Head - Equity Strategy
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Political chatter has ailed the US healthcare sector lately. We see the resulting equity sell-off as a buying shorter-term opportunity, but also stress the need to diversify globally.
Hearing too much talk about politics can easily leave you feeling slightly queasy. The US healthcare sector, however, has lately developed a nastier case of politically-induced nausea. Relative to the S&P 500 index, healthcare has underperformed sharply – figure 1 – selling off by 7.5% between mid-March and mid-April. The trigger was a speech by Democratic presidential hopeful Bernie Sanders. Were he to win the 2020 election, Mr Sanders vows to create a nationwide health insurance program, giving all Americans taxpayer-funded medical care, irrespective of their age or finances. In response, a leading healthcare provider’s chief warned Sanders’ plan would ‘destabilize the nation’s healthcare system,’ his company’s stock shedding 4% on the day.
Source: Haver, as of 19 April 2019. Past performance is no guarantee of future returns.
We believe that it is too early to wade into the political and technocratic ramifications of a hypothetical overhaul of the US health care system. Even if Democrats sweep both Houses of Congress and the Presidency in 2020, any major reform is unlikely until late 2021 at the earliest. With the US presidential election still eighteen months away, investors with short- to medium-term horizons should focus instead upon the sector’s ‘defensive growth’ characteristics, particularly in today’s late-cycle environment. Healthcare tends to outperform during economic downturns, and has experienced EPS growth during both of the last two US recessions.
History also provides some reassurance about recovery from politically-induced nausea. Over the last decade, we identify various episodes where healthcare equities sold off amid political threats to the status quo, but then bounced back once the threat faded. Of course, we cannot rule out the possibility that ‘this time is different’ and a major healthcare reform may be on the horizon. But since that any systemic change is several years away at least, we think today’s episode may prove similar to those previous scares. As such, we believe that it is a dip worth buying. But what of our longer-term case for healthcare?
As we set out in Outlook 2019, we favor the sector on a long-term view. Our case is based on healthcare’s exposure to two unstoppable trends: aging populations worldwide and ongoing economic development in emerging markets. We remain confident that these forces will see greater healthcare spending globally over the coming decades. We believe that such spending could drive outperformance in the equities of firms that make healthcare products, drugs, and equipment. In the US, such firms tend to earn around half or more of their revenues overseas. By contrast, healthcare providers – such as the operators of hospitals and medical insurance – are typically much more focused on the domestic market. A globally diversified healthcare allocation could have various benefits therefore, including less vulnerability to US politics-induced nausea.
Clients can read Global Equity Strategy: Health Care Prognosis Isn’t Terminal by logging in.
Healthcare sector risk: The profitability of companies in the health care sector may be adversely affected by the following factors, among others: extensive government regulations, restrictions on government reimbursement for medical expenses, rising costs of medical products and services, pricing pressure, an increased emphasis on outpatient services, a limited number of products, industry innovation, changes in technologies and other market developments. A number of issuers in the health care sector have recently merged or otherwise experienced consolidation. The effects of this trend toward consolidation are unknown and may be far-reaching. Many health care companies are heavily dependent on patent protection. The expiration of a company's patents may adversely affect that company's profitability. Many health care companies are subject to extensive litigation based on product liability and similar claims. Health care companies are subject to competitive forces that may make it difficult to raise prices and, in fact, may result in price discounting. Many new products in the health care sector may be subject to regulatory approvals. The process of obtaining such approvals may be long and costly, and such efforts ultimately may be unsuccessful. Companies in the health care sector may be thinly capitalized and may be susceptible to product obsolescence.