With less than nine months to go before the 2020 US presidential election, this might seem a foolish time for investors to park their money in healthcare stocks — one of the most politically sensitive sectors of the market. But there are reasons to think that steering clear of the industry could prove to be more costly.
The rhetoric around healthcare policy, particularly insurance and drug pricing, has heated up in Washington. Democrats are fighting among themselves over their versions of “Medicare for All”, and President Donald Trump pledged to “never let socialism destroy American healthcare” at his State of the Union address earlier this month. Despite this political overhang, the sector is healthier than it looks.
Firstly, that is because damaging policy changes are considered too divisive to garner sufficient Congressional support. Secondly, the sector will be supported over the longer term by the pace of drug innovation and the ageing US population.
The Census Bureau notes that in just one decade all the baby boomers in the US, numbering more than 70m, will be older than 65. That means the customer base for the healthcare sector is set to grow and push spending higher in the coming years, with the Centers for Medicare and Medicaid Services, a federal agency, projecting national health spending will grow at an average rate of 5.5 per cent a year until 2027, when it will reach nearly $6tn.
Alongside that demographic boost is innovation in healthcare. “We are in an era of pretty strong research and development productivity and where regulators are more accommodating, rather than less, in terms of approving new drugs,” said Marshall Gordon, a senior research analyst at ClearBridge Investments. Over the past two years about 100 new drug approvals were granted in the US alone, with much of that related to genomics, according to Mr Gordon.
Innovation has come in the form of robotic surgery and diagnostics, as well as gene therapy, which alters defective genes and replaces them with healthy ones — a great source of hope for conditions from cancer and heart disease to haemophilia.
Vinay Thapar, portfolio manager for US growth equities at asset manager AllianceBernstein, said the healthcare sector was both defensive — meaning it is more resilient than some other stocks in a downturn — and has “secular growth” due to demand and product development, adding: “Few if any other defensive sectors have this unique combination.”
Healthcare stocks have some ground to make up in terms of valuation, having underperformed the broader stock market last year. The S&P 500 posted a total return of 31.5 per cent last year, while healthcare returned 21 per cent — the second weakest performance of the 11 major sectors on the benchmark index.
The lacklustre performance came even as healthcare was set to exit 2019 with projected annual earnings and revenue growth of about 9 per cent and 14 per cent respectively — the highest of all the sectors on the S&P 500, according to data provider FactSet.
Thus far in 2020, the healthcare segment has continued to underperform the wider index. The spectre of policy changes seems to have depressed valuations. The healthcare segment currently trades on a forward price-to-earnings ratio — one of the classic metrics investors use to value shares — of about 16.5 times, far lower than that of the wider index at 19.4 times, and also lower than other defensives.
Federal Reserve chair Jay Powell continues to paint an upbeat assessment of the US economy, but it is in the late stages of the current cycle — the longest economic expansion in American history, currently in its 11th year. “This typically has been a good time to be invested in healthcare,” Erin Xie, portfolio manager at BlackRock, said in a blog post.
The coronavirus outbreak that originated in China has already sparked some giddy stock moves among small biotechs hunting for a vaccine. Overall, though, the impact of the health crisis may prove lumpy for US pharma stocks. Generic pharmaceutical makers and medical device companies — which source ingredients and components, respectively, from China — could see a disruption in their supply chain. Concerns about the economic fallout from the coronavirus have resurfaced and could make defensive sectors attractive again.
Within healthcare, portfolio managers point to opportunities in managed care, therapeutics, life science tools and diagnostics companies, and urge caution when dealing with small biotechs whose share prices tend to be extremely volatile.
There is always the risk of more painful political intervention than the market is pricing in. “Proposals that would allow Medicare as a group to negotiate lower drug prices, that could cut into profits for pharma,” cautioned Randy Frederick, vice-president of trading and derivatives at Charles Schwab.
There is bound to be some volatility ahead of the election, but ignoring policy-driven swings could yield investors healthy returns in coming years.