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Weekly Market Analysis - Healthcare: 2023’s Pain is 2024’s Gain
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MedTech Growth on Sale
In the U.S. alone, 10,000 people turn 65 daily. Managing disease and chronic illness has become more expensive, and innovation within the healthcare industry is currently facilitating a shift from treatment to prevention.
At our latest Global Investment Committee, we recommended that clients consider adding exposure to innovative healthcare companies, with a particular focus on high quality MedTech along with a selective or actively managed approach to biotech investments.
2023 was Tough for Healthcare but 2024 Looks Promising
The 2023 downturn has created potential opportunities for the unstoppable trends of longevity and innovation. Healthcare stocks are transitory, in our opinion, thus creating a favorable setup for the sector’s potential outperformance in 2024. It already has had a solid start this year.
Don’t Fear a US Election Year
Drugmakers are an easy punching bag for politicians on both the left and right, and in previous cycles socialized medicine and drug pricing reform were key topics of debate.
However, on average, healthcare has returned 3.5% during election years, slightly outperforming the S&P 500. Among subsectors, medical devices and biotech have outperformed S&P 500 the most, by 5% and 2% respectively.
Summary
After a year of headwinds and lagging performance, the healthcare sector looks to be on the cusp of a breakout in 2024. We see the following themes emerging likely to drive higher earnings this year:
- The success of new weight loss drugs is likely to accelerate
- We expect a broad based recovery across MedTech
- Healthcare innovation is on sale
- M&A activity in biopharma is likely to pick up in 2024, favoring small and mid-cap biotech
Higher rates and tighter capital spending, along with regulatory uncertainty and an ongoing hangover from COVID-19, weighed on healthcare share prices in 2023.
Overall, 2023 marked the first earnings recession for healthcare shares in decades. In our opinion, many of the issues that held back healthcare stocks are transitory. This creates possibility for sector outperformance in 2024. In fact, the market seems to embrace this view as initial healthcare performance is brightening.
Portfolio considerations
Medical devices and life sciences tools (MedTech) have historically traded at a premium to the S&P 500. Leading MedTech companies are looking to launch a wave of new products in areas such as cardiology and robotic surgery, and there are seven key product launches this year. We believe this should help this sector outperform in 2024. Our preference is on companies with strong balance sheets and innovative capacity and for quality MedTech companies and a selective or actively managed approach to biotech investments. The subsector that includes healthcare equipment and supply has grown dividends at a 9% annual rate the past three decades.
Source: Haver Analytics, March 5, 2024.
MedTech Growth on Sale
We are all getting older, but there are more people turning 65 now than ever before. According to American Association of Retired Persons (AARP), in the US alone, 10,000 people turn 65 each day. With age comes wisdom, but also more illnesses. According to the National Council on Aging, nearly 80% of adults 60 and older have two or more chronic conditions.
As societies age, healthcare services consume an ever-growing share of government and household expenditures. And escalating costs for healthcare are impacting both. Reversing that tide requires better health outcomes at a lower cost of care. And that will necessitate a shift from the traditional approach of managing symptoms to addressing underlying causes, and from treating disease to preventing it.
At our latest Global Investment Committee meeting in February, we suggested that clients consider adding exposure to innovative healthcare companies, with a particular focus on high quality MedTech along with a selective or actively managed approach to biotech investments. Healthcare is diverse, and ranges from defensive value large cap pharma to speculative growth in small cap biotech. Medical devices and life science tools (MedTech) straddle in between.
2023 was Tough for Healthcare but 2024 Looks Promising
For those who recognize the unstoppable trends of longevity and innovation, 2023’s downturn presents potential opportunities. To us, many of the issues that held back healthcare are transitory. This creates possibility for sector outperformance in 2024 and the market seems to embrace this view as initial healthcare performance is brightening.
Last year, surging sales of the new generation of anti- obesity drugs (GLP-1 drugs) led to healthcare’s “AI moment”, with two leading drug makers dominating equity market performance. 4Q23 earnings results confirmed that demand for GLP-1s continues to far exceed drugmakers’ manufacturing capacity. In fact, consensus for GLP-1 drug sales is around US$100bn by 2030. GLP-1 drug makers are now racing to collaborate with life sciences tools companies to manufacturing capacity. In the immediate term, companies that are able to fill the shortages in supply should benefit. For example, firms that produce active pharmaceutical ingredients are seeing better gross margins. The injection pens used in the treatment rely on specialized contract development and manufacturing organizations (CDMOs) as well as on device component makers for autoinjectors.
The medical technology industry is emerging from 2023’s events that led to delays or cancelations of surgeries and medical procedures. But as 2023 went on, the industry saw a steady recovery in procedure volumes as patients returned. This cyclical rebound was confirmed by stronger-than-expected guidance from managements in 4Q23.
Although still short of pre-pandemic levels, dealmaking momentum is likely to build over the course of 2024. Global large- cap pharma and biotech companies sitting on significant dry powder are looking to fill pipeline gaps in the face of impending patent cliffs. Some of the largest biopharma companies are facing significant loss of drug exclusivity by 10% to 60% beyond 2025. Approximately US$400bn of annual sales from large pharma players could lose exclusivity by the beginning of the next decade, increasing the urgency to make acquisitions. With corporate cash balances reaching approximately US$301 bn by the end of 2023, we have reason to believe M&A will continue to accelerate.
MedTech investors: Don’t Fear an Election Year
There is little basis to assume that election rhetoric will hurt Medtech stocks. On average, healthcare has returned 3.5% during election years, slightly outperforming the S&P 500. Among subsectors, medical devices and biotech have outperformed S&P 500 the most, by 5% and 2% respectively, while pharmaceuticals typically lag. This historical observation is consistent with conventional wisdom that candidate debates usually center around basic welfare topics like drug pricing and healthcare access, while MedTech tends to garner a lower profile. The most disruptive policy implemented by the Inflation reduction Act last year is granting Medicare to negotiate prices for a handful of major drugs. The negotiated prices for ten of the most popular drugs face discounts of 50% or so. As this year’s election season heats up, we believe other issues will be more dominant, including immigration, trade, and taxes. So, if left to its own devices, MedTech looks to potentially flourish.
