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By Vinay Thapar, CFA
Healthcare stocks have remained in vogue through volatile markets, driven by increased interest in the sector during COVID-19. Yet the sources of the sector’s appeal run deeper than the pandemic’s effects and can provide a source of resilient return potential through uncertain market conditions in 2023.
During a painful year for equity investors in 2022, healthcare stocks offered a pocket of relative stability. Global healthcare stocks ended the year down just 5.4% in local currency terms, outperforming the MSCI World Index, which tumbled by 18.1% (Display). During the fourth quarter market rebound, healthcare stocks advanced more than 13% – also ahead of the global index.
Healthcare Stocks Have Performed Well in Rising and Falling Markets
Past performance does not guarantee future results. As of December 31, 2022Source: Morningstar, MSCI and AllianceBernstein (AB)
So, what is it about healthcare stocks that fostered such solid performance patterns in both falling and rising markets? And do these features justify investing in a standalone single-sector portfolio?
Thematic Trends Transcend Macroeconomic Swings
To answer these questions, we need to understand why healthcare stocks were attractive even before COVID-19. Healthcare stocks benefit from long-term thematic trends, driven by efforts to mitigate the impact of disease through therapeutics, technology and services that span people to pets.
Scientific progress is opening doors to new treatments while reducing costs. And demand for healthcare tends to transcend cyclical turns in the economy.
With global economic growth facing huge challenges, healthcare businesses can still perform well. That’s because the core driver of healthcare growth is people.
Global demographics support healthcare growth in different ways. In developed markets, an aging population will require more treatments. In emerging markets, faster population growth is fuelling demand for healthcare products and services as societies become wealthier and the middle class grows. These demographic trends will persist no matter what happens in the wider economy.
Innovation for Evolving Needs
To meet growing needs around the world, healthcare companies must constantly innovate. Scientific innovation has underpinned healthcare advances for decades. Yet in many ways, the technological revolution in healthcare is just beginning – and it extends beyond pharmaceuticals.
Robotics are already changing surgical procedures. New diagnostics and life science tools can help identify diseases at an earlier stage. Treatments for Alzheimer’s disease and cardiovascular disorders will help combat the physical and economic costs of demographic change. Telehealth and digitization offer dramatic potential to deliver better patient care.
Traditional drug development is also being redefined. Big data could improve the efficacy of drug trials. Synthetic biology is transforming the nature of industrial scale in the medical industry, including drug discovery, making it possible to profitably design personalized treatments, even for rare diseases that affect small numbers of patients.
Innovation will help healthcare systems around the world cope with the strain of rising costs – an acute problem even for countries with universal healthcare systems. Historically, healthcare innovation has tended to drive prices up – unlike technology, where innovation leads to price declines.
For example, 20 years ago, cancer patients paid about $200 a month for chemotherapy, and success was limited. Today, some chemotherapy treatments can often successfully cure cancer with fewer side effects, but at a cost of $100,000.
The tension between rapid innovation and the need to contain costs will continue to shape the healthcare industry – while creating opportunities for investors. In the US, for example, the recent Inflation Reduction Act will require pharmaceutical companies to limit or lower some drug prices.
While this legislation may pressure prices of some products, we believe it will also serve as an impetus for research and development efforts. Innovative companies that can reduce costs will be best positioned for longer-term outperformance if they can demonstrate the value of their products to the overall system.
These trends all create compelling reasons to consider allocating to a dedicated and diversified healthcare portfolio. What’s more, healthcare firms help address key environmental, social and governance challenges.
Many are aligned with the United Nations Sustainable Development Goal #3, which seeks to “ensure healthy lives and promote well-being for all at all ages,” with sub-targets aimed at combating disease and promoting healthcare coverage. Healthcare companies also tend to have low carbon footprints.
Healthcare as a Core Equity Asset
Healthcare can play a role as a core asset in equity allocations, in our view. Exposure to long-term growth driven by demographics makes healthcare companies less vulnerable to the economic environment. And beyond medicine for humans, animal health is a burgeoning business segment, driven by rising spending on pets that is unlikely to wane in a slowdown.
Across the sector, sales growth is relatively stable in uncertain times, and many healthcare companies command pricing power – an important attribute when inflation is high. Earnings have generally held up well in economically challenging times (Display).
As a result, healthcare share prices are often less volatile than those of companies in other sectors. So, a strategically constructed healthcare portfolio can offer investors both offensive and defensive characteristics: solid growth potential in rising markets and less downside risk.
Healthcare Earnings Have Been Resilient in Periods of Economic Stress
Past performance does not guarantee future results. 2022 revisions are earnings-per-share (EPS) revisions for the 12-month period through December 31, 2022Economic downturns defined as a trough in the Purchasing Managers’ Index, a measure of industrial production. Trough dates are: December 31, 2008, November 30, 2012, January 29, 2016, April 30, 2020. Trough for 2022 is assumed at December 21, 2022, though the actual trough may not yet have been reached. Average is the average of EPS revisions over the 12 months prior to a PMI trough December 1998 to December 2021. As of December 31, 2022Source: FactSet, MSCI and AB
Of course, there are risks to consider. Many healthcare companies are growth stocks, whose share prices are more vulnerable to rising interest rates. Legislative and policy changes can impact company business models and financial forecasts. And the outlook for individual companies may be affected by scientific success or failure in R&D and drug development efforts, which is very hard to predict.
That’s why we believe healthcare investors should not try to predict the outcome of scientific research. The best approach, in our view, is to focus on the underlying businesses of companies. Even the best scientists in the world cannot reliably forecast drug-test results, so why should investors gamble?
With a clear focus on business fundamentals and profitable companies across the sector, a portfolio of diversified healthcare stocks can serve as a potent antidote to market volatility by offering strong risk-adjusted return potential through periods of shifting macroeconomic conditions.
The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AB portfolio-management teams and are subject to revision over time.
MSCI makes no express or implied warranties or representations, and shall have no liability whatsoever with respect to any MSCI data contained herein.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.
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