By Ed Yardeni & Jackie Doherty
The S&P 500 Health Care sector has gone from the best-performing of the S&P 500’s 11 sectors in 2018 to the worst-performing sector in 2019.
Some disappointing drug trials, political squabbling over drug prices and insurance, and the stock market’s new focus on growth and offense has led to the sector’s underperformance this year.
Here’s the performance derby for the S&P 500 sectors ytd through Tuesday’s close: Information Technology (21.4%), Industrials (19.0), Real Estate (17.3), Consumer Discretionary (16.6), Energy (16.2), Communication Services (15.7), S&P 500 (14.4), Materials (11.8), Financials (10.5), Consumer Staples (10.0), Utilities (9.2), and Health Care (6.0) (Fig. 1).
Last year, the Health Care sector’s performance wasn’t any better, but the market was rewarding defensive investments, so the sector was the top dog (Fig. 2). Here’s the performance derby for the S&P 500 sectors for 2018: Health Care (4.7%), Utilities (0.5), Consumer Discretionary (-0.5), Information Technology (-1.6), Real Estate (-5.6), S&P 500 (-6.2), Consumer Staples (-11.2), Financials (-14.7), Industrials (-15.0), Communications Services (-16.4), Materials (-16.4), and Energy (-20.5).
I asked Jackie to take a look at what has made the Health Care sector so sickly. Here’s what she found:
(1) Obamacare battle continues. The tussle over the Affordable Care Act (a.k.a. ACA or Obamacare) has continued during the Trump presidency. Until this week, President Trump was planning to introduce a Republican replacement for Obamacare. He backed off his plans Tuesday after Senator Mitch McConnell privately warned the President that the Senate would not address health care before the November 2020 elections, a 4/2 NYT article reported. As a result, we can look forward to a year of haranguing about health insurance from both parties during the course of the presidential campaign.
The Trump administration is also supporting US District Judge Reed O’Connor’s ruling last month that the ACA is unconstitutional. The ruling stated the ACA “became unconstitutional following Republicans’ move in 2017 to eliminate the individual mandate penalty,” a 3/26 CNBC article explained. The judge’s decision is now being appealed.
Health insurance companies benefitted from the implementation of Obamacare as more people with health insurance sought services. Since Obamacare was signed into law on March 23, 2010, the S&P 500 Managed Care stock price index has risen 489.3%, making it the third-best-performing industry that we track. It easily outpaced the S&P 500’s 144.2% return.
The threat of unwinding Obamacare has hurt the S&P 500 Managed Health Care stock price index, which has fallen 0.3% ytd (Fig. 3). The industry is expected to post forward revenue growth of 10.6% and forward earnings growth of 15.8% (Fig. 4 and Fig. 5). The strong growth makes the industry’s forward P/E of 15.2 seem reasonable if you can stomach the political wrangling over the next year and a half (Fig. 6).
(2) Drug prices are a piñata too. Drug prices continue to be one of politicians’ favorite targets. Senator Bernie Sanders (D-VT) told “Face the Nation” that he’d cut prescription drug prices in half if elected president. And, he warned, if the pharmaceutical companies don’t like it, then “we’ll take a look at their patents,” a transcript of the 3/31 TV program on RealClear Politics stated.
Senator Sherrod Brown (D-OH), who’s considering a presidential run, and Senator Amy Klobuchar (D-MN), who is running for president, co-sponsored a proposal allowing the federal government to negotiate Medicare drug costs with drug companies, a 2/17 article in the Dayton Daily News reported. He also introduced another bill with presidential contender Senator Kirsten Gillibrand (D-NY) requiring drug companies to report and justify price increases to the government. And Senator Elizabeth Warren (D-MA) has a plan to manufacture generic drugs when the market fails.
Fundamentally, the biotech industry has benefitted from a number of acquisitions early in 2019. Bristol-Myers Squibb offered $74 billion to acquire Celgene, and Eli Lilly purchased Loxo Oncology for $8 billion. Earlier this week, Novartis announced the $1.6 billion deal for IFM TRE, which develops anti-inflammatory drugs, and Roche Holdings offered $4.8 billion for gene therapy company, Spark Therapeutics. Weighing on the industry was news that Biogen and Eisai halted late-stage studies of an Alzheimer’s drug. Biogen shares fell by almost a third on the news and have yet to recover.
(3) Moderately happy pills. The S&P 500 Pharmaceuticals and Biotechnology industries have been top performers in the health care sector. Analysts aren’t expecting much from the pharmaceuticals industry, which has appreciated 4.9% ytd (Fig. 7). Forward revenue is expected to inch up by 1.7% and forward earnings by 2.6% (Fig. 8 and Fig. 9). Earnings growth is expected to pick up in 2020 (by 8.1%) and 2021 (9.4%). For those who can wait, the industry’s forward P/E of 15.4 may seem reasonable (Fig. 10).
Growth in the Biotech sector is slightly better. The industry’s stock price index is up 3.4% ytd (Fig. 11). Analysts forecast forward revenue growth of 3.2% and forward earnings growth of 7.6% (Fig. 12 and Fig. 13). The industry’s forward P/E, at 11.0, is near 20-year lows (Fig. 14).
(4) Middle men under fire, too. President Trump is also promising to lower drug prices, but he has proposed doing so by ending the annual rebates drug makers give pharmacy-benefit managers that work with Medicare and Medicaid. The three largest pharmacy-benefit managers are UnitedHealth Group’s OptumRX, which is in the S&P 500 Managed Health Care industry, and Cigna’s Express Scripts and CVS Health’s Caremark, which are both part of the S&P 500 Health Care Services industry. A number of industry executives are expected to testify on Tuesday before the Senate Finance Committee about the role of pharmacy benefit management, or PBM, contracts in drug price increases.
Yesterday, Cigna may have taken a step toward mollifying critics. It lowered the out-of-pocket cost of insulin for some of its members to $25 for a 30-day supply, down from $41.50. The lower price will cover non-government Cigna plans for employers, unions, and individuals, a 4/3 CNBC article reported. Last month, Eli Lilly introduced a generic version of its rapid-acting insulin at half the price of its brand-name drug.
The S&P 500 Health Care Services industry is among the worst-performing industries we track, having fallen 13.2% ytd (Fig. 15). The poor stock price performance of CVS and Cigna has more than offset the stronger results of DaVita, Quest Diagnostics, and Laboratory Corp. of America Holdings. The industry is expected to have 36.4% forward revenue growth and 5.2% forward earnings growth (Fig. 16 and Fig. 17). Its forward P/E of 9.1 is at a 15-year low (Fig. 18).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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