CIO unpacks how massive US sector broke out of the doldrums
Health care stocks look like they’re bookending the year. Using the Dow Jones U.S. Health Care Index as a measure, the sector was one of the top performing equity categories in Q1, before Liberation Day upended the market and big tech’s momentum took hold. While the sector languished through Q2 and Q3, it’s become the top performing equity sector on US markets so far in the final quarter of the year. That same health care index is significantly outperforming the S&P 500 Information Technology Index since both the start of October and November.
Despite that uptick, Paul MacDonald isn’t ready to call a bull market in health care just yet. The CIO and Portfolio Manager at Harvest ETFs leads management for the Harvest Healthcare Leaders Income ETF (HHL). He explained how a range of fundamental and macro factors have resulted in this performance so far, while highlighting the risks of politics and policy that still hang over the sector. He stressed that despite these risks many health care companies have shown that mixture of strong growth and defensive characteristics that may suit equity investors looking to de-risk from their big tech wins.
“Sentiment went negative and moved in favour of strong sentiment elsewhere. Despite the fundamentals in the health care sector still remaining intact, in aggregate, it was a source of cash for areas of growth that were working,” MacDonald says. “The rest of the market was expanding while healthcare stayed relatively flat, and the differential was so extreme that by the time we got to early fall, we started to look for catalysts.”
These catalysts, MacDonald explains, have been progressive for the sector. They began with Berkshire Hathaway’s purchase of around five million shares in UnitedHealth, a company that had been struggling for a while. Policy calls in the US to reshore manufacturing saw Pfizer announce $70 billion in US-based research and manufacturing investment, adding a tailwind to the stock. Then, as Q3 earnings reports started coming out, investors were unable to ignore the successive earnings beats and forward guidance raises from big names in the health care sector.
Wider equity market dynamics have also played a role. MacDonald explains that because mega-cap growth technology has been such a dominant performer this year many investors are now looking to take some profits and move them into more defensive sectors. As markets have corrected somewhat and tech has pulled back slightly, MacDonald notes that investors have shifted towards health care, a sector that is both traditionally defensive and showing strong earnings growth at the right time.
Despite all that reason for positivity, MacDonald says he’s not ready to call this a health care bull market just yet, because policy risk still hangs over the sector. Health care has long carried something of a political risk association, as various governments might put the sector in its crosshairs. Some of the reason for health care’s underperformance in Q2 and Q3, MacDonald notes, was the overhang of a Secretary of Health and Human Services with anti-vaccine leanings and the overall issues that come with a somewhat arbitrary US administration.
Policy overhangs, however, are not a new dynamic for health care investors. MacDonald notes that while some of the noise out of Washington can cause upticks in implied volatility, it is more often being discounted as just noise. Other complicating stories like risks to Fed independence appear to have subsided and while a new political focus on affordability in the United States may introduce new risks for US healthcare companies, there could be a shift in cost-bearing away from US markets and towards the rest of the world to compensate.
Because policy remains a risk factor in health care, and this recent rally is still somewhat nascent, MacDonald stresses the importance of diversification and prudence on the part of advisors as they discuss this sector’s short-term uptick and long-term prospects.
“Diversity is the call of the day. I'm a big believer in buying dips here in the growth area. But having that sort of that core longer-term allocation, I think, makes total sense. Especially given the political environment and where valuations are having that that core allocation towards sort of some of the defensive areas I think makes total sense here,” MacDonald says. “We're seeing it at play real time health care is doing what it should do in an environment that it should do it in.”
