Prognosis Negative

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by Jason Norris, CFA
Executive Vice President

Prognosis Negative

While the broad market finished the holiday-shortened week positive, healthcare investors weren’t as fortunate. Continued chatter regarding “Medicare for All” as well as a Health and Human Services proposal to ban drug rebates for Medicare are weighing on the sector. In the last month alone, the healthcare sector in the S&P 500 has fallen 8 percent while the market has rallied 2 percent. The chart below highlights the relative performance of the sector versus the market. As you can see, the sector delivered poor relative returns in the run up to the 2016 elections as the presidential candidates regularly criticized drug prices.  

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Source: FactSet
*Healthcare underperformed the S&P 500 by close to 20 percent from mid-2015 to end of 2016

Fundamentally, we believe the space is still “healthy” as witnessed this week with two bellwether stocks reporting earnings, Johnson and Johnson (JNJ) and United Healthcare (UNH). However, the CEO of UNH made comments on their earnings call that also spooked investors. David Wichmann said, “The wholesale disruption of American healthcare being discussed in some of these proposals would surely jeopardize the relationship people have with their doctors, destabilize the nation's health system, and limit the ability of clinicians to practice medicine at their best. And the inherent cost burden would surely have a severe impact on the economy and jobs, all without fundamentally increasing access to care.”

While the likelihood of “Medicare for All” becoming a reality is relatively small, there are multiple proposals, from both parties, that are attempting to address drug pricing. This overhang may affect valuations in the sector. The chart below highlights the price-to-earnings ratio of the sector relative to the S&P 500. As you can see, during the deliberations of the ACA in 2010 as well as leading up to the 2016 election, the sector can trade up to a 15-20 percent discount to the market.

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Source: FactSet

While it is difficult to handicap what will eventually come out of Washington, the risk of uncertainty will remain at least through the 2020 election. Thus, while we believe the sector offers some of the best defensive growth characteristics, the headlines may weigh on the space. With this in mind, we have been reducing our exposure to healthcare in client portfolios.

Week in Review and Our Takeaways for the Week

  • Corporate earnings continue to come in positive with notable strength from industrial companies Honeywell and Union Pacific

  • Over 80 percent of companies reporting have beaten expectations, with an average upside of 6 percent

  • The moment of truth comes next week with over a quarter of S&P 500 companies reporting earnings