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Health care: Short-term defense, long-term growth potential

Key takeaways

  • The health care sector lived up to its reputation as a defensive play in the past year by outperforming the broad US market.
  • While much of 2022 was driven by macro concerns, there are signs that investors are starting to pay more attention to company-specific considerations again.
  • Managed-care firms offer a number of attractive characteristics for the short and long term, including the ability to pass through inflationary pressures with premium increases, and a long-term tailwind from the shift to value-based care.

For much of the past year, markets and sectors were driven by broad macro concerns—namely, worries over inflation and the Fed's pace of interest-rate hikes.

But with so much negative sentiment already priced into stocks, it's possible that 2023 could see renewed investor focus on fundamentals. If that proves to be the case, then some segments of the health care sector could offer attractive potential.

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Playing defense for investors

Health care stocks are typically viewed as defensive, given that people generally go to the doctor and take their medications regardless of what's going on in the economy. The sector lived up to that reputation in the past year—performing substantially better than the broad market.

Chart shows 2022 year-to-date performance for the health care sector and for the S&P 500.  As of December 9, health care sector stocks had lost 0.83% at the index level, compared with the S&P 500's 16.17% loss year-to-date on a total return basis.
Past performance is no guarantee of future results. Health care sector performance is represented by the S&P Health Care Select Sector index. Data as of Dec. 9, 2022. Source: S&P Dow Jones Indices, a division of S&P Global.

That outperformance was led by segments of the sector that can offer relative safety, such as large-cap pharmaceutical companies and large-cap managed care companies. Those segments have relatively steady businesses and limited cost pressures, which could help them weather weakening growth and rising costs.

The year even brought some modest tailwinds for parts of the sector. The US Inflation Reduction Act, which was signed into law in August 2022, included a 3-year extension of enhanced subsidies for consumers who purchase health coverage on the Affordable Care Act marketplaces—a benefit to health insurers offering Medicare and/or Medicaid plans.

Another tailwind to the sector was drug development: 2022 saw strong launches for diabetes treatments, accelerated US Food and Drug Administration approval for some promising gene therapies, and the long-awaited clinical trial results for an Alzheimer's disease drug. Beyond those specific examples, drug innovations continued across the sector in virtually every other industry.

Looking ahead: Do fundamentals matter again?

A lot of negative sentiment has already been priced into many stocks, so I think it is unlikely that in 2023 we will see the kind of rapid shift into defensive shares that we experienced in 2022. If anything, it's possible we could potentially see a reversal of that trend.

On the policy side, risks to health care stocks appear low: Health care legislation has just passed (in the form of the Inflation Reduction Act), which may eliminate the risk of more significant legislation coming up for consideration soon. Plus, Congress will be divided over the next 2 years, reducing the likelihood of major new legislation passing in the near term.

While we saw a broad and fairly indiscriminate sell-off in the first half of 2022, by the latter part of the year it looked as though investors were beginning to focus more on company-specific considerations—like the outcomes of key clinical trials or the implications of quarterly financial results.

This indicates to me that stock fundamentals are becoming more important to investors again. While we can't be certain of how long this dynamic will continue, this backdrop bodes well for companies in the sector that can grow their earnings.

Potential opportunities among insurers and life sciences

Unlike much of the rest of the sector, managed care firms (i.e., health insurance networks) give us good visibility into their future earnings. That's because they have the ability and scale to push through premium increases to customers every year, which also enables them to pass through inflationary pressures. Another potential positive for the near term: Utilization of health care services by consumers is coming back slowly from its pandemic lows.

The group also stands to significantly benefit from the long-term trend toward "value-based care." The industry is undergoing a transition from a traditional fee-for-service model, in which providers are compensated based on the volume of visits and services they provide, to a value-based model, in which physicians are compensated based on patient outcomes rather than on service volumes. This model emphasizes quality of care through preventive and proactive treatments—realigning incentives among payer, provider, and patient. UnitedHealth Group () and Humana (), 2 of the largest health insurers in the US, are exemplary of firms at the forefront of the transition to value-based care.

Another part of the industry that could show resilience in the face of further inflationary pressures is the so-called life sciences segment—which includes companies that make specific tools or ingredients used in manufacturing biotech and other drugs. These companies often have strong pricing power due to the highly specialized nature of their products. Recent portfolio holding Danaher () has supported this thesis. The conglomerate has a number of life sciences subsidiaries, including companies that develop and sell tech for developing cell lines, and companies that develop and sell nucleic acid.

Fund top holdings*

Top-10 holdings of the Fidelity® Select Health Care Portfolio () as of October 31, 2022:

  • 11.9% – UnitedHealth Group, Inc. ()
  • 6.1% – Eli Lilly and Co. ()
  • 5.6% – Danaher Corp. ()
  • 5.4% – Boston Scientific Corp. ()
  • 5.0% – Thermo Fisher Scientific Inc. ()
  • 4.7% – Humana Inc. ()
  • 4.5% – Cigna Corp. ()
  • 3.1% – Regeneron Pharmaceuticals Inc. ()
  • 3.0% – Insulet Corp. ()
  • 2.9% – Penumbra Inc. ()

(See the most recent fund information.)

Short-term positives, long-term focus

No matter where US markets are headed next, the health care sector can offer a combination of defensive and growth characteristics that may be attractive in a variety of scenarios.

But my focus remains on the long term—that is, trying to invest in the most innovative areas of health care, including managed care, where Fidelity's research insights can help deliver material value over time.

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Before investing, consider the funds' investment objectives, risks, charges, and expenses. Contact Fidelity for a prospectus or, if available, a summary prospectus containing this information. Read it carefully. * Any holdings, asset allocation, diversification breakdowns or other composition data shown are as of the date indicated and are subject to change at any time. They may not be representative of the fund's current or future investments. The Top Ten holdings do not include money market instruments or futures contracts, if any. Depository receipts are normally combined with the underlying security. Some breakdowns may be intentionally limited to a particular asset class or other subset of the fund's entire portfolio, particularly in multi-asset class funds where the attributes of the equity and fixed income portions are different. Under the asset allocation section, international (or foreign) assets may be reported differently depending on how an investment option reports its holdings. Some do not report international (or foreign) holdings here, but instead report them in a "Regional Diversification" section. Some report them in this section in addition to the equity, bond and other allocation shown. Others report international (or foreign) holding as a subset of the equity and bond allocations shown. If the allocation without the foreign component equals (or rounds to) 100%, then international (or foreign) is a subset of the equity and bond percentage shown.

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the speaker or author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.

References to specific securities or investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. This information must not be relied upon in making any investment decision. Fidelity cannot be held responsible for any type of loss incurred by applying any of the information presented. These views must not be relied upon as an indication of trading intent of any Fidelity fund or Fidelity advisor. Investment decisions should be based on an individual's own goals, time horizon, and tolerance for risk. This piece may contain assumptions that are "forward-looking statements," which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Past performance is no guarantee of future results.

Investing involves risk, including risk of loss.

Stock markets are volatile and can fluctuate significantly in response to company, industry, political, regulatory, market, or economic developments. Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.

The health care industries are subject to government regulation and reimbursement rates, as well as government approval of products and services, which could have a significant effect on price and availability, and can be significantly affected by rapid obsolescence and patent expirations.

The S&P 500® Index is a market capitalization-weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent US equity performance. The S&P Health Care Select Sector index comprises those companies included in the S&P 500 that are classified as members of the health care sector, with capping applied to ensure diversification among companies within the index.

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