The rationale for investing in life sciences and biotechnology and the urgent need for capital market tools for this sector

 

The 1970s were a dismal period for finance. There were two oil shortages (1973 and 1979), extremely high interest rates and terribly slow GDP growth (stagflation). The Dow Jones Industrial Average was 750 on 1/1/70 and 900 on 1/1/81. The yield on the 30 Year Treasury Bond was 15% in 1981 (it is 1.3% today). The unemployment rate peaked at 12% in 1981.

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Individuals were not investing their money. In fact, the savings rate for the United States reached an all-time high of 13% in 1981. Two years earlier, on August 13, 1979, an article appeared in Business Week, the most popular financial magazine at the time, entitled “The Death of Equities.” In cogent logical terms, it explained why there could not be a bull market in stocks for an exceptionally long time.

 

You can read the article here:

https://ritholtz.com/1979/08/the-death-of-equities/

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In fact, an eighteen-year bull market began in 1982 and lasted until 2000. The Dow went from 1000 in 1982 to over 10,000 in 2000. More wealth was created in that 18-year period than in the entire history of the United States.

What did that article miss? Plenty. But, most importantly, it missed the advent of the personal computer and the coming-of-age of the baby boom generation. Apple Computer went public in 1980 ushering in the Information Age. In 1980, the U.S. was still a manufacturing-based country.

 

Here is a list of the 100 largest companies in the United States in 1980: https://archive.fortune.com/magazines/fortune/fortune500_archive/full/1980/

 

Over the next 20 years are economy was completely transformed.

 

Here is the list for 2000:

https://money.cnn.com/magazines/fortune/fortune500_archive/full/2000/

 

And here is today’s list:

https://www.corporateinformation.com/Top-100.aspx?topcase=b

 

The transition from manufacturing to the information age is complete. Technology companies completely dominate our economy today. They have been the source of great improvements in quality of life and had an even greater impact in terms of creation of wealth.

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The key point is the information age was born at a time of great distress in the economy. The elements of the technology were clearly in place but the capital formation for the industry was lacking. But while we were suffering two important changes were taking place. The baby boom generation was born between 1946 and 1964 and numbered 76 million people (now about 72 million). The oldest boomers turned 35 years-of-age in 1981. That is the age at which individuals start to experience peak earnings and develop discretionary capital. The peak years for stock ownership are between 35 and 55 years-of-age. 12,000 boomers turned 35 every day for the next 18 years. (interesting to note the bull market ended in 2000 right after the last boomers turned 35). And, because of the passage of the Employment Retirement Income Security Act of 1974 we created the retirement accounts that today contain $15 trillion of assets. This law ushered in the mutual fund industry which got going in earnest around 1980 and today controls nearly $20 trillion in assets.

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A perfect storm developed. A massive number of new investors, wonderful new technology was ready for commercialization and professional asset managers were available to invest in it on behalf of a willing public.

 

But this was only the beginning. The new computing and telecommunications technologies were put to work in the financial markets allowing for investing not only in a company’s equity but also directly in its products. In 1983, the first oil futures contracts were traded. The first credit-default-swaps were created in 1994. Over the past 25 years, the derivatives market has exploded to a notional value of $650 trillion.

 

This report from the Treasury Department explains the critical role of derivatives in the U.S. economy:

https://www.treasury.gov/press-center/press-releases/Documents/A-Financial-System-Capital- Markets-FINAL-FINAL.pdf

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The savings rate today has now exceeded the record set in 1981:

https://www.cnn.com/2020/04/30/investing/savings-rate-federal-reserve/index.html

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As in 1981, this is fuel for the next bull market.

 

The number of millennials now exceeds the number of baby boomers. And their age range is 23 to 38 years-of-age, about where the boomers were in 1981. In other words, most are not investors today, but they will start now. 15,000 people will turn 35 every day for the next 16 years.

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https://www.pewresearch.org/fact-tank/2020/04/28/millennials-overtake-baby-boomers-as- americas-largest-generation/

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There were mutual funds in 1981, there are Exchange Traded Funds (ETFs) in 2020. In March 2020, after 12 years of deliberation, the Securities and Exchange Commission granted approval for Non-transparent actively managed ETFs (ANTs). This will allow professionals to manage portfolios for investors. This will create a new wave of asset accumulation for wealth managers. It is likely that several trillion dollars will flow into ANTs in the next ten years:

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https://www.pionline.com/industry-voices/commentary-how-non-transparent-etfs-will- disrupt-fund-industry

 

The Opportunity for the Intelligent Medicine Exchange (the IMX):

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The list of the largest companies in the United States today is replete with technology. These are the most powerful companies in the world. The same would have been said of the companies on the 1980 list. Clearly, technology as an industry is as mature today as manufacturing was in 1980. Before the pandemic, life science companies had been making great strides and creating many successes. But these companies were toiling in the shadows of the technology giants. The pandemic has cleared the air in more ways than one.

 

Many Wall Street pundits and journalists have already claimed we have entered the Biotech Age:

https://www.wsj.com/articles/a-spur-to-the-biotech-century-ahead-11585238908

 

The biotech revolution had been well underway. Gene therapies are being developed and commercialized for diseases that were considered undruggable ten years ago. The business models of the major pharmaceutical companies are transforming from the blockbuster drugs for chronic treatment of symptoms to precision medicine that mitigates and sometimes cures disease. The new pharmaceutical company model is many drugs with smaller profit margins instead of few extremely profitable drugs. But the industry has no capital market tools to handle the transition or manage the new business. While the total value of financial derivatives is now more than $700 trillion and none of that relates to healthcare. In the Treasury Department report about the economy (https://www.treasury.gov/press-center/press- releases/Documents/A-Financial-System-Capital-Markets-FINAL-FINAL.pdf) the word healthcare is not mentioned once. The capital markets have been immersed in the Information Age and have not yet focused on what’s next.

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The history of derivatives in the United States begins with farm commodities in the 1830s. Farmers entered contracts for the following growing season so they would not have to haul their crops to market without knowing if they could be sold. Based upon that legacy, derivative markets have always been based upon a cash market or a deliverable item (a bushel of wheat or a barrel of oil). But over time, the markets have expanded and most contracts in derivatives market are settled for cash before the delivery date. Many derivative instruments have been created that can only be settled for cash (volatility futures or Consumer Price Index Futures).

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At the same time, electronic health records (EHR) have given us virtually real-time data that allows us to precisely measure the cost of various treatments, procedures, and chronic care. Data aggregators collect this information from payers and license it to the marketplace. We can know the cost of popular surgical procedures and the annual cost of treating various chronic illnesses. We can know how much is spent on individual drugs. This data can be turned into financial products (options, futures, swaps and forwards). An example: an orthopedic hospital or group of hospitals can create a futures contract that represents 100 hip replacements. An insurance company can buy that contract. The hospital can then list additional contracts on an exchange, and they can trade in the open market. Indexes can be created that represent the cost of chronic care for various illnesses and capital market tools can be built based upon those indexes. The financial markets have not realized this development which has only happened over the past ten years. We have the ability to create hundreds of financial instruments to allow for the financial management of healthcare just as we manage energy and agriculture.

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But a marketplace for these kind of instruments does not exist. And most of the instruments do not exist either. This market and these products will be novel. But they are no more novel than a financial futures market in 1980 or an oil futures market in 1983. A futures market is a two- sided market. There is always a buyer and a seller. Consider the financial futures market which was created in 1976 and became commercially viable in 1980. Prior to that market, the interest rate market was one-sided. The banks set the rates. The futures market evidenced future demand and the price the customer was willing to pay. Now the banks could see the demand and they competed on price. Over the last 40 years, interest rates have fallen from mid-double digits to where they are today.

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Oil was a one-sided market until a futures exchange was created in 1983. Oil, with few exceptions, has declined in price ever since. Look at bitcoin which was near $65,000 (again a one-sided market). A futures market was created last year, and the price fell by more than 50%.

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Healthcare is a one-sided market. The payers set the terms. Creating a futures market gives equal footing to the providers and ultimately the patients. The entire healthcare industry recognizes it is vulnerable to price shocks from new expensive drugs. A futures market can alleviate that by allowing manufacturers to sell into a futures market before the drugs are even manufactured. This will greatly reduce the cost of capital. The creation of a complete derivatives market for healthcare will allow for the industry to create more products with smaller margins with a much lower capital cost. They can be more profitable than ever.

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Healthcare is 20% of the $20 trillion GDP of the United States. The market cap of the Chicago Mercantile Exchange (CME) is $80 billion. The CME has no healthcare-related instruments. A new exchange clearly has the potential to be worth $20 billion or more. The oil price is down 80% since the creation of a futures market. Interest rates are down 90% since the creation of a futures market. Food remains affordable because of a futures market. If healthcare costs dropped by just 25%, that would be a $1 trillion dividend to society which, subject to the multiplier effect, would be worth $4 trillion in GDP. At the same time, this very market, by lowering the cost of capital significantly, will allow for many more lifesaving and life-extending products adding a good deal more to GDP. There are only two paths to economic expansion: participation and productivity. Healthcare is the great accelerator of both.

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IMX is uniquely positioned because of its mission and the collected talent residing within. We know both payers and providers realize they can benefit from such tools. Healthcare needs to be de-risked to reduce the cost of capital. Doing so will spare the industry from government regulation and price controls.