Healthcare has been the second-best performing sector since 1970, according to our William O’Neil + Co. database, trailing Retail only slightly.
The reasons for this strong historical performance are obvious upon reflection. The U.S. population has grown. Medical technology has improved dramatically. The pharmaceutical and biotechnology industries have evolved. And, most critically, both government and employee healthcare have expanded to the point where most U.S. residents are covered by some form of insurance and have access to healthcare services.
But the sector has found itself under pressure over the past year. Fears of regulatory bogeymen, particularly in the form of Democratic presidential nominees Elizabeth Warren and Bernie Sanders, have roiled the group with threats of a Medicare-for-All system that would dramatically lower prices and likely ration services. As a result, the Health Care sector has lagged the S&P 500 for the past four years, the second-longest period of underperformance since 1970.
Recently, Health Care’s relative and absolute performance have begun to improve. This can be clearly seen on our O’Neil Sector Rotation Graph, below, which analyzes both four-week momentum and 26-week long-term performance. Health Care has moved into the top right quadrant on the graph, which signifies outperformance over both the short and long term. This has also corresponded with the sector reaching absolute highs, breaking out of a 13-month consolidation. Driving its relative move, as one can see from our 197 O’Neil Industry Group rankings, is that many healthcare groups are currently top performers.
So what’s driving Health Care’s improvement? We see several factors. First, investors are increasingly skeptical that either Warren or Sanders can win the Democratic presidential nomination, much less beat President Trump. If either Warren or Sanders were to become president, it seems unlikely that they could actually get Congress to pass a Medicare-for-All bill that would change 49% of the U.S. population’s, or 156 million people’s, employer-sponsored healthcare. As a result, healthcare service stocks, and HMOs in particular, have begun to rally sharply from depressed levels. As a group, HMOs are currently inexpensive, trading near five-year lows on price-earnings multiples despite strong 2020 earnings growth estimates (+10%).
Like HMOs, biotechnology stocks are also historically inexpensive. The table below shows a set of publicly traded profitable biotech companies, which have a current price-earnings multiple using 2020 estimates of only 16x, versus a five-year high of 78x and a five-year average of 46x.
Although the S&P 500 Health Care sector has estimated 2020 earnings growth of +12%, it trades at a discount to its growth rate at a 17x price-earnings multiple. The total S&P 500’s 2020 earnings growth estimate is +9% and it trades at a 17x price-earnings multiple. We suspect, given the current muted world economy, that S&P 500 earnings growth is likely to disappoint next year, whereas Health Care earnings should be steady.
Overall, Health Care’s secular growth drivers remain intact. The U.S. population continues to get larger and older, resulting in increased demand for services. The number of Americans over 65 is estimated to rise from 52 million in 2018 to 95 million in 2060, ballooning from 16% of the population to 23%. People are living longer, which means they will use these services for a longer period of time. The number of Americans using nursing homes is projected to increase from 1.2 million in 2017 to 1.9 million in 2030, a +58% increase. Also, according to the IQVIA Institute for Human Data Science, medicine use in the U.S. continues to rise, with the number of prescriptions rising +2.7% last year and resulting in a net +4.5% increase in spending for pharmaceutical and biotechnology products. Additionally, IQVIA estimates that net spending on pharmaceuticals will grow +3–6% annually through 2023. As a result, healthcare spending continues to expand faster than the overall economy, +4.4% in 2018 versus U.S. GDP growth of +2.9%, and makes up 18% of the national GDP. While political solutions may be coming, they will likely get tangled in the legislative process and be slow to implement. In the meantime, investors can benefit from steady growth in a sector that has lagged with reasonable valuations.
Health Care just caught up to the S&P 500 on a trailing six-month basis this week but is still lagging on a trailing 12-month basis by almost 10%. Looking all the way back to 1970, the sector has spent the most time of any sector leading the S&P 500 on both a trailing six-month and 12-month basis, again providing some solid footing for this short-term outperformance to persist over a longer time frame.
To capture some of this trend, Health Care stocks that we at William O’Neil + Co. currently recommend buying include Vertex Pharmaceuticals, a biotechnology company with a new cutting-edge treatment for cystic fibrosis; UnitedHealth Group, the nation’s largest HMO; Intuitive Surgical, the global leader in surgical robotics; and Danaher Corporation, a leader in medical diagnostics and testing equipment.