The health care sector struggled in late 2015 and early 2016, as candidates took positions on health care policy and drug pricing. While the sector has recovered some early losses, it has continued to trail the market.
But in the long term, the performance of stocks in the health care sector will likely be driven by more than just political debates. Innovations, globalization, demographics, fundamentals, and the relative competitive position of individual companies will all play a role, along with policy decisions.
Viewpoints checked in with Eddie Yoon, manager of Fidelity Select Health Care (FSPHX), to ask about his outlook for health care stocks. His answer: They look strong regardless of the election outcome.
Q: The health care sector has lagged the market this year after leading it for five straight years. What has hurt performance in 2016?
Yoon: Health care stocks as a group have been hurt this year as presidential campaign debates raised questions about drug pricing, and there has been increased uncertainty about the future of the industry’s pricing power. Stocks in the sector fell as a result, with strong declines toward the end of last year and into the beginning of 2016. That cloud of uncertainty has continued to hang over health care stocks, depressing returns throughout the year.
In my opinion, pricing power in the sector is still very much intact. I think that’s going to become increasingly clear as we approach and move through the election. As we get greater visibility into the next administration and the next Congress, investors will gain greater certainty about the policy backdrop. That should bring the market’s focus back to health care companies’ fundamentals, which continue to be very strong.
Q: How big an impact might the outcome of the election have on health care policy and health care stocks?
Yoon: Regardless of who wins this election, I think it’s unlikely that we’d see major policy changes to health care under a new administration.
I should point out that I don’t think the uncertainty will dissipate immediately on election day. It may take the first 100 days of the new administration for investors to determine what the president’s priorities are, though conditions could change a bit more quickly if those priorities come out in a strong way during the debates and the run-up to the election. Given how politically popular it is to talk about the skyrocketing cost of medicine, the headline risks will persist for some time, even past this election cycle. That said, I currently don’t expect the economic model that drives sector earnings to be impaired regardless of who wins the presidency.
Q: What’s driving the strong fundamentals you see in the health care sector?
Yoon: Health care companies are generating a ton of innovation. When people think about innovation in health care, they tend to think about biotechnology. While it is most prominent in biotech, it’s also happening across the sector, particularly in the medical devices industry.
For example, biotechnology is making it possible to think about treating cancer as a chronic disease. New oncolytics are changing the survival expectations for cancer patients, to the extent that patients who used to live six to 12 months after diagnosis are living two, three or four years.
On the medical device front, smart devices made by companies like Dexcom (DXCM) are able to monitor blood glucose on a continuous basis and patients will soon be able to dose insulin accordingly. That’s changing the paradigm for how type-one diabetics treat their disease: Instead of a finger stick that’s very inaccurate and captures only one moment in time, you can monitor glucose continuously and dose it through a pump made by a company like Insulet (PODD).
That’s really changing the life experiences of diabetic patients. Trans-catheter heart valves are doing something similar for heart valve patients; now instead of putting them on life support, stopping their hearts and surgically replacing the valve, we can replace the valve through a catheter. It’s changing the long-term outcomes and survival curves for these patients.
Other factors also are giving a tailwind to health care stocks. Steady employment growth for several years has boosted health care utilization in the U.S., which tends to lag employment. Meanwhile, I expect emerging markets to continue producing very strong growth in health care utilization. Despite tough headlines about the economies in places like Brazil, China, and Russia, I expect health care demand in emerging markets continues to grow by double digits annually for many companies in the medical equipment industry.
And one of the big problems for health care companies selling abroad in 2015 and early 2016 was the strength of the dollar, which was a strong headwind to operating earnings. The dollar isn’t quite as strong anymore, so I think this will be a diminishing headwind to earnings, especially compared to a year earlier.
Q: What do valuations look like in health care at this point?
Yoon: In general, valuations for health care stocks overall stayed reasonable even during the sector’s five-year run of strong performance. The stocks gained, but the earnings were so strong that the price-to-earnings multiples never reached the long-term median. Then, in late 2015 and early 2016, prices fell but earnings continued to come through as expected, so valuations became appealing, and continue to be.
Coming into 2016, I thought biotech looked expensive and large-cap pharmaceutical stocks looked more attractive. But biotech corrected very aggressively in the first half of the year, because it was a crowded area and was considered to be at the center of the drug pricing debate. As investors looked for safety, they rotated into Big Pharma, in part to capture the yields on those stocks, and now those stocks look somewhat expensive relative to their fundamentals.
As of the of July, I had positioned the Health Care Portfolio with more biotech stocks than the sector overall biotech relative to the sector, particularly the large-cap stocks, some of which have strong current drug portfolios, rich product pipelines, good earnings visibility, and durable earnings growth. I think a lot of innovation is being underappreciated by investors, and it’s possible to buy some of these companies at very reasonable valuations. I’m hopeful that valuation multiples can expand, as investors see that the companies aren’t hurt by many of the issues the market has seemed to be worried about.
Q: What is your outlook for the health care sector going forward?
Yoon: It’s very positive. Health care is a growth industry that’s innovating while the world population is aging. It’s also an important export industry, giving emerging markets access to modern-day medicine and modern medical technology methods. Health care demand is fairly insensitive to economic cycles and other macro factors like the price of oil and the outlook for short term interest rate moves. This secular demand coupled with innovation provides a great environment to find companies that can compound earnings overtime. In the long run, investing in these types of companies is how I can create value for shareholders.
None of this has been fundamentally changed by the recent political environment. Despite these short-term issues that create some volatility in the market, as long as these core underpinnings of the sector persist, I believe health care will continue to be a great place to invest.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917