Despite sell-off, healthcare fundamentals appear strong
Like the broader equity market, healthcare stocks experienced bouts of volatility during the third quarter. But attractive valuations, continued innovation and an uptick in merger and acquisitions could help lift the sector, says Portfolio Manager Andy Acker.
4 minute watch
Key takeaways:
- Like the broader equity market, healthcare stocks experienced volatility during the third quarter, though for sector-specific reasons.
- In particular, a sharp pullback in small- and mid-cap biotech stocks that started in February continued through mid-August.
- However, low valuations and continued innovation have led to an uptick in mergers and acquisitions, which could help support the sector. In addition, other headwinds could prove transitory.
Healthcare stocks
Price-to-earnings (P/E) ratio – measures share price compared to earnings per share for a stock or stocks in a portfolio.
Volatility – The rate and extent at which the price of a portfolio, security or index, moves up and down. If the price swings up and down with large movements, it has high volatility.
Andy Acker: Q3 continued to see significant volatility for the markets, and healthcare was no different, although probably for different reasons than the rest of the market. In particular, we saw a continued sell-off in biotech stocks, especially small- and mid-cap biotech stocks, that really started in February and proceeded through the middle of August.
We think there were three key reasons for that sell-off. First, we have still continued uncertainty about drug-pricing policy. And there are worries about what that might do for drug pricing in the United States. We think those concerns are significantly overblown. In particular, one of the most concerning pieces of policy from the House [of Representatives], we think, is very unlikely to make it through the Senate. And given the very narrow majority for Democrats in the Senate, they really need 100% of votes to make that happen. So, we think resolution there could be helpful for the sector.
We have also seen a slowdown in merger and acquisition (M&A) activity in the first half of the year. That only recently started to pick up again, with several multibillion-dollar deals that have been announced in just the last few months.
And finally, the Food and Drug Administration (FDA) remains without leadership and continues to be quite active in reviewing COVID applications. That has created some uncertainty about recent approvals and some delays around approvals. These are all factors that we think could change in the coming months that could lead to an improved outlook for biotech going forward.
Biotech and pharmaceutical stocks are trading near all-time lows as far as P/E multiples and, we think, have very low expectations. And we think this sets up the healthcare sector for a strong period of absolute and relative performance going forward.
We think the need for M&A activity in the sector remains high. The top 20 biopharmaceutical companies are generating over $150 billion in free cash flow per year. And most of the innovation is coming from small- and mid-cap biotech stocks. So, we think M&A will recover, that will be supportive for many of these stocks. Valuations are near all-time lows, which we think also will be supportive. And importantly, the innovation in the sector remains extremely high. We are seeing advances in many different areas, from gene editing to gene therapies to new precision oncology treatments; and that is not just in therapeutics but also in medical devices, with advances in robotic surgery and advances especially in diabetes, with new continuous glucose monitors and glucose pumps that can replace the function of the pancreas for diabetic patients.
So, we remain extremely excited about the innovation we are seeing in the sector. We think the valuations are attractive, and we think this really sets up well for long-term, patient investors.
These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. References made to individual securities do not constitute a recommendation to buy, sell or hold any security, investment strategy or market sector, and should not be assumed to be profitable. Janus Henderson Investors, its affiliated advisor, or its employees, may have a position in the securities mentioned.
Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.
The information in this article does not qualify as an investment recommendation.
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- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
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Specific risks
- Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
- Shares of small and mid-size companies can be more volatile than shares of larger companies, and at times it may be difficult to value or to sell shares at desired times and prices, increasing the risk of losses.
- If a Fund has a high exposure to a particular country or geographical region it carries a higher level of risk than a Fund which is more broadly diversified.
- The Fund is focused towards particular industries or investment themes and may be heavily impacted by factors such as changes in government regulation, increased price competition, technological advancements and other adverse events.
- The Fund may use derivatives to help achieve its investment objective. This can result in leverage (higher levels of debt), which can magnify an investment outcome. Gains or losses to the Fund may therefore be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
- If the Fund holds assets in currencies other than the base currency of the Fund, or you invest in a share/unit class of a different currency to the Fund (unless hedged, i.e. mitigated by taking an offsetting position in a related security), the value of your investment may be impacted by changes in exchange rates.
- When the Fund, or a share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency (hedge), the hedging strategy itself may positively or negatively impact the value of the Fund due to differences in short-term interest rates between the currencies.
- Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
- The Fund may incur a higher level of transaction costs as a result of investing in less actively traded or less developed markets compared to a fund that invests in more active/developed markets.
- The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
Specific risks
4 minute watch
Key takeaways:
- Like the broader equity market, healthcare stocks experienced volatility during the third quarter, though for sector-specific reasons.
- In particular, a sharp pullback in small- and mid-cap biotech stocks that started in February continued through mid-August.
- However, low valuations and continued innovation have led to an uptick in mergers and acquisitions, which could help support the sector. In addition, other headwinds could prove transitory.