Key Takeaways
- The health care sector lived up to its reputation as a defensive play in the past year by outperforming the broad US market.
- While much of 2022 was driven by macro concerns, there are signs that investors are starting to pay more attention to company-specific considerations again.
- Managed-care firms offer a number of attractive characteristics for the short and long term, including the ability to pass through inflationary pressures with premium increases, and a long-term tailwind from the shift to value-based care.
For much of the past year, markets and sectors were driven by broad macro concerns—namely, worries over inflation and the Fed's pace of interest-rate hikes.
But with so much negative sentiment already priced into stocks, it's possible that 2023 could see renewed investor focus on fundamentals. If that proves to be the case, then some segments of the health care sector could offer attractive potential.
Playing defense for investors
Health care stocks are typically viewed as defensive, given that people generally go to the doctor and take their medications regardless of what's going on in the economy. The sector lived up to that reputation in the past year—performing substantially better than the broad market.
Consider that 2020 and 2021 were banner years for biotech fundraising, both in number of initial public offerings (IPOs) and in total dollars raised. Fundraising is particularly prevalent among companies that provide cell and gene therapy treatments, and while not all these companies will succeed, most—if not all—will need to purchase bioprocessing tools to develop drugs.
Past performance is no guarantee of future results. Health care sector performance is represented by the S&P Health Care Select Sector index. Data as of Dec. 9, 2022. Source: S&P Dow Jones Indices, a division of S&P Global.
That outperformance was led by segments of the sector that can offer relative safety, such as large-cap pharmaceutical companies and large-cap managed care companies. Those segments have relatively steady businesses and limited cost pressures, which could help them weather weakening growth and rising costs.
The year even brought some modest tailwinds for parts of the sector. The US Inflation Reduction Act, which was signed into law in August 2022, included a three year extension of enhanced subsidies for consumers who purchase health coverage on the Affordable Care Act marketplaces—a benefit to health insurers offering Medicare and/or Medicaid plans.
Another tailwind to the sector was drug development: 2022 saw strong launches for diabetes treatments, accelerated US Food and Drug Administration approval for some promising gene therapies, and the long-awaited clinical trial results for an Alzheimer's disease drug. Beyond those specific examples, drug innovations continued across the sector in virtually every other industry.
Looking ahead: Do fundamentals matter again?
A lot of negative sentiment has already been priced into many stocks, so I think it is unlikely that in 2023 we will see the kind of rapid shift into defensive shares that we experienced in 2022. If anything, it's possible we could potentially see a reversal of that trend.
On the policy side, risks to health care stocks appear low: Health care legislation has just passed (in the form of the Inflation Reduction Act), which may eliminate the risk of more significant legislation coming up for consideration soon. Plus, Congress will be divided over the next two years, reducing the likelihood of major new legislation passing in the near term.
While we saw a broad and fairly indiscriminate sell-off in the first half of 2022, by the latter part of the year it looked as though investors were beginning to focus more on company-specific considerations—like the outcomes of key clinical trials or the implications of quarterly financial results.
This indicates to me that stock fundamentals are becoming more important to investors again. While we can't be certain of how long this dynamic will continue, this backdrop bodes well for companies in the sector that can grow their earnings.
Potential opportunities among insurers and life sciences
Unlike much of the rest of the sector, managed care firms (i.e., health insurance networks) give us good visibility into their future earnings. That's because they have the ability and scale to push through premium increases to customers every year, which also enables them to pass through inflationary pressures. Another potential positive for the near term: Utilization of health care services by consumers is coming back slowly from its pandemic lows.
The group also stands to significantly benefit from the long-term trend toward "value-based care." The industry is undergoing a transition from a traditional fee-for-service model, in which providers are compensated based on the volume of visits and services they provide, to a value-based model, in which physicians are compensated based on patient outcomes rather than on service volumes. This model emphasizes quality of care through preventive and proactive treatments—realigning incentives among payer, provider, and patient.
Another part of the industry that could show resilience in the face of further inflationary pressures is the so-called life sciences segment—which includes companies that make specific tools or ingredients used in manufacturing biotech and other drugs. These companies often have strong pricing power due to the highly specialized nature of their products.
Short-term positives, long-term focus
No matter where US markets are headed next, the health care sector can offer a combination of defensive and growth characteristics that may be attractive in a variety of scenarios.
But my focus remains on the long term—that is, trying to invest in the most innovative areas of health care, including managed care, where Fidelity's research insights can help deliver material value over time.