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3 Trends Affecting Future Share Prices in the Health Care Industry
Since the Affordable Care Act was signed into law, the number of uninsured U.S. residents has fallen by millions. (iStockPhoto)
One of the most talked about sectors among investors in recent years has been the health care industry. The sector’s prominence in increased global merger and acquisition activity, as well as its direct linkages to major policy initiatives by the Obama administration, have worked to fuel a multi-year rally in health care equities.
From June 2010 to June 2015, the Standard Poor’s 500 health care sector (190.5 percent) and Nasdaq Biotechnology index (394.0 percent) have meaningfully outperformed the S P 500 index (122.0 percent). Biotechnology companies have been a particularly hot topic as many market participants have openly questioned the magnitude of the rally while drawing comparisons to the ill-fated technology bubble from the late 1990s and early 2000s.
Will the multi-year rally continue? Rather than speculate on the future share price direction of the health care and biotechnology sectors. here are three key fundamental and macroeconomic trends affecting both industries that may help investors better understand this recent period of strong performance and potential signals to watch for in the future within this market segment.
Scientific advancements will continue to broaden the profitability potential for health care companies. It can be seen in the daily headlines – innovation is rapidly expanding within the health care sector. Technological advances and an expedited drug approval process by the FDA have led to lower costs and higher success rates at earlier trial phases. These cost reductions have produced profit opportunities for industry players as they seek to leverage a greater understanding of the root cause of diseases to research and develop more effective end drug solutions. Data shows that the 12-month research and development expenditures for the S P 500 health care sector have had a 6.4 percent compound annual growth rate since 2005, a figure that is well in excess of the broader S P 500’s 1.8 percent rate for the same period.
While innovation presents a significant opportunity, acquisition may be another area of potential opportunity. We have seen larger capitalization companies continue to aggressively pursue competitors and smaller firms in an effort to boost their own drug pipelines via acquisition. Despite not even eclipsing the end of the third quarter, global health care M A activity set a new yearly record in 2015 with $482B in announced transactions.
Global demand trends may provide a foundation for future advancement of the sector. For the first time, the generation dubbed “baby boomers” are approaching 70, which is a meaningful demographic trend not to ignore. The overall population aged 65 and above is expected to increase over the next four decades. Unsurprisingly, the median age of a person living in the U.S. is also expected to rise.
And for the first time, birth rates in the U.S. posted their first increase in 2014 after seven consecutive years of declines. Both increasing births and an increase in the number of elderly individuals are supportive of higher levels of health care utilization in the U.S. and signaling an enormous growth potential for health care within emerging markets.
As individuals in developing countries become wealthier, health care becomes more prominent. According to the World Bank, total health care spending (as a percentage of GDP) has grown by more than 19 percent from 2000 to 2013 in developing economies. Lastly, the sector may be poised to benefit from a wave of newly insured individuals in the U.S. as a result of the Affordable Care Act, typically referred to as Obamacare.
Political policy is currently supportive of the health care sector. One of the Obama administration’s key policy initiatives was the signing into law of the ACA in March 2010. That year, health care was the worst-performing sector; however, since then, the ACA has become a tailwind. The stated goal of the ACA is to “make health care more affordable, accessible and of a higher quality.” Since being signed into law, data from the Center for Disease Control indicates that the number of uninsured U.S. residents has fallen by 11 million. As more people in the U.S. avail themselves of health care as a result of accommodative government policy, this increased utilization could represent a continued, significant tailwind for the sector (barring a major policy change) domestically.
When coupled with demographic trends, the recent growth in health care spending by both the public and private sector as a component of domestic GDP highlights the growth in capital spending impacting the industry.
What are the implications? At a high level, the health care sector can represent an attractive hunting ground for investors as it frequently demonstrates a high degree of return distribution among individual companies. For context, from June 3, 2010, to June 30, 2015, the Russell 3000 Healthcare benchmark (an all capitalization index) posted a gain of 176.8 percent. For that same period, the 10 best-performing stocks in the index averaged a gain of 1,823.1 percent, while the 10 worst performing stocks averaged a loss of 73.6 percent.
The arrival of new technologies, development of new drugs and potential for further M A activity in the sector should work to facilitate continued dispersion. Government policy and demographic trends may continue to provide a tailwind as companies strive to capitalize on the current macro environment.