Healthcare Will Outperform The Market In The 2020's. Just Look At The Data
Why demographic shifts and the current market climate may just lead to a healthcare sector renaissance
In the world of 2021, financial markets are a bit… out of the ordinary. We have companies going public with zero revenue for multi-billion dollar valuations, Small-cap tech companies trading at 30x revenues, & NFTs selling for tens of billions. Speculation in financial markets is actually starting to rival that seen during the .com boom and there has been a complete disregard of value. This has left open a fair share of investment opportunities despite markets around the world trading at all time highs.
One of those opportunities is in this little known sector called Healthcare. Alright healthcare may be pretty well known but it often isn’t thought of as the “cool” place to invest. After all, how can the company that makes band-aids possibly deliver higher returns than a tech company that grown 100% YoY for the past 3 years? The answer largely comes down do the current market climate and broader demographic trends. Coupled, these promise above-average returns with a degree of certainty not typically seen in financial markets. I will break down each of the factors propelling and dragging on the sector.
Demographics: Strong Tailwind
As you likely know, there’s this generation called the baby boomers and they’re starting to get pretty old. What you may not realize though is exactly how large this baby boomer generation actually is. Starting around 2010, the population of Americans age 65+ started to grow rapidly and over the next 10 years, were expected to see the population of Americans 75+ nearly double.
Now this is a particularly important trend to pay attention to because of the exponential correlation between age and health care spending. These two factors, when taken together, allow us to infer with a high degree of certainty that healthcare spending will increase substantially over the next decade.
But don’t take my word for it, take the United States Governments’. The Centers for Medicare & Medicaid project total healthcare expenditure to grow at an average rate of 5.5% over the next 5 years. The chart below shows how healthcare spending is projected to grow faster than the broader economy in the coming years and take up an increasingly large portion of US GDP.
Political Climate: Neutral
Having a democratic president and and democrat-controlled congress actually plays on both sides of the coin as a headwind and a tailwind. Coupled, these two factors mean that it is largely a coin toss if the administration passes significant healthcare legislation and whether that healthcare legislation increases or decreases spending.
The first potential outcome is: no major healthcare legislation is passed. While it is a major priority of the democratic party & Joe Biden himself, nothing is certain in Washington and there will be strong opposition to any legislation that may be introduced. In this outcome, healthcare spending nor availability would be changed.
The second potential outcome is an “Affordable Care Act”-like bill that aims to increase healthcare availability & participation. The Affordable Care Act, created a subsidy system that allowed lower income Americans to take out government subsidized private health insurance plans. This decreased the uninsured portion of the US population from 14% to 9% and actually acted as a boon to the private healthcare industry. It leveraged the private insurance industry to increase health insurance participation and, consequently, increased the overall size of the pie availible to the health payer (insurer) segment. Similarly in the healthcare provider segment, this 5% of the US population that was now newly insured, went on to consume more healthcare services as well. This can be seen in the graph below showing healthcare spending per capita for the insured and uninsured. In the case that a bill is passed during the current administration that aims primarily increase health-care participation, we’d likely see increased spending in both the payers and providers segments of the healthcare sector.
The last piece of legislation that could be passed in one that primarily aims to address US healthcare costs. Now there is no real precedent for this as there is significant private healthcare lobbying power and congressional opposition to changing the privatized US healthcare system. However, if passed, this would look something like the public option or a single-payer system seen in almost every other country of the world. This would likely revert US healthcare spending closer to other developed countries like Switzerland and Germany. This would lower profits and sentiment in the entire industry and drive lower returns as a result
(Note: This risk, though, is far more heavily skewed to payers (insurance companies) than providers & pharmaceuticals (hospitals, drugs & doctors). While prices or overall spending may decrease by some small percentage, say 10%, the advent of a public option could take away a significant portion of overall private health insurance revenues.)
On balance, these factors mean that it is hard to say what, if any, effect the current administration will have on healthcare spending. For this reason, I rated potential political effects as a net neutral.
Current Market Climate: Tailwind
Value is hard to come by in today’s markets. Every sector has managed to achieve record-breaking returns over the past year and this has resulted in much of the market looking overvalued in terms of book value, profits, and growth. However, this trend does not quite extend to all of the market. Certain sectors are not especially expensive by historical standards; most notably financial services, energy and healthcare.
Breaking each one of these “value” sectors down, we can clearly see the opportunity present. Financial services, while cheap, is notoriously recession sensitive making it a risky selection for all but the most strong willed (e.g. those that don’t sell upon 60% declines). On top of recession exposure, financial services also has limited earnings growth prospects due to shrinking net interest rate spreads, or the difference between the interest rate charged to borrowers and paid to depositors. Inflation risks brought on by prolonged loose monetary policy and supply chain constraints further pose growth risks to the sector. All in all, while the financial services sector is cheaper than the rest of the market in a valuation respect, the risks & headwinds the sector faces justifies those valuation.
The story is much the same for the energy sector. Unless carbon capture becomes a multi-trillion dollar industry or oil suddenly becomes a renewable resource, growth prospects look pretty bleak for the energy sector. Again, the sectors risks largely justify the lower valuations fetched.
Now here is where the healthcare industry really starts to stand out. With an average P/E (price to earnings ratio; a crude method of valuation) in the high teens, it is priced like much of the rest of the “value” sectors. While the sector does face headwinds similar to those seen in energy and financial services, the strong tailwinds it faces are nearly certain and particularly strong. It is unique in that it has both strong projected growth and low current valuations. While political risks are great, their improbability does not nearly justify just how lowly valued the sector is. While it is never smart to put all of your chips in one basket, you should be considering healthcare as core segment of your portfolio for the next decade.
