In a year-end poll of our Fundamental Active Equity investors, two themes stood out: The U.S. election is seen as a key market driver, and health care is among our favored sectors. The two juxtaposed may surprise some readers. Health care reform and drug pricing are hot-button political topics. You might assume it’s the year to stay away ― but that could be a hasty diagnosis.
I recently spoke with Erin Xie, lead portfolio manager of BlackRock’s Health Sciences Opportunities Fund, to get a temperature check on the sector.
Tony: Let’s start with the 800-pound gorilla: How do you see politics affecting health care stocks this year?
Erin: Assessing the implications of the elections on the sector broadly is an imperfect science. There are many complexities associated with each potential outcome.
Much of the conversation has centered around “Medicare for All.” Talk of such a program by some Democratic presidential hopefuls dented health care sector gains somewhat in 2019. We think markets may have overreacted. We see such sweeping health policy changes as too divisive to be a real possibility. Such a program would cost trillions of dollars, and paying for it is a huge challenge. Even Democrats are divided on the topic.
Ultimately, the current political agenda does little to sully our outlook on health care stocks. The sector is underpinned by long-term secular growth drivers, and we see powerful diversification opportunities given limited reliance on economic growth. Health care is a necessity regardless of the economic climate.
Tony: One of those structural growth drivers must be the aging population?
Erin: Absolutely. In 1985, roughly 1 in 12 adults in the U.S. was over the age of 65. By 2025, we expect this proportion will be 1 in 5 ― 20% of the U.S. population. This trend is not unique to the U.S. As health care innovation improves, people are living longer all over the world. These societal shifts are supportive of the sector. Based on our estimates, health care costs roughly triple after age 65. Aging demographics worldwide mean increased health care spending for the years to come ― a fact that is not affected by geopolitical tensions, where we are in the market cycle, or who wins the U.S. election in November.
Tony: What else shapes your positive outlook for the sector?
Erin: There is tremendous innovation happening across the industry. In drug development, for example, biotechnology and pharmaceutical companies are working with years of genomic research. They now have better insight on the cause of diseases, allowing them to develop better products in multiple therapeutic areas, such as in the treatment of cancer, autoimmune disorders and genetic diseases. The American Cancer Society recently reported the largest single-year drop in cancer deaths in the U.S., citing breakthrough treatments for lung cancer.
Meanwhile, digital technology and data science are increasingly permeating the health care space. This has translated into exciting innovation in medical equipment, diagnostic services and robotic surgery. And the use of big data and the application of artificial intelligence are only in their early days in health care.
Finally, we believe emerging countries will increase spending in health care as their economies grow. Developing countries spend a small fraction of their GDP on health care. We estimate a percentage in the low- to mid-single digits compared to teens in developed countries. We expect this gap to close over time.
We see all of these as important drivers of long-term growth.
Tony: You mentioned earlier the sector’s limited reliance on the economic cycle. Can you expand on that?
Erin: Health care historically has demonstrated a lower beta (a measure of risk exposure) to global GDP than any other sector. And yet health care is priced at a lower valuation than other defensive sectors such as consumer staples and telecomms. (See the chart below.)
History also shows health care has tended to be a top performer in both late-cycle and recessionary periods. We aren’t forecasting a recession, but 10 years into a bull market, it’s reasonable to assume we’re in the latter stages of the cycle. This typically has been a good time to be invested in health care.
But we really believe health care is an all-weather opportunity. The past two years offer a microcosm: In 2019, the sector lagged the broad market but was still up an impressive 23%. And in 2018, health care’s resilience was on display: Global equity markets were down 9%, but the sector was up 2%. It’s also worth noting that trade disputes have led to increased market volatility, but we’ve seen limited read-through to the health care sector.
Tony: Before you began investing, you wore a lab jacket. This gives you special insight into the health care sector. How do you apply your training?
Erin: Our team of five has three PhDs in the sciences and one MD. I myself have a PhD in biochemistry. We believe this scientific expertise has given us important advantages in health care investing.
The sector is technologically complicated. Evaluating innovation potential is critical to assessing companies’ future prospects. We believe our scientific training gives us an edge in evaluating the strength of the pipeline and technologies. It also affords us the ability to do in-depth due diligence and have productive discussions with R&D executives and physicians. We see this as a differentiator and value-add for our investors.
Tony: I’m a big believer that price matters. How are health care stocks priced currently?
Erin: That’s really the sweetener today. Health care will typically trade at a premium to the broader market. That premium has shrunk, making the sector attractively valued versus broader global equity markets and relative to its own history. We believe favorable valuations only strengthen an already compelling investment proposition in the health care space.
Tony DeSpirito is Chief Investment Officer for U.S. Fundamental Active Equity and a regular contributor to The Blog. Erin Xie is a Managing Director and Portfolio Manager of the BlackRock Health Sciences Opportunities Fund.
Returns cited are based on the MSCI All Country World Index (ACWI) and MSCI AWCI Health care Index and sourced from Bloomberg. Valuations (PE ratios) were assessed using Bloomberg data and covering the period from Jan. 31, 1995, to Dec. 31, 2019.
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