The U.S. healthcare sector is undergoing a resurgence, showcasing signs of life after a lackluster performance in 2023. Investors are turning their attention to this previously overlooked sector, betting that its cheap valuations will offset historical tendencies to underperform during presidential election years. The S&P 500 healthcare sector’s recent 6% climb since December has caught the eye of investors, doubling the gains of the broader index during the same period.
Lagging Performance in 2023:
Healthcare, constituting approximately 13% of the S&P 500, struggled to keep pace with the market in 2023. While the broader S&P 500 experienced a robust 24% jump, the healthcare sector managed only a modest 0.3% increase. This underperformance was attributed to investors’ focus on a select group of massive tech and growth stocks, leaving healthcare stocks undervalued and overlooked.
Causes of Underperformance:
The rise of new obesity treatments raised concerns about diminishing demand for medical treatments related to weight-related health conditions. Additionally, as the demand for COVID-19 products waned, investors shifted their focus away from the healthcare sector.
Attractive Valuations:
The lackluster performance has made healthcare an attractive target for investors seeking undervalued opportunities. Currently trading at 17.9 times forward earnings estimates, the healthcare sector offers a 9% discount compared to the S&P 500, which boasts a P/E ratio of 19.7. Historically, healthcare has traded at a 4% premium, indicating potential for significant upside.
Investor Sentiment and Earnings Outlook:
Investors are now eyeing sectors that underperformed in 2023, with healthcare emerging as a promising option. Earnings in the healthcare sector are expected to increase by 17.5% in 2024, surpassing the 11.1% rise forecasted for the S&P 500 as a whole, according to LSEG data. This positive outlook, combined with the sector’s current undervaluation, is attracting investor interest.
Discounts in Specific Subsectors:
Certain areas within healthcare present even more significant discounts. Excluding Eli Lilly, a group of large-cap drugmakers and biotech companies tracked by JPMorgan is trading at a 30% discount to the S&P 500. This “historically low” level of discount is drawing attention from value investors.
Reasons for Caution:
Despite the promising indicators, caution is advised. The healthcare sector faces challenges such as a stable but slowing economy, ebbing inflation, and falling interest rates. These factors may not provide enough incentive for investors to shift from the tech and growth stocks that performed well in 2023. Additionally, healthcare stocks tend to struggle in presidential election years, with only three out of the past 12 years seeing the sector outperform the S&P 500.
Mitigating Election Risks:
The upcoming presidential election year introduces an element of uncertainty, as healthcare costs often become a political focal point. However, some investors believe that this election cycle poses less risk to healthcare stocks. With neither political party expected to secure significant majorities in Congress, the likelihood of major industry-altering legislation diminishes. President Joe Biden has also already addressed drug prices during his first term, potentially reducing the impact of new regulations on the sector.
The U.S. healthcare sector is experiencing a revival as investors seek undervalued opportunities. Despite historical underperformance during presidential election years, the sector’s attractive valuations and promising earnings outlook are drawing attention. While caution is advised due to broader economic factors and historical trends, investors are cautiously optimistic that the healthcare sector may offer substantial returns in 2024.
