary Prepayment Method in the Provision of Personal Health Services, emerged in the first Eisenhower administration to enact a federally funded health reinsurance pool. Rockefeller intended the reinsurance as a means toward an end, what would eventually be dubbed a “third way” among proponents of national health insurance. President Truman and organized labor championed the approach into the mid-’50s. So did the Chamber of Commerce and congressional Republican adversaries of the New Deal and Fair Deal, who were chaffing to undo Social Security as quickly as they could. The American Medical Association also supported this third way because it opposed federal healthcare reinsurance as an opening wedge for socialized medicine. Despite limiting risk and offering new products, insurers demurred because of comfort zones with state regulators and trepidation about a federal role.

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Nelson A. Rockefeller, then-undersecretary of the Department of Health, Education and Welfare, presenting a federally funded health reinsurance plan, 1954.
Source: Department of Health Education and Welfare—now Health and Human Services

Rockefeller’s health reinsurance plan would “achieve a better understanding of the nation’s medical care problem, of the techniques for meeting it through voluntary means, and of the actuarial risks involved,” HEW Secretary Oveta Culp Hobby testified to a Senate subcommittee in 1954.

Rockefeller’s health reinsurance plan did not make it through the House. Organized labor decried it as too little, the AMA said it was too intrusive. Upon hearing news of the House vote, a frustrated Dwight Eisenhower blistered to reporters, “The people that voted against this bill just don’t understand what are the facts of American life,” according to Cary Reich in The Life of Nelson A. Rockefeller 1908-1958. “Ingenuity was no match for inertia,” Rockefeller biographer Richard Norton Smith remarked of industry and labor interests in those hard-wired, central-switched, mainframe times.

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“’It’s déjà vu all over again’ like Yogi Berra,” said one insurance commissioner immersed in the ACA on hearing Ike’s quote.

Source: Yogi Berra Museum & Learning Center

The idea of national health insurance went nowhere despite initiatives by Sen. Edward M. Kennedy (D-Massachusetts) in the late ’70s and President Bill and First Lady Hillary Clinton roughly 20 years ago, until Congress legislated Obamacare.

Innovative, Transparent Technologies Can Deliver Results

Nowadays, more than 60 years after Rockefeller’s attempt, innovative information technologies can get beyond these legislative and regulatory hurdles. Much of the data and networking is at hand. Enrollee actuarial risks, coverage actuarial values, utilization, local area costs of business and cost-sharing impacts on utilization are knowable in current systems. Broadband deployment and information technology innovations drive customer acquisition and information management costs ever lower each succeeding day. Long-term efficiencies for reinsurers, insurers, carriers, regulators, technology innovators and state regulators await evaluation and development.

Reinsurance Going Forward From 2017

So, if state reinsurance programs can provide benefits, what should they look like, and how should they be delivered?

For technology innovators—such as GoogleMicrosoftOverstockZebra or CoverHound—these opportunities with reinsurance would apply their expertise in search, processing and matching technologies to crucial billion-dollar markets and functions. The innovators hope to achieve successes more readily than has occurred through retail beachheads in motor vehicle and travel insurance and credit cards and mortgages. One observer noted that some of those retail initiatives faltered due to customer experience shortfalls and trust and privacy concerns. Another points out that insurers view Amazon, Apple and Netflix as setting new standards for customer experiences and expectations that insurers will increasingly have to match or supersede. A news report indicated that Nationwide already pairs customer management data with predictive analytics to enhance retention.

Reinsurers including Berkshire Hathaway, Munich Reinsurance Company, Swiss Reinsurance Company Limited and Maiden Holdings could rationalize risks and boost earnings while providing a wealth of risk management information, perhaps on a proprietary basis.

For issuers, state-of-the-art transparent solutions improve the current system by enabling issuers to offer more products and services and becalm more ferocious industry adversaries while lowering risks and extending markets. Smaller, nimbler issuers may provide more innovative solutions and gain market share by providing the dual objectives of better health outcomes with lower costs.

For regulators, innovative, timely information sustains the indispensability of state regulators ensuring financial soundness and legal compliance—while allowing innovators to upgrade marketplace and regulatory systems, key regulatory goals that Iowa’s insurance commissioner, Nick Gerhart, pointed out recently. Commissioner Gerhart envisions regulators as orchestra conductors, acknowledging that most insurance regulatory entities are woefully understaffed to design or operate such reinsurance programs themselves, but they will, and they can lead if the participants can provide turnkey capabilities.

Think of health insurance and reinsurance as generational opportunities for significant innovation rather like the Internet and email. When the Department of Defense permitted the Internet and email to evolve to civilian markets from military capabilities in the 1980s, the DOD initially approached the U.S. Postal Service. Senior Post Office management said it welcomed the opportunity to support email: All users need do is email correspondence to recipients’ local post offices by nine p.m. for printing, enveloping, sorting and letter-carrier delivery the following day.

Similarly, considerable opportunities chart innovative pathways for state and regional health reinsurance for 2017 and beyond.

One path, emulating the post office in the ’80s, keeps on coding and bemoans a zero sum; it would allow the existing programs to fade away and will respond to whatever the president and Congress might do.

Another path lumps issuer health reinsurance as an incumbent reinsurer service without addressing the sustainability of state health exchanges or, indeed, any private health insurers in the absences of risk spreading with readily available information technologies.

The approach suggested here—mandated state health reinsurance—innovates to build sustainable futures. Enabling technologies empower all stakeholders to advance private and public interests through industry solutions advancing affordable healthcare.

Q4 Economic and Investment Outlook

Although it may not seem like it, in the second quarter of this year the U.S. economy passed into the beginning of its seventh year of expansion. In the 158 years that the National Bureau of Economic Research (the arbiters of “official” U.S. economic cycles) has been keeping records, ours is now the fifth-longest economic cycle, at 75 months. For fun, when did the longest cycles occur, and what circumstances characterized them? Is there anything we can learn from historical perspective about what may lie ahead for the current cycle?

The first cycle longer than the current, by only five months, is the 1938-1945 U.S. economic expansion cycle. Of course, this was the immediate post-Depression recovery cycle. What preceded this cycle, from 1933-1937, was the bulk of FDR’s New Deal spending program, a program that certainly rebuilt confidence and paved the way for a U.S. manufacturing boom as war on European and Japanese lands destroyed their respective manufacturing capabilities for a time. More than anything, the war-related destruction of the industrial base of Japan and Europe was the growth accelerant of the post-Depression U.S. economy.

In historically sequential order, the U.S. economy grew for 106 months between 1961 and 1970. What two occurrences surrounded this economic expansion that were unique in the clarity of hindsight? A quick diversion. In 1946, the first bank credit card was issued by the Bank of Brooklyn, called the “Charge-It” card. Much like American Express today, the balance needed to be paid in full monthly. We saw the same thing when the Diners Club Card became popular in the 1950s. But in 1958, both American Express and Bank of America issued credit cards to their customers broadly. We witnessed the beginning of the modern day credit culture in the U.S. economic and financial system. A support to the follow-on 1961-1970 economic expansion? Without question.

Once again in the 1960s, the influence of a major war on the U.S. economy was also apparent. Lyndon Johnson’s “guns and butter” program increased federal spending meaningfully, elongating the U.S. expansion of the time.

The remaining two extended historical U.S. economic cycles of magnitude (1982-1990, at 92 months, and 1991-2001, at 120 months) both occurred under the longest bull market cycle for bonds in our lifetime. Of course, a bull market for bonds means interest rates are declining. In November 1982, the 10-year Treasury sported a yield of 10.5%. By November 2001, that number was 4.3%. Declining interest rates from the early 1980s to the present constitute one of the greatest bond bull markets in U.S. history. The “credit cycle” spawned by two decades of continually lower interest rates very much underpinned these elongated growth cycles. The question being, at the generational lows in interest rates that we now see, will this bull run be repeated?

So fast-forward to today. What has been present in the current cycle that is anomalistic? Pretty simple. Never in any U.S. economic cycle has federal debt doubled, but it has in the current cycle. Never before has the Federal Reserve “printed” more than $3.5 trillion and injected it into U.S. financial markets, until the last seven years. Collectively, the U.S. economy and financial markets were treated to more than $11 trillion of additional stimulus, a number that totals more than 70% of current annual U.S. GDP. No wonder the current economic cycle is pushing historical extremes in terms of longevity. But what lies ahead?

As we know, the U.S. Fed has stopped printing money. Maybe not so coincidentally, in recent months macroeconomic indicators have softened noticeably. This is happening across the globe, not just in the U.S. As we look forward, what we believe most important to U.S. economic outcomes is what happens outside of the U.S. proper.

Specifically, China is a key watch point. It is the second-largest economy in the world and is undergoing not only economic slowing, but the very beginning of the free floating of its currency, as we discussed last month. This is causing the relative value of its currency to decline against global currencies. This means China can “buy less” of what the global economy has to sell. For the emerging market countries, China is their largest trading partner. If China slows, they slow. The largest export market for Europe is not the U.S., it’s China. As China slows, the Euro economy will feel it. For the U.S., China is also important in being an end market for many companies, crossing industries from Caterpillar to Apple.

In the 2003-2007 cycle, it was the U.S. economy that transmitted weakness to the greater global economy. In the current cycle, it’s exactly the opposite. It is weakness from outside the U.S. that is our greatest economic watch point as we move on to the end of the year. You may remember in past editions we have mentioned the Atlanta FED GDP Now model as being quite the good indicator of macroeconomic U.S. tone. For the third quarter, the model recently dropped from 1.7% estimated growth to 0.9%. Why? Weakness in net exports. Is weakness in the non-U.S. global economy the real reason the Fed did not raise interest rates in September?

Interest Rates

As you are fully aware, the Fed again declined to raise interest rates at its meeting last month, making it now 60 Fed meetings in a row since 2009 that the Fed has passed on raising rates. Over the 2009-to-present cycle, the financial markets have responded very positively in post-Fed meeting environments where the Fed has either voted to print money (aka “Quantitative Easing”) or voted to keep short-term interest rates near zero. Not this time. Markets swooned with the again seemingly positive news of no rate increases. Very much something completely different in terms of market behavior in the current cycle. Why?

We need to think about the possibility that investors are now seeing the Fed, and really global central bankers, as to a large degree trapped. Trapped in the web of intended and unintended consequences of their actions. As we have argued for the past year, the Fed’s greatest single risk is being caught at the zero bound (0% interest rates) when the next U.S./global recession hits. With declining global growth evident as of late, this is a heightened concern, and that specific risk is growing. Is this what the markets are worried about?

It’s a very good bet that the Fed is worried about and reacting to the recent economic slowing in China along with Chinese currency weakness relative to the U.S. dollar. Not only are many large U.S. multi-national companies meaningful exporters to China, but a rising dollar relative to the Chinese renminbi is about the last thing these global behemoths want to see. As the dollar rises, all else being equal, it makes U.S. goods “more expensive” in the global marketplace. A poster child for this problem is Caterpillar. Just a few weeks ago, it reported its 33rd straight month of declining world sales. After releasing that report, it announced that 10,000 would be laid off in the next few years.

As we have explained in past writings, if the Fed raises interest rates, it would be the only central bank on Earth to do so. Academically, rising interest rates support a higher currency relative to those countries not raising rates. So the question becomes, if the Fed raises rates will it actually further hurt U.S. economic growth prospects globally by sparking a higher dollar? The folks at Caterpillar may already have the answer.

Finally, we should all be aware that debt burdens globally remain very high. Governments globally have borrowed, and continue to borrow, profusely in the current cycle. U.S. federal debt has more than doubled since 2009, and, again, we will hit yet a U.S. government debt ceiling in December. Do you really think the politicians will actually cap runaway debt growth? We’ll answer as soon as we stop laughing. As interest rates ultimately trend up, so will the continuing interest costs of debt-burdened governments globally. The Fed is more than fully aware of this fact.

In conjunction with all of this wonderful news, as we have addressed in prior writings, another pressing issue is the level of dollar-denominated debt that exists outside of the U.S.. As the Fed lowered rates to near zero in 2008, many emerging market countries took advantage of low borrowing costs by borrowing in U.S. dollars. As the dollar now climbs against the respective currencies of these non-dollar entities, their debt burdens grow in absolute terms in tandem with the rise in the dollar. Message being? As the Fed raises rates, it increases the debt burden of all non-U.S. entities that have borrowed in dollars. It is estimated that an additional $7 trillion in new dollar-denominated debt has been borrowed by non-U.S. entities in the last seven years. Fed decisions now affect global borrowers, not just those in the U.S.. So did the Fed pass on raising rates in September out of concern for the U.S. economy, or issues specific to global borrowers and the slowing international economies? For investors, has the Fed introduced a heightened level of uncertainty in their decision-making?

Prior to the recent September Fed meeting, Fed members had been leading investors to believe the process of increasing interest rates in the U.S. was to begin. So in one very real sense, the decision to pass left the investment world confused. Investors covet certainty. Hence a bit of financial market turbulence in the aftermath of the decision. Is the Fed worried about the U.S. economy? The global economy? The impact of a rate decision on relative currency values? Is the Fed worried about the emerging economies and their very high level of dollar-denominated debt? Because Fed members never clearly answer any of these questions, they have now left investors confused and concerned.

What this tells us is that, from a behavioral standpoint, the days of expecting a positive Pavlovian financial market response to the supposedly good news of a U.S. Fed refusing to raise interest rates are over. Keeping rates near zero is no longer good enough to support a positive market sentiment. In contrast, a Fed further refusing to raise interest rates is a concern. Let’s face it, there is no easy way out for global central bankers in the aftermath of their unprecedented money printing and interest rate suppression experiment. This, we believe, is exactly what the markets are now trying to discount.

The U.S. Stock Market

We are all fully aware that increased price volatility has characterized the U.S. stock market for the last few months. It should be no surprise as the U.S. equity market had gone close to 4 years without having experienced even a 10% correction, the third-longest period in market history. In one sense, it’s simply time, but we believe the key question for equity investors right now is whether the recent noticeable slowing in global economic trajectory ultimately results in recession. Why is this important? According to the playbook of historical experience, stock market corrections that occur in non-recessionary environments tend to be shorter and less violent than corrections that take place within the context of actual economic recession. Corrections in non-recessionary environments have been on average contained to the 10-20% range. Corrective stock price periods associated with recession have been worse, many associated with 30-40% price declines known as bear markets.

We can see exactly this in the following graph. We are looking at the Dow Jones Global Index. This is a composite of the top 350 companies on planet Earth. If the fortunes of these companies do not represent and reflect the rhythm of the global economy, we do not know what does. The blue bars marked in the chart are the periods covering the last two U.S. recessions, which were accompanied by downturns in major developed economies globally. As we’ve stated many a time, economies globally are more linked than ever before. We live in an interdependent global world. Let’s have a closer look.

If we turn the clock back to late 1997, an emerging markets currency crisis caused a 10%-plus correction in global stock prices but no recession. The markets continued higher after that correction. In late 1998, the blowup at Long Term Capital Management (a hedge fund management firm implosion that caused a $3.6 billion bailout among 16 financial institutions under the supervision of the Fed) really shook the global markets, causing a 20% price correction, but no recession, as the markets continued higher into the early 2000 peak. From the peak of stock prices in early 2000 to the first quarter of 2001, prices corrected just more than 20% but then declined yet another 20% that year as the U.S. did indeed enter recession. The ultimate peak to trough price decline into the 2003 bottom registered 50%, quite the bear market. Again, this correction was accompanied by recession.

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The experience from 2003 to early 2008 is similar. We saw 10% corrections in 2004 and 2006, neither of which were accompanied by recession. The markets continued higher after these two corrective interludes. Late 2007 into the first quarter of 2008 witnessed just shy of a 20% correction, but being accompanied by recession meant the peak-to-trough price decline of 2007-2009 totaled considerably more than 50%.

We again see similar activity in the current environment. In 2010, we saw a 10% correction and no recession. In 2011, we experienced a 20% correction. Scary, but no recession meant higher stock prices were to come.

So we now find ourselves at yet another of these corrective junctures, and the key question remains unanswered. Will this corrective period for stock prices be accompanied by recession? We believe this question needs to be answered from the standpoint of the global economy, not the U.S. economy singularly. For now, the jury is out, but we know evidence of economic slowing outside of the U.S. is gathering force.

As you may be aware, another U.S. quarterly earnings reporting season is upon us. Although the earnings results themselves will be important, what will be most meaningful is guidance regarding 2016, as markets look ahead, not backward. We’ll especially be interested in what the major multinationals have to say about their respective outlooks, as this will be a key factor in assessing where markets may be moving from here.