The health care sector continues to lag behind the broader equity market, but according to sector analysts, investor pessimism is overdone. Innovation, improving earnings growth, and declining political risks could give the sector renewed momentum in the coming years.
Over the past five years, the global index in dollars delivered an average annual return of 10.5 percent. The MSCI World Health Care Index remained at 5 percent. However, this underperformance can partly be explained by the fact that the global index was heavily driven by a small number of large technology companies. Without the Magnificent Seven, the gap would have been significantly smaller.
Politics also played an important role. The election of President Trump weighed on sentiment toward the sector, said Noushin Irani, health care specialist at DWS. Many health care companies are active in the US and are therefore sensitive to discussions about drug pricing.
“Trump wants pharmaceutical companies to offer US patients the lowest price paid in comparable countries. The expiration of patents has also led to lower growth expectations and declining valuations for some companies,” Irani said.
According to her, political risks have now diminished. For the so-called most favored nations pricing policy, a large number of agreements have been made between pharmaceutical companies and Trump. “It is currently no longer a point of discussion. It could become a theme again ahead of the midterm elections, but that risk currently appears limited.”
At the same time, interest in defensive sectors is returning due to uncertainty around AI and economic growth. The health care sector is also benefiting from this.
Innovation as a growth driver
According to Irani, the sector’s fundamentals remain strong. She pointed to the continuous stream of innovations, particularly in oncology and cardiovascular diseases. “New drugs can accelerate growth at individual companies. At the sector level, we expect an acceleration in earnings per share growth in the coming years.”
Valuations have risen in the meantime. “The sector is no longer as cheap as it was in mid-last year, when it traded at a discount of about 30 percent relative to its historical price-to-earnings ratio. With a P/E of 16.8, the sector is now at the upper end of its historical average, but still below the global index.”
Historically, the sector often traded at a premium. “The ratio between enterprise value and revenue, at around two, is also still below levels that were closer to three in the past. That suggests further upside potential.”
For long-term investors, it therefore remains an attractive entry point, despite the still uncertain impact of artificial intelligence. “AI may reduce costs over time, but the greatest value will likely be in faster and better drug development. That is a lengthy process due to complexity, safety requirements, and strict regulation.”
Those high barriers to entry make the sector relatively well protected against disruption by AI in the short term. “The likelihood that AI will fundamentally pressure the sector’s business model is small. That makes health care a relatively safe haven at the moment.”
AI productivity gains
Dan Lyons, portfolio manager Health Care & Biotech at Janus Henderson, also sees improving prospects. His team focuses explicitly on companies with strong innovation pipelines. “We focus on innovation within biotechnology, medical technology, and pharmaceuticals, where companies have promising new products.”
As an example, he mentioned Revolution Medicines, which is working on a new treatment for pancreatic cancer targeting RAS proteins, which play a key role in the development of this disease. “The initial research results are promising, and we see significant potential here,” Lyons said.
He also sees innovation supporting growth in other subsectors. According to him, investors still underestimate that potential. “US health care companies are still trading below their historical valuations. Given the improving earnings outlook, we see this as an attractive entry point. More clarity on US pricing policy could further support the recovery.”
Lyons is not concerned about artificial intelligence either. He expects productivity gains instead. AI helps biotech companies identify promising drugs more quickly at an early stage. “AI can significantly increase the productivity of research and development.”
Medical device manufacturers are also benefiting. For example, Intuitive Surgical uses AI in the training of surgeons to make procedures more efficient. “AI will not suddenly lead to spectacular margin expansion in the sector, but we do expect a gradual improvement in efficiency and profitability.”