Healthcare stocks witnessed significant annual underperformance in 30 years

Things could hardly have gone worse for healthcare investors in 2023.

While shares of Eli Lilly and Novo Nordisk NVO 0.97% rocketed amid excitement about their new weight loss drugs, the rest of the sector limped through the year. As of Tuesday’s close, the S&P 500 Health Care index was down 0.4% since Jan. 1, while the broader S&P 500 was up 24%. Goldman Sachs analysts called the gap at mid December, with health care stocks down nearly 2% and the S&P 500 up more than 205, the sector’s “most significant annual underperformance in 30 years.”

Recent history suggests we should expect more of the same in 2024. The healthcare sector typically underperforms the broader market in general election years, as presidential hopefuls pledge to reform drug prices or health insurance, spooking investors into a selloff.

But the mood among healthcare investors and analysts is surprisingly bullish. While few seem to expect explosive growth, and some segments are better positioned than others, the general mood is that the sector overall is primed for a rebound.

“Everyone worries about these stocks in election years, and I feel like we’ve [already] taken a lot of pain,” says Ziad Bakri, a portfolio manager at T. Rowe Price and manager of the T. Rowe Price Health Sciences fund. “Most of the sub-sectors are pretty well set up for next year.”

After a year of selling, valuations across healthcare are low, creating plenty of buying opportunities. Worries over antitrust regulation are easing, after both Amgen AMGN 0.93%’s acquisition of Horizon Therapeutics and Pfizer’s acquisition of Seagen received clearance. And the expected interest rate cuts would be a boon across the sector.

Meanwhile, the concerns that often prompt investors to ditch healthcare stocks during election years may be muted in 2024. “The most likely candidates have both already been president,” says Andy Acker, a portfolio manager on the health care team at Janus Henderson Investors. “And we’ve seen what they’ve done.”

Trump didn’t make many changes to health care, Acker says, and Biden already passed his big drug pricing overhaul policy, the new Medicare drug price negotiation program. That program is moving ahead, and has so far proven resistant to legal challenges. Experts say its anticipated effects are now built into expectations.

One sign that investors won’t be dumping stocks over drug pricing concerns came in mid-December, when the Biden administration announced a new effort to allow government agencies to effectively invalidate the patents of certain high-priced drugs. That’s the sort of thing that might have sparked a selloff of drug stocks in any other year, but investors just shrugged, and share prices remained stable.

“I’m not sure it’s as much of a boogeyman anymore,” says William Blair analyst Tim Lugo of worries over drug price regulation.

What’s left is an environment of cautious optimism. Here’s what healthcare investment experts expect from some of the most-watched sectors in healthcare.

Biotech
Biotech hasn’t had a good year since 2020, and much of 2023 was particularly dire. Stock prices have begun to climb in the past few months, however, and there’s optimism that the sector may have turned a corner.

“The last time we had three down years in a row in biotech was 1992,” says Acker. “And in the following year, the sector was up about 60%. So we’re seeing almost a depression in biotech. And that’s a great time to be investing.”

Biotech valuations collapsed after the pandemic boom, as higher interest rates increased the cost of raising capital, and a glut of IPOs flooded the market. The structural challenges haven’t gone away, but many of those pandemic-era biotechs are maturing to the point where they will start to produce data. That provides buying and selling opportunities, and can create some long-term winners.

At the same time, biotech M&A seems to be picking up. And lower interest rates, if they do arrive, would improve the outlook for biotech.

“We’re not going to get back to this roaring XBI,” says Debra Netschert, portfolio manager for Jennison’s Healthcare Strategies, referring to the SPDR S&P Biotech ETF, which is down around 50% since early 2021. Still, she said, within biotech, “there are a lot of factors coming together to hopefully see an increase in the number of names that can outperform over time.”

Stocks to watch in early 2024 include Vertex Pharmaceuticals VRTX 0.10%, which will have more data on its experimental pain drug, and Amgen, which is expecting data on a new obesity pill.

MedTech
Investors’ obsession with the implications of the new GLP-1 weight loss medicines led to selloffs across the medical devices sector, on the theory that the drugs would eliminate the need for all sorts of procedures and devices. The iShares Medical Devices ETF fell 13.9% from the start of the year through the end of October, though it gained ground through November and December. Experts say the sector could keep climbing.

“A lot of these things have only partially retraced their GLP-1 losses,” says Bakri. While he expects the GLP-1 concerns to remain something of an overhang on the stocks, he adds: “I think there’ll be an understanding by the market that the impacts are going to be further out, especially if rates come down.”

Pharma
In pharma this year, it’s been Eli Lilly LLY 1.90% and Novo Nordisk on the one hand, and everyone else on the other. While the S&P 500 Pharmaceuticals index was down a bit more than 3% for the year as of Tuesday’s close, Lilly was up 56% and Novo more than 45%. Investors have had the year to consider the implications of the new weight-loss medicines from Novo and Lilly, and it’s created an enormous divergence in performance

For Novo and Lilly, 2024 could bring tough questions, as the rubber meets the road and Lilly actually begins to roll out Zepbound, its highly anticipated weight-loss drug. In a year-end note, Goldman Sachs analysts wrote that they believe the enormous market opportunity for the drugs is now fully reflected in Lilly’s valuation, and that focus will turn to whether Lilly’s manufacturing capacity can keep up with demand. For Novo, investors might start to get anxious about Ozempic joining the list of drugs whose prices Medicare will negotiate under the new negotiation program. Any revision to the price Medicare pays for the drug would go into effect in 2027, but its inclusion on the list would be announced in early 2025.

As for the rest of the pharma stocks, the calculation for spotting winners hasn’t changed: “You have to find the companies that have really innovative drugs that are going to lead to revenue acceleration, and that don’t have really large patent cliffs that are going to evaporate growth,” says Netschert.

Pfizer and Bristol Myers Squibb BMY -0.47% are both expecting waves of patent expirations in the coming years and Pfizer, in particular, has struggled enormously to satisfy investors that their strategy to mitigate the effect of that patent cliff is working.

Still, in pharma and the rest of healthcare, rising rates and low valuations are creating a setup where outperformance is possible. It’s hard to have much near-term confidence in healthcare’s biggest 2023 losers, such as Moderna, Pfizer, and the DNA sequencing company Illumina. But across the sector, investors should look for opportunities in stocks that have lagged this year, and where fundamentals remain solid.

“If you look back on 2023, it very much was a stock pickers market,” Netschert says. “This is the year that showed you that stock picking matters in the [healthcare] sector, especially when things are complicated.” Barron’s