Healthcare Sector May Be a Port in the Storm

Many might well believe the health care sector was a market leader over the last couple of years given how COVID-19 thrust health care companies into the global spotlight. But the health care sector overall actually underperformed the S&P 500 Index during the equity bull markets of 2020 and 2021. However, as market volatility took hold in the first six months of 2022, the more traditionally defensive health care sector significantly outperformed the S&P 500 Index. Here are several reasons why the health care sector may continue to offer both growth potential for your investment portfolio over the long term and a possible port in the storm in the near term.

Recovery Opportunity Health care stocks overall struggled during the pandemic in large part due to postponed elective surgeries, delayed non-emergent procedures and deferred medical exams. However, as restrictions ease, individuals are resuming these foregone appointments driving a rebound for the sector and a runway of potential recovery still ahead.

Historical Outperformance Amid Economic Downturns Health care sector earnings have historically grown when earnings for the broad U.S. equity market have contracted. The 12-month trailing earnings per share (EPS) for the S&P 500 Index* declined by an average of 27.1% during the three pre-pandemic earnings recessions since 2000, while EPS for the S&P 500 Healthcare Index* rose by an average of 14.2% during those same time periods.¹

Reduced Inflation Impact Health care costs have been rising for well more than a decade now. So, while elsewhere, businesses are struggling to adjust to a new economic environment of high inflation, health care companies have been operating with increasing cost inputs for years. Also, notably, the inflation rate for medical care commodities and services has actually been significantly lower than that of the broad Consumer Price Index during the last year.² As the need for health care is rather economy-resistant, the impact of inflation on demand is reduced.pe.

Attractive Valuations Outside of a brief period at the outset of the COVID-19 pandemic, health care equity valuations were at the bottom end of their eight-year range as of May 31, 2022³—in large part due to concerns in recent years around opioid litigation and whether a new political administration might push through drug price controls. These low valuation levels imply a compelling risk/reward opportunity for long-term investors to increase their portfolio allocations to the sector.

Steady Growth Potential The expectation for earnings and revenue growth of S&P 500 Health Care Index companies in calendar year 2022 is 5.2% and 7.1%, respectively,⁴ well above the 1.7% annualized growth rate of the U.S. economy projected by the Federal Reserve Board.⁵

Beneficiary of Shifting Demographics The 65+ population, currently comprising more than 16.5% of the U.S.,⁶ grew by more than a third during the past decade, driven by the aging of Baby Boomers.⁷ As more people live longer, there is an anticipated increase in need for health care goods and services.

Exposure to Technological Advances Recent advances in medical technology, such as robotics, gene sequencing, monitoring devices and 3D printing, are expected to increase efficiency, enhance the use of a multitude of medical procedures and provide a new frontier for investors in the health care sector.

Specialized Products/Services Health care companies thrive on innovation, typically offering niche, or specialized, products or services. Notably, in 2021, there were 1,839 merger and acquisition deals made across the health care and life sciences field, compared with 1,618 in 2020 and 1,543 in 2019.⁸ Deal activity is expected to remain strong in 2022 with the key factors that drove landmark activity, including low cost of capital, pressure to deploy capital, and the needs to sustain innovation, expedite advances and replace lost revenue from maturing products, still in place.

Driven by Secular Demand Trends The health care sector accounts for about 12% of all U.S. jobs⁹, and health care spending accounts for more than 19.7% of U.S. GDP.¹⁰ With demand driven by a number of secular trends, both of these figures are expected to increase. Such secular trends include lifestyle changes that have led to a pandemic of obesity; a growing middle class which implies greater spending on health care and people living longer with chronic diseases and conditions; and the consumerization of medicine wherein individuals take a more active role in stewarding their own health care via evolving health care systems, including telehealth, wearables and other remote patient monitoring tools; and customized, integrated precision health care.

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Past performance is no guarantee of future results, but health care stocks have historically outperformed the broader U.S. equity market over the long term. Those seeking a comparatively defensive sector currently offering compelling valuations might consider a carefully-managed fund of health care stocks as a way to add quality, diversification and growth potential.mid Economic Downturns Health care sector earnings have historically grown when earnings for the broad U.S. equity market have contracted. The 12-month trailing earnings per share (EPS) for the S&P 500 Index* declined by an average of 27.1% during the three pre-pandemic earnings recessions since 2000, while EPS for the S&P 500 Healthcare Index* rose by an average of 14.2% during those same time periods.