Originally published in the CokerConnection newsletter.  Reprinted with permission from the Coker Group.

By Mark Reiboldt, Director, Coker Capital Partners

It has been a common argument that the healthcare sector is particularly resilient against economic downturns, primarily based on the justification that even in tough economic times, patients still need healthcare services.  While the idea that patients still need healthcare, regardless of economic status, is true, this by no means should lead us to think that healthcare as a market sector is recession-proof.  Not only is the term "recession-proof" a myth in and of itself (as far too many people have learned in the past year, no sector is completely shielded from recession), but the idea that healthcare is the ideal staple during bear markets is being debunked on a daily basis.  I wrote some of my earlier thoughts on this a few weeks ago; however, in thinking on the subject further, I have realized that there are some very clear economic and financial arguments that disprove the myth of healthcare's resiliency.  I will also be putting this discussion into a podcast, which will be published here at the CokerConnection, and for more details when listening to the podcast, feel free to follow along in my PowerPoint presentation.  Ultimately, there are three core reasons why healthcare is not recession-proof, which I will outline below.  

The first reason as to why healthcare is not recession-proof is in response to the idea that consumer demand for healthcare services does not decline during economic downturns, as it does with other market sectors (i.e., retail, etc).  While I understand the rationale for such an assumption, the data shows that this is not an accurate statement.  According to data from the Kaiser Foundation, 36% of patients are postponing needed care, while another 36% are skipping tests, exams and other healthcare services outright.  These trends grew by 7% between the second and third quarters of 2008 (source).  So, while patient demand may not completely fade away as the markets for plasma televisions and SUV's have seemed to do, there's absolutely no indication that demand for healthcare services will remain at their pre-recession levels.

The second key reasoning for healthcare's vulnerability to bear markets and economic downturns is perhaps not as straightforward as the first, but this is probably one of the most significant factors that investors in the healthcare sector need to understand.  When the common consumer tends to think of healthcare, they think about the relationship between the patient and their doctor.  Unfortunately, healthcare as a segment of the overall financial markets includes far more than this picture.  Indeed, the patient-doctor dynamic only represents a relatively small portion of the actual flow of funds within the healthcare sector, even though that dynamic is the cornerstone of the industry altogether.  Or, worded differently, even though the healthcare industry doesn't exist without the relationship between the patient and doctor, the actual transaction of such only represents a very small portion of the healthcare market. 

So, what makes up most of the healthcare sector?  All of the companies contributing to that doctor-patient dynamic, such as medical device companies, biotech and pharma (although pharma is often considered a separate market sector altogether), healthcare services and management companies, professional services firms, healthcare real estate firms (also often tracked in real estate markets), health insurance firms (also often tracked in financial/insurance sector), technology firms, and generally any firm that contributes to the flow of the healthcare delivery system.  As I have indicated, many of these firms have alternative focus areas, so a portion (or all) of their revenues may be tracked in other sectors; however, it is these ancillary companies that represent a bulk of the healthcare market sector.  

According to this data from the Kaiser Foundation, you can see that basic healthcare services only represents a percentage of the overall market.  If you were to break down the data further by public companies within the healthcare sector and traded on public exchanges, you would find even a wider gap between patient-doctor services and ancillary healthcare firms.  What this ultimately says is that the healthcare market sector is not as decoupled as we might think, primarily because such a little portion of the overall market is dependent upon that doctor-patient dynamic that most people assume drive the industry's flow of funds.  

And finally, the third reason as to why the healthcare industry is not recession-proof is probably the most challenging for people to grasp, yet it is no doubt the most important.  Healthcare is probably the best example of a truly inefficient marketplace.  The healthcare sector almost acts as a cross between a socialized market and a market wherein monopolistic pricing drives an imbalance between supply and demand.  This reasoning relates back to the second one, because one of the problems in the healthcare sector is that the stakeholders at the bottom of the chain are the most critical to the sector's existence (i.e., the patient and provider).

I won't go into a diatribe about third-party payers, except to say that one of the key sources of economic efficiency within healthcare is the fact that insurance companies control the market pricing and market access.  So, what happens is that prices and access to the marketplace (key components of the microeconomic flow of funds in any sector) are being determined by supply and demand.  Insurance companies set providers' prices through limited negotiated reimbursement, in addition to restricting consumer access to the marketplace through their limited coverage.  Needless to say, this is not an efficiently operating market sector. 

Ultimately, there are a number of reasons why healthcare is not as resilient as we once thought to economic downturn.  Indeed, there are many reasons as to why our healthcare system poses a major systemic threat for the next economic crisis that our country will likely experience; however, there are some steps that can be taken to limit some of the inefficiencies within the market, while improving healthcare's resiliency within the overall financial markets.  As a strong believer in the power of the free-markets, I believe that once we address those inefficiencies, the benefits will trickle down throughout the financial markets, ultimately improving healthcare's strength against general market volatility.

Editor's note:  this article was first published on the author's blog, Mark to Market, at www.reiboldt.com