Jon Stephenson, senior portfolio manager for US equities and specialist for healthcare innovators in our Boston office, discusses the outlook for healthcare stocks after a hectic year.
Pharmaceutical stocks initially outperformed during the depth of the early shock last March as the scale of the pandemic became clear, governments shut down economies and it became apparent the world was unable to detect and treat the virus. Gradually, the concerns eased as diagnostics and testing became available, treatment infrastructure was put in place and work on producing vaccines got under way.
As investors took the pandemic more into their stride, their attention began to shift and they moved away from drug stocks. From last April, the reopening trade gained in prominence and at the same time, market concerns about regulatory reforms such as drug price legislation re-emerged. It is worth noting that throughout this period, biotech stocks continued to outperform.
What happened in the healthcare economy and what are the short and long-term effects?
When the pandemic hit, healthcare went into shutdown, just like the broader economy. At that point, the world struggled to detect the virus and had no remedy for it. Most elective and non-elective procedures were put on hold. In-person visits to doctors’ offices and even emergency room visits fell (they remain below pre-COVID levels.) Healthcare stocks outperformed the broader market during this period.
Initially, we saw a surge in investment in bedside monitoring equipment, enhanced protective gear, increased intensive care unit (ICU) capacity, bedside monitoring equipment, etc. Massive investments were made in various testing methods to more quickly identify those who were infected and isolate them, and in therapeutics and vaccine development. Beyond hospitals, clinics and labs, the pandemic rapidly highlighted the significant inequities in healthcare in our societies and economies, including the availability of and access to it.
We are seeing various longer-term effects, too. Healthcare has embraced the virtual world: It has become clear that many visits and interactions can be handled online and in the cloud. This offers benefits in many settings – notably, in behaviour medicine, nutrition counselling, care triaging and certain primary care functions. Patient-physician connectivity has increased, resulting in better-managed care of patients with more complex problems. Doctors can now gain a more holistic view of their patients.
The large-scale investment in ICU surge capacity means that equipment can be shifted from COVID wards to general or post-surgical wards. The availability of more bedside monitoring equipment can improve patient care and, for example, limit the need for sedation with opioids, potentially reducing cases of opioid-related respiratory depression or death.
Suspension of non-COVID care during the pandemic could have a disturbing effect. For patients with cancer or cardiovascular disease, deferring care might now mean that they will be diagnosed later in their disease, resulting in more complex care and poorer long-term outcomes.
On the testing side, increased capacity might mean that people are tested more frequently, which could restrict acute outbreaks of infectious diseases including the flu, possibly reducing flu-related mortality in the long term.
Our improved ability to identify pathogens and quickly develop scalable vaccines to address pandemic infections should increase the long-term resilience of economies.
Finally, on the inequities that have come to light or have become more prominent, we could see efforts by governments to expand the insured population. Other longer-term issues that need to be addressed include vaccine scepticism, the question of investing in vaccination efforts for developing economies to significantly reduce pools of virus, thus reducing the risk of resistant variants, and popular resistance to non-pharmacologic interventions such as mask-wearing.
What is the outlook for healthcare regulation in the US?
The United States is the world’s largest healthcare market, accounting for around 40% of the global market. Clearly, given its size, what happens in the US market matters to global healthcare companies, so we believe it is important to monitor developments. There are currently two areas weighing on investors’ minds:
- The risk that the US government steps into the healthcare insurance market to move the US toward a government-run insurance programme similar to those in Europe. On the regulatory front, it is likely that we will see proposals for a ‘government option’ on the healthcare exchanges and an expansion of people’s eligibility to Medicare (the US policy for the elderly). However, I expect support in Congress to be limited for such plans. More likely would be an enhancement of the subsidies provided to individuals for the individual exchange market. That would have the positive effect of bringing more people into the insured population, enabling better underwriting. This in turn would mean a lower rate of uninsured and lower premiums for those already insured, clearly a positive outcome.
- The risk of drug industry reform. US drug prices are higher than in most other countries. In my view, we could see legislation to limit future drug price increases to the rise in general consumer price inflation, which would reduce the out-of-pocket costs for consumers. Insurers could be required to cover a larger proportion of drug costs. The plan would require pharma companies to make price concessions, something we believe they would be prepared to do. Such a development would be positive for all stakeholders and end regulatory uncertainty for the industry. It would also save billions of dollars in healthcare costs, which could help pay for the government’s plans for greater infrastructure spending.
What are the prospects for healthcare stocks for the remainder of this year?
So far this year, healthcare stocks have underperformed materially. This is due to an investor preference for cyclical, post-COVID recovery investments, concerns over more government regulation and greater regulatory scrutiny of biopharma mergers and acquisitions (M&A).
However, we believe the outlook is relatively good, for example, given the substantial discount at which healthcare stocks are trading relative to the broader market. In our view, this discount is overdone. We expect the healthcare policy backdrop to become clearer in the coming months. Improved clarity should act as a catalyst for stronger performance across the segment.
Importantly, the secular growth drivers remain intact – population ageing, the need to reduce the incidence of unhealthy lifestyles, and the growing appetite for healthcare in developing economies.
Finally, innovation is incredibly robust (see Exhibit 1 below) but unappreciated in the sector. It is creating new markets, particularly in biotech and pharmaceuticals. Science is advancing so rapidly that treatments are becoming available for conditions previously considered incurable.