The Challenge
The health care sector has been left behind as investors continue to chase the Magnificent Seven—the tech giants that now represent over 37% of the S&P 500’s market capitalization and have a total value of $22.2 trillion.1 Health care valuations now sit at their deepest discount in 35 years. Small biotechs have been hit particularly hard by rising interest rates and tight credit conditions.
The biotech industry has gone through big ups and downs over the last few years, as the pandemic and mRNA vaccines triggered a big influx of capital into the industry.
“We had a supply shock. We had too many companies,” says Eirene Kontopoulos, Biotech Analyst and Portfolio Manager in Fidelity’s health care suite. The rush created unrealistic expectations from generalist investors unfamiliar with the sector. “A lot of tech investors said, ‘Well, if I understand tech, I understand biotech,’” she recalls.
The reality was far more complicated. Many biotech companies lacked experienced personnel, and capital flooded into both promising and less promising ideas alike. Clinical trial success rates fell, and when weak companies started failing, valuations plummeted across the board.
That shakeout, while painful, improved the sector’s fundamentals. For investors willing to apply focused insights, this disconnect between price and potential could offer a compelling entry point.
The Impact
Today, the landscape looks drastically different. Small-cap biotechs have healthier balance sheets and better access to capital, and clinical trial success rates have recovered from where they were a decade ago. This can position these companies to deliver high-impact clinical events—with the potential to cause a 10x spike in a stock’s trading volume—that historically drive industry returns.
“The companies that have true innovation are the ones getting funded and also getting rewarded in the stock market, as investors seem to be a bit more discerning now,” says Kontopoulos. “However, as always, there are still some valuation dislocations, which makes this a sector ripe for stock picking.”
Meanwhile, large-cap pharma companies are sitting on record cash reserves while facing an approaching patent cliff: the looming expiration of exclusivity on blockbuster drugs (such as Merck’s Keytruda, whose patent expires in 2028). This combination of conditions historically spurs acquisition activity, as pharma giants look to smaller biotech companies to replenish their pipelines.
Health care innovation is occurring on multiple fronts. Beyond traditional drug development, breakthroughs are emerging in gene therapy and in liquid biopsy for cancer detection, and in medical devices such as closed-loop insulin pumps. These advances represent years of scientific progress in technologies that are finally reaching commercialization.
The Takeaway
The biotech industry's improving fundamentals and depressed valuations have created what some analysts see as a rare opportunity.
“These health care stocks have been left on the back burner for the last three or four years. They’ve massively underperformed the S&P 500, yet it’s not like these companies over the last three or four years have stood still,” says Eddie Yoon, Portfolio Manager at Fidelity (FSPHX, FSMEX, FMED).
While their stock prices stagnated, the underlying businesses didn’t. Companies advanced their drug pipelines and improved capital efficiency, all while trading at steep discounts. The industry's unique economics make this positioning particularly compelling.
“When these companies turn profitable, they historically turn just massively profitable because these are regulated monopolies. Their gross margins can be 90% plus,” says Yoon.
There are some signs that investors are starting to look beyond the Mag Seven. The equal-weighted S&P 500 has begun outperforming its market-cap-weighted counterpart, suggesting that capital is finally flowing beyond the largest companies.
Given health care’s relatively small market cap compared to Big Tech, even a modest flow could have a big impact. “You don’t need a lot of money to come out of technology to move these health care stocks,” Yoon says. “A little bit of capital rotation can go a long way.”
The appeal extends beyond the numbers. “There are a lot of things going on in biotech that are positive under the surface of this market that are being kind of lost in the AI excitement,” says Dan Kelley, Portfolio Manager at Fidelity (FPURX, FDSVX). “Over the past 10 years, we have had continued innovation in biotech that has gone largely unnoticed. That’s one area that fits that mispriced growth profile that we look for in companies.”
Capitalizing on this opportunity requires expertise that extends beyond quarterly earnings reports. The Fidelity Health Care team—which has one of the highest average tenures in Morningstar’s health care sector category—can translate complex scientific pipelines into focused insights. Drawing from this deep domain expertise, the team identifies opportunities that others may overlook.
“I have a rockstar team, including two with Ph.Ds, that can actually translate these pipelines to a generalist fund manager like me,” Kelley says. “I lean heavily on the deep expertise across sectors and industries that we have at Fidelity to help me identify those potential pockets of growth that are obscured by major market trends.”
For investors seeking opportunities beyond Big Tech, the message is clear: While AI captures headlines, the biotech industry's improving fundamentals and compelling valuations potentially offer a different path to returns. Sometimes the most exciting opportunities are the ones almost everyone else has overlooked.
Created by Fidelity and Bloomberg Media Studios.