Recession Ahead? Plus, an Obesity Breakthrough.

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It's truly stunning, actually. So patients lost over 20% of their body weight. To put that in perspective, let's say that someone was 260 pounds. They could have come down to approximately the 200-pound range.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is David Reisinger. He's a biotech analyst at SVB Securities. You might have heard that there's no magic pill for obesity. That's true, but there's a new class of injections that are producing significant weight loss. In a moment, we'll hear about how they work and what investors should know about them We'll also talk with a top investment strategist about the chances of a recession and what moves to make now. Listening in is our audio producer Jackson. Hi, Jackson.

Hi, Jack.

What are you weighing these days? Give me a weight.

Right around 165.

165. Height?

5 foot 10. I'm not sure this is like— what's going on here?

165, 5 foot 10. Hold on, I'm doing it, doing a calculation here from the CDC. Wait a second, your BMI is 23.7. You know what, you're squarely in the healthy range. You're above the midpoint of the healthy range, but you know what, you're right in there. You're in great shape. Now you're in great shape.

Come on, my insurance isn't gonna bill me for this, right? Jack?

I was, uh, making a push last year, and then I did some backsliding. I'm making another push. I'm happy to report that I've lost 10 pounds over the past month. I am less happy to report that I still weigh an eighth of a ton. I'm pretty tall, about 6'4", but even so, I'd have to get down to 205 or less to be considered healthy according to the Centers for Disease Control. The next category up from healthy is called overweight, which is more polite than saying fat. But if I'm nitpicking, it's not really that accurate. Weight is a product of mass and gravity. If I were standing on the moon, I'd be lighter but just as fat. But okay, I'm all for politeness.

I think overmass might be the more scientifically correct term.

Thank you, Mr. Science. The problem is that at 253, I'm 8 pounds over the line into an altogether different category called obese. And that one the CDC does not have a polite nickname for. It's an awful word. O-beast. O is, I mean, let's be honest here, the fattest letter in the alphabet, right? And beast sounds a little too much like beast for my comfort. When exactly was the medical conference when doctors decided that the word fat is no longer acceptable, but obese is a keeper? I'd like revote.

I actually used to be chubby in fourth and fifth grade, but I think I figured it out.

And what did you figure out?

You just have to get taller.

Oh, you son of a— Okay, now look, if I stick with the healthy eating and exercise I've been doing for a month now, then by my calculations, I can get down to merely overweight by mid-July. It's a strange goal, I grant you, but I have to start somewhere. And I am not a statistical outlier, sorry to say. 42% of Americans are obese. That's up more than 10 percentage points since 2000. Nearly 1 in 10 Americans are in a category sometimes called super obese. I'd have to gain 80 pounds to qualify for that one, which hopefully isn't going to happen. But then again, I'm guessing that none of the people in that category set out to be there. People have evolved for a world where calorie-rich foods are scarce, but we live in a world where calorie-rich foods are everywhere. Not everyone has access to good grocery stores and a flexible work schedule and a house full of high-tech fitness equipment. And anyhow, I have all of those things, and like I said, I'm working my way back from a visit to the wrong side of 250. So it's hard, which is why the market for medicine that can help is potentially enormous, which is why Wall Street is paying close attention to recent developments.

The way that the Lilly drug works is it impacts the satiety hormones, and it's really impacting the central nervous system in the brain.

That's David Risinger. He covers biotech for an investment bank that specializes in healthcare, SVB Securities, and he's talking about a new drug from Eli Lilly called terzepatide. The trade name is Mounjaro.

And simply put, the drug causes people to be more satiated and thus to seek out less food. And, uh, it's important that people stay on the medication to maintain the weight loss that they achieve.

Oh, so if you take it, you lose a great deal of weight over 9 months, you still continue taking the drug afterward?

Exactly. So for patients that stop taking the medication, their weight will rebound. So it's important for patients to, to stay on therapy.

Okay, that part is not ideal. You have to keep taking the drug even if it works and you lose weight. Also, it's an injection, although you can give it to yourself using a pre-filled injector. Also, it's expensive, listing for close to $1,000 a month. And this particular drug isn't approved yet for obesity, only for type 2 diabetes. But we'll come to that. How about the weight loss?

Yes, it's truly stunning, actually. So for patients that were titrated up to the high dose— so there are 3 doses of the drug: 5, 10, and 15 milligrams. It's administered once a week via a small needle injection. Patients at the 15-milligram dose lost over 20% of their body weight. To put that in perspective, let's say that someone was 260 pounds, they could have come down to approximately the 200-pound range.

Were they still losing weight when the study was ended, or had their weight kind of plateaued?

In the data that was presented at the American Diabetes Association, the line charts suggested that patients were still losing a little bit of weight at 72 weeks, so it was starting to stabilize but not completely stabilized at 72 weeks.

You know, people seem pretty impressed by this drug. So are the indications that the drug was like well tolerated in people? There weren't a lot of side effects?

Yes. So with respect to the data specifically for obesity, the key side effects were gastrointestinal related, so nausea, diarrhea, vomiting, etc. But interestingly, you know, when people start the drug, they experience these symptoms, you know, at a higher rate, and then over the course of time, the tolerability issues fade.

There's a Danish drugmaker called Novo Nordisk that already has similar drugs for obesity on the market. Two of them, actually. They're both what are called GLP-1 receptor agonists, which means they can play a role in both regulating glucose and controlling appetite. They were both developed for type 2 diabetes and later for obesity. But the newer one, called Wegovy, is expected to quickly outsell the older one because it's a weekly injection rather than daily, and it has proven more effective in studies. But the Lilly drug appears so far to be better still. It's both a GLP-1 and GIP receptor agonist, and I don't quite know what that means, but David describes it as dual-acting.

So that dual-acting drug drives greater efficacy and more tolerable side effects than the Novo Wegovy product. With respect to tirzepatide, what's important to note is that it was approved for diabetes a few weeks ago, and Lilly's gonna update us in the second half of this year with respect to when it may be able to file for an indication for obesity. It could potentially file later this year, or they may need to wait for additional obesity readouts in 2023 before filing.

Eli Lilly stock has been running ahead of the market this year. It traded recently at 36 times this year's projected earnings, which is definitely a premium valuation. That's because the company's earnings per share are expected to double over the next 4 years, and that's because the sales opportunity on these new obesity drugs is quite large. JP Morgan estimates that obesity drugs could bring in $34 billion a year by 2031. That's about $5 billion more than Lilly's total sales today. Put it this way: Novo Nordisk sales have long been dominated by insulin. Obesity is a relatively new and small category today, but it's seen overtaking insulin in sales within 5 years. Novo's Wegovy has been held back by manufacturing constraints, But Novo is in a better position at the moment than Lilly, which doesn't yet have its obesity drug on the market. Then again, Lilly might have the better drug. Then again, again, both Novo and Lilly are already working on follow-up obesity medicines. It's difficult to say. JP Morgan predicts that by 2031, Novo will control 60% of sales. It recently upgraded the stock to Overweight. Which is awkward, and it sees upside of 20% over the next year. David doesn't cover Novo, but he's bullish on Lilly. He predicts about 12% upside. As I said earlier, these drugs are quite expensive. Lilly's drug has a lower list price than Novo's for diabetes, but neither sells for an amount that dieters would be happy about paying full price for, especially as an open-ended commitment. So I asked David, How likely are these drugs to be covered by insurance?

That is a big question. Historically, insurers have really tried to put anti-obesity medications in the bucket of cosmetic-type drugs along the lines of a Botox for wrinkles. But the transformational health benefits that these drugs offer really, we think, will drive much greater adoption by both health plans and employers in coming years. And there were some early signs of the health benefits beyond just losing weight in the secondary endpoint data that was presented at the American Diabetes Association. So for example, quite meaningful reductions in blood pressure, meaningful reductions in triglycerides, and ultimately we think these drugs will be demonstrating cardiovascular benefits as well.

Thank you, David. I'm deeply curious about these drugs. Will they become commonplace? Will America's obesity rate fall as a result? Will insurance pay? What will happen with prices? And will the drugs drive insurance rates up? I don't plan to take either drug, by the way, because I'm cheap and needles don't match well with my fitness motto. You've heard the expression "no pain, no gain." Mine is "no pain, period." That applies to both running and injections I might be able to do without. I plan to stick with walking, biking, and rowing, and eating more fruits and veg, and staying away from the chips, sweets, and beer. We'll see how it goes.

Jack, you know how I said I lost that weight in elementary school by getting taller?

I'm gonna take a few bites of minestrone, you keep going.

Well, now I remember I also did the George W. Bush Presidential Fitness Challenge.

I did the Woodrow Wilson Presidential Challenge. Go ahead.

You know, George Bush made a play at getting all the kids in America to do pull-ups, or a pull-up in my case, and the sit and reach and push-ups. And the worst was something called the pacer test where you lined up with every kid in gym class and Uh, there were two beeps and you had to get between the two cones in the time that the second beep would occur, and the beeps would get faster and faster. And if you didn't get to the cone in time, you got kicked out.

Did you go to X-Men school or something? I don't remember beeps or cones. I don't know what—

I think they based Squid Game off of it.

Okay, time for a topic change. When are we getting a recession and what should investors do about it? That's next after this quick break. Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks. Welcome back. JP Morgan CEO Jamie Dimon said recently that we could be headed for an economic hurricane. Tesla chief Elon Musk reportedly wrote to his executives in emails that he has a, quote, super bad feeling about the economy. And Cardi B tweeted, when y'all think they going to announce that we going into a recession? Jackson, how do the words from that song that made Cardi B famous go?

Yeah, I like it. I think it's, uh, I like dollars, I like diamonds, I like stunting, I like shining, I like million-dollar deals, where's my pen, B-word, I'm signing.

We're a long way from that kind of confidence now. A measure called GDPNow, which is a running estimate of economic growth based on available data, points to 0.9% growth during the second quarter. That's annualized and seasonally adjusted, and it's after subtracting for inflation. It's by no means strong growth, but I wouldn't call it a hurricane or super bad. So what should investors make of these signs? I reached out to Seema Shah. She's the chief global strategist at Principal Global Investors, the asset management arm of the big insurance company.

Yeah, I think the timing is what's key here. So, you know, as Jamie said about the hurricane, it's very colorful language. And it certainly makes sense when you hear about the Federal Reserve raising rates as aggressively as the market thinks it is. When you think about the inflation, so the living cost crisis which is facing households not just in the US but all over the world, it makes it very clear that there's probably going to be some kind of economic slowdown coming. And the question is whether or not the Fed is able to, to create that balance where they get that soft landing or if they just tip it over the edge into recession. Now, from our perspective, if you look at the current strength of the US economy, it seems like a recession this year is extremely unlikely. You just have to look at the labor market. You have to see the unemployment rate close to pre-pandemic lows. Extremely tight, very, very strong labor demand. You look at consumers with that wealth of savings cushion that they have to fall back on, which means that consumer spending is going to be really resilient. And you look at corporate balance sheets, which are still very healthy.

Recession this year, extremely unlikely, Sima says. That's good news. I guess we can put that matter to rest.

But you have to remember that all of the Fed hikes, it works with a 6 to 24-month lag. So fast forward to this time next year, and the economic picture is going to be considerably weaker than it is today. And as we take that process forward, we do actually see recession very likely in early 2024.

Well, that's not great, but 2024 is better than right now. The The question is, how bad will it be? Sima says deep recessions like the one during the global financial crisis just over a dozen years ago typically result from major imbalances. And she sees something different now.

What we have here is a traditional U.S. recession, which is created by overfed tightening when they deal with inflation pressures. And typically in that situation, it turns out to be a short and shallow recession. So something which is maybe a couple of quarters, it's not particularly deep and it doesn't really set the U.S. economy back a number of years like you it did for the global financial crisis.

Okay, I'm back to feeling a little better. So can stock investors rest easy then? Not quite.

The market has been able to have perfect clarity, a vision of what the Fed is going to do. So they started to fall. The next round though is when the growth fears start to kick in. So we can see equity markets stabilizing right now for the next couple of months because, as I said before, the US economy is pretty solid footing right now. But once you see that economic data start to roll over, once you start to see earnings growth really start to slow down, that's almost your second leg of the equity market declines coming.

The old second leg down. Not a fan. The Fed is raising rates to fight high inflation, remember, and those rate hikes are what is making investors nervous about stocks and bonds. Sima says she expects inflation to fall very slowly. To 5% and change by the end of this year, which is still about double where the Fed would like to be, and to around 3% by the end of next year. She says that many investors expect the Fed to change course on its rate hikes if the stock market falls further, but that the Fed is likely to stick with its plan. By September, it will have raised rates by 2.5 percentage points, and at that point, Sima says it might slow down from half-point hikes to quarter-point ones, but If it does, that won't quite be a pivot away from raising rates. So what should investors do? Sima says that investors should be thinking about resilience with their stocks. They should favor companies with pricing power and strong balance sheets, and with their bonds, they should focus on higher quality issues. But more than anything, she says it's time to think about real assets, traditional assets, she recently wrote. Solve yesterday's problems. I asked what she meant by that.

Traditional asset classes have done really well. So this is your fixed income and equities parts. They've done really well when the Fed has been extremely expansionary, right? When they've kept rates really low, they've been flooding the market with liquidity. That has been a perfect time for equities and a perfect time— well, a more challenging time for fixed income, but certainly a decent time. And it's meant that almost you don't even need to understand what the market dynamics have been. Just everything has performed well. But when you get into a phase where the Fed is actually withdrawing liquidity from the market, fixed income is clearly going to be challenged and equities, it just becomes a little bit more difficult. The firm has to be really, really strong to perform well. So that's where your traditional asset classes start to suffer and you have to look outside. So for us, this is where real assets start to come in. When I mean real assets, I'm talking mainly about stuff like infrastructure, commodities.

Sima says that infrastructure and commodities can do well during inflationary environments. Serve as good diversifiers. There are a number of exchange-traded funds that can provide exposure to companies in the infrastructure industry, like iShares Global Infrastructure, ticker IGF, and SPDR S&P Global Infrastructure, ticker GII. For commodities, there's Invesco DB Commodity Index Tracking Fund, ticker DBC, and others. And Seema says that investors can buy into countries with heavy commodity exposure.

A perfect example of that is the United Kingdom. The UK, despite having pretty horrible macro fundamentals for the last couple of months, has been one of the best performing markets this year because it has one of the largest exposures to the energy sector.

Sima expects the US to continue to outperform other developed markets, but she says Europe, although deeply challenged, has some appeal.

Europe is one of the more interesting cases because from a fundamental perspective, They are very much in the epicenter of the Russia-Ukraine crisis. They are struggling with a cost of living crisis considerably greater than what the US is facing. They are looking at an earnings slowdown. They are looking at possibly recession before the end of this year. And yet the valuations are already reflecting a lot of this stuff. So you've already seen major growth forecast downgrades. You've seen earnings growth downgrades as well. So as a result, the European market actually looks pretty cheap. It's only one of the cheapest it's been relative to the US since, I think, since the European sovereign debt crisis.

Sima says that investors should lower their return expectations for the next decade, but that it's a mistake to sit in cash because those who do are likely to miss the bottom and get back in late. Thank you, David and Sima, and thank all of you for listening. You have a question you'd like answered on the podcast? Is it about Jackson's presidential fitness test scores? Maybe not that one, but if there are others, just tape them on your phone using the voice memo app and send them to jack.hough@barons.com. Our producer is Jackson Cantrell. Subscribe, rate, review, and follow me on Twitter. It's @jackhough. I'm like a financial Cardi B, right, Jackson?

I think Cardi B is a financial Cardi B.

That's a good point. See you next week. Data is everywhere. When orchestrated properly, it sings. At Morningstar, we analyze and enrich data, making it actionable and powerful for you. Morningstar, where data speaks.