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Shares of Cigna Group and Humana Inc. moved lower in the afternoon cash session following the report from The Wall Street Journal that the two healthcare companies are engaged in merger talks. 

According to people familiar with the discussions, the merger is a stock and cash deal that could be finalized by the end of the year. If talks don’t fall apart, the merger will combine Cigna’s market cap of about $80 billion and Humana’s of about $63 billion and create a new powerhouse in the health insurance industry to challenge the market dominance of UnitedHealth Group. 

Merging would allow the combined entity of Cigna/Humana to compete with industry giants UnitedHealth and CVS, propelling them into the top tier of integrated healthcare firms. Last year, Cigna’s revenues were $181 billion, which could combine its large pharmacy-benefit unit, which manages drug plans, and its strength in commercial insurance with Humana’s rapidly expanding Medicare segment, something Cigna has been pursuing. 

Humana, having generated around $93 billion in revenue last year, is the second-largest Medicare insurer, trailing only UnitedHealth. In contrast, Cigna’s current Medicare Advantage division is significantly smaller. Additionally, Humana’s substantial home-health business and its expanding network of primary-care clinics could greatly enhance Cigna’s Evernorth health services arm.

However, the proposed merger is expected to encounter antitrust challenges in an industry where regulators have previously blocked the last two significant mergers. This includes a proposed union between Cigna and Anthem, now known as Elevance Health Inc.

“A possible Cigna-Humana merger as reported by the Wall Street Journal would make strategic sense via cross benefits between the pharmacy-benefit manager (PBM) and the Medicare-focused insurer, but could face regulatory hurdles. Even if an agreement is reached, the odds of the deal closing are questionable given the size of the combination and increased federal scrutiny of PBMs and health insurers,” Bloomberg’s BI analyst Glen Losev wrote in a report. 

Shares of Cigna are down 6.5%, while shares of Humana are down 2.7%. 

A mega-deal between Cigna and Humana would be a welcoming sign for the merger and acquisition markets amid high-interest rates crushing deal flow this year. It would likely be the biggest deal of the year, exceeding Exxon Mobil’s $60 billion agreement to acquire Pioneer Natural Resources last month. 

Authored by Michael Lebowitz via RealInvestmentAdvice.com,

“For me context is the key – from that comes the understanding of everything.” -Abstract Artist Kenneth Noland. That holds true for us as well! Proper context is required to appreciate better if market narratives accurately describe the truth.

For example, in Moody’s recent decision to put the United States government on credit watch negative, the context driving their decision is not necessarily run-away deficit spending, as most investors believe. They made their decision within the context of high-interest rates.   

In the context of higher interest rates, without effective fiscal policy measures to reduce government spending or increase revenues, Moody’s expects that the US’ fiscal deficits will remain very large, significantly weakening debt affordability.

Make no mistake, large fiscal deficits and accompanying Treasury debt issuance are a problem. However, the downgrade is directly attributable to the level of interest rates. The concern will vanish quickly, regardless of debt issuance patterns, if interest rates fall appreciably.

At zero percent interest rates, Uncle Sam, or for that matter, you and I, can borrow trillions upon trillions of dollars and not have to worry about making good on the interest payments.

Let’s provide context and facts to assess better if the latest bond market bear narrative claiming that higher yields are a direct function of massive Treasury debt issuance holds water.

Surging Government Interest Rate Expense

Our article, The Government Can’t Afford Higher for Longer, discusses how higher interest rates are and will potentially affect federal interest expenses. To wit:

Total federal interest expenses should rise by approximately $226 billion over the next twelve months to over $1.15 trillion. For context, from the second quarter of 2010 to the end of 2021, when interest rates were near zero, the interest expense rose by $240 billion in aggregate. More stunningly, the interest expense has increased more in the last three years than in the fifty years prior.

Let’s reread the last line- “More stunningly, the interest expense has increased more in the last three years than in the fifty years prior.”

Since 2020, the federal debt has risen by $9 trillion. In the fifty years prior, federal debt grew by approximately $24 trillion. $9 trillion is significant and fiscally imprudent. However, the primary culprit behind the sharp upturn in the nation’s interest expense is interest rates, not debt issuance.

The graph below shows that the weighted average interest rate on all government debt has increased by about 1% over the last three years. If interest rates had not risen, today’s interest expense would be a little over $600 billion, not $1 trillion as it is. In that scenario, it would only be up by about $50 billion from the eve of the pandemic.

The Bear Narrative Du Jour

A popular bond bear market narrative claims exceptional debt issuance is behind the soaring bond yields. Many bond bears believe that even if inflation falls back to the Fed’s 2% goal, interest rates will stay high due to current levels of debt issuance.  

In 2020, the government’s debt outstanding grew by $5 trillion, including a whopping $3.25 trillion in the second quarter alone. In 2020, the average ten-year UST yield was 0.92%. During the second quarter, when the market was digesting years’ worth of issuance in three months, the average yield was 0.69%.  

Apparently, tremendous debt issuance was not problematic in the bond markets then. Might the level of yields and the ensuing interest expense matter a lot more than the amount of debt issuance? 

Japan adds credence to that thought. It has a debt-to-GDP ratio of more than double that of the U.S., yet even with inflation rising, it has interest rates of 1% and lower.

Massive Debt Issuance Put Into Context

We searched Twitter for “massive Treasury issuance,” and the quotes below, all from the last six months, are just the tip of the iceberg.

The following graph shows quarterly and annual Treasury debt issuance. The bulge in 2020 and 2021 is prominent. But is the massive debt issuance we are currently experiencing that different from pre-pandemic periods?

Again, proper context is needed to answer our question. Since 2020, the economy has grown by about $5.5 trillion, about 25%. Over that period, the government’s tax receipts have increased by 33%.  

The graph below shows the longer-term increase in the federal debt-to-GDP ratio and the surge occurring during 2020. However, look at the recent trend, which we blow up in the second graph. It seems that “massive” debt issuance is not problematic in the context of the size of the economy and the tax base.

The Real Problem

As Moody’s notes, the problem is not a deficit or a debt issuance problem. It’s an interest rate problem. Regardless of logic, markets often trade on false narratives for short periods. So, let’s assume the narrative of massive debt issuance continues to weigh on the bond market. What might the Treasury or Fed do to lower rates?

The first thing to consider is that each day interest rates are high, the interest expense will keep rising. Treasury debt with low interest rates matures and is refunded with higher interest-rate debt. As such, higher interest rates feed the narrative, increase the pressure on the bond markets, and boost funding needs.   

The Fed can sway long-term rates lower with Operation Twist. Such allows them to continue to do QT, but all the while selling short-term bond holdings and buying long-term bonds. While not likely in the near term, they can also buy bonds (QE). The risk is that doing so would be perceived as inflationary and might cause investors to push yields higher.

The Treasury is already trying to limit its long-term debt issuance. As we wrote in the November 2, 2023 Daily Commentary:

The Treasury is favoring shorter-term debt as it likely wants to avoid locking in current yields for long periods. Consequently, less than 10% of the debt increase will come from the 10-30 year sectors. Long-term Treasury note and bond investors should like the Treasury’s stance.

Additionally, the Fed and Treasury can change bank regulatory and capital rules to make it more advantageous for banks and other financial institutions to hold Treasury debt versus other assets.

Summary

Fiscal imprudence is a big problem, and we are not making light of it. We have written volumes on how unproductive government spending ultimately weakens our economy and reduces citizens’ wealth.

However, as bond investors, we need to understand what drives bond yields and what doesn’t. Having debunked the “massive debt” narrative, we end with a reminder of what drives bond yields.

The graphs below, from our article Bond Market Noise Hides Tremendous Opportunity, show the near-perfect correlation between Treasury yields versus inflation and inflation expectations.

 We end this article with a quote from the article:

The noise in the bond market is thunderous these days as inflation is still well above norms, deficits remain high, and the Fed continues to promise higher rates for longer. Noise creates differences between the yield on bonds and their true fair value.

Noise is hard to ignore, but it can create tremendous opportunities!

Perhaps all the cheer around record Black Friday online sales, fueled by ‘Buy Now, Pay Later‘ options, may be unwarranted, as a new Bloomberg report suggests that this year’s most important shopping day fell short of expectations for major retailers.

According to an analysis of Bloomberg Second Measure transaction data, the median decline in Black Friday sales was about 4% for a basket of 40 companies that have a higher percentage of year-to-date sales from the shopping holiday versus peers. The data showed that this year’s drop was sharper than Black Friday 2022. 

Data from Bloomberg Second Measure is derived from a sample of millions of US credit and debit card users. The retailers in focus heavily relied on Black Friday. 

“Black Friday represented more than five times an average day’s worth of observed US direct-to-consumer sales to date, according to the median estimate for the group. That’s the highest level since 2019, meaning these retailers are relying more on this one shopping day even as the number of bargain hunters they’re attracting dwindled,” Bloomberg noted. 

Despite Adobe Analytics data that showed Black Friday spending online jumped 7.5% compared to last year, the data from Bloomberg appears to show a shift in consumers who are gravitating away from traditional Black Friday retailers that Bloomberg tracks to discount retailers (trading down) and or spending more on experiences and travel purchases. 

This might be why Bloomberg Second Measure data shows rising sales for discounters such as Walmart, TJ Maxx, and Marshalls. Even Amazon touted its ‘record-breaking’ sales to kick off the holiday season.

As for most other retailers that Bloomberg tracks, Black Friday actually fell by double digits in some cases. 

Weeks ago, before the shopping holiday, corporate executives from Walmart to McDonald’s were correct about consumers, calling them “choiceful” in third quarter earnings calls. 

The biggest takeaway from this report is that consumers traded down from traditional retailers to discounting ones on Black Friday, as Bidenomics has been a complete and utter failure for the working poor. And if consumers are heavily relying on BNPL services at discount retailers, then this is a very ominous sign heading into 2024.