BlackRock sector outlook 2021: Healthcare

Feb 19, 2021
  • BlackRock

2020 healthcare review

The global spread of the COVID-19 pandemic and subsequent lockdown and social distancing measures put pressure on the global economy and caused a sharp decline in equities in late February and March. Unprecedented levels of monetary and fiscal stimulus led broad markets to recover from the March lows and surpass previous highs.

While not immune to the broad market volatility created by the pandemic, the healthcare sector displayed relative resilience in February and March and went on to post strong relative returns compared to other sectors through the end of the year.

As the pandemic spread, the fragility of global hospital systems was brought to bear as economies worldwide anticipated an overwhelming number of hospitalized COVID-19 patients. In anticipation of this influx, many hospitals delayed or canceled elective procedures, which helped to increase hospital capacity and reduce transmission of the virus. However, these cancellations put pressure on medical device companies with exposure to elective procedures. Fears of contagion also delayed clinical trials and closed academic research laboratories. As many parts of the developed world appeared to flatten the rising number of COVID-19 cases, elective procedures and clinical trials resumed, while laboratories reopened. Towards the end of the period there were large surges that put pressure on hospital systems and threatened additional elective procedure cancellations. Despite the increased pressure put on hospitals towards the end of the period, hospitals became better equipped at providing care for COVID-19 patients without cancelling procedures. This also led to better patient outcomes and lower mortality rates.

2020 sector performance

The healthcare sector delivered strong performance in 2020, with the Russell 3000 Healthcare Index up 19.3% while the broad market Russell 3000 Index was up 20.9%.

2020 performance

Sources: Top-right chart: Morningstar, December 31 2020. Bottom-left chart: Bloomberg, December 31 2020. Past performance is no guarantee of future results.  Index performance is shown for illustrative purposes only.  It is not possible to invest directly in an index.

The pandemic put the healthcare sector front and center as development of therapies and vaccines to combat the virus got underway, with more than 150 therapy programs and over 100 vaccine programs in progress. Pfizer/BioNTech, Moderna, and AstraZeneca released positive phase 3 trial data for their COVID-19 vaccines in November. In December, Pfizer received emergency use approval to begin distributing their vaccine in the US and UK, while also receiving broad approval in Europe. Similarly, Moderna gained emergency use approval in the US, and AstraZeneca gained emergency use approval in the UK. Many companies pursuing therapies, vaccines, and COVID-19 diagnostics were rewarded over the period.

Telehealth companies were rewarded over the period as these services saw increased demand. The US government amended certain regulatory measures, including covering telehealth related expenses and increasing the breadth of prescriptions available, in an effort to reduce the strain on the medical system.

Looking beyond the pandemic, after several tense weeks of President Trump challenging the election results, Joe Biden was officially elected the 46th President of the United States. At the time, the perceived likelihood of a Republican-led Senate was viewed favorably by investors. This result was also viewed as relatively supportive for the healthcare sector, as the perceived likelihood of a split Congress would make it difficult for President-elect Biden to pass any transformation tax or healthcare policy reform. The lead up to the election had created additional uncertainty and volatility for the sector, but the increased policy certainty created by the outcome of the election led healthcare companies, and in particular healthcare insurers and providers to respond positively.

From a policy perspective, President Trump signed several executive orders centered around reducing drug pricing, but we believe these orders are unlikely to be implemented given the election results.

2021 outlook

Vaccine distribution

With the recent emergency use approval of Pfizer and Moderna’s efficacious COVID-19 vaccines, healthcare workers and patients in long-term care facilities will continue to be vaccinated through the beginning of 2021 in the US. We expect that these vaccinations will be extended to the elderly, other vulnerable populations, and frontline workers as more vaccines are made available. While this is a necessary first step in insulating our highest risk populations from the virus, the vaccine will likely not be broadly available to the general public until mid-year 2021.

We should have clinical trial data from Novavax, Sanofi, and Johnson & Johnson sometime in 2021, and we are fairly confident these vaccines will show reasonably good efficacy as they target the same spike protein that Pfizer, Moderna, and AstraZeneca have targeted. Total vaccine production capacity should ramp up throughout 2021 as more vaccines are approved, which should aid in vaccinating large swathes of the global population by the end of 2021.

Despite potential stock price increases on the back of positive trial data announcements, we expect that production and distribution of COVID-19 vaccines will only have an incremental impact on the earnings of many of the companies producing COVID-19 vaccines.

Companies producing COVID-19 vaccines

Source: BlackRock.  As of 12/31/2020. Estimated. References to specific securities and their issuers are for illustrative purposes only and are not intended and should not be interpreted as recommendations to purchase or sell such securities.

A return to normalcy

As COVID-19 vaccines are more broadly distributed we expect medical device companies with exposure to elective procedures to see the most benefit in the short-term as hospitals will safely be able to return to a more normal level of operations. In addition, pharmaceutical and biotechnology companies who have recently launched new products should benefit in 2021, as a return to normalcy would likely lead to an increase in new patient diagnoses and increased adoption. Conversely, as successful vaccines are broadly distributed, we expect that diagnostic companies who have benefited from increased demand for COVID-19 tests may experience waning demand.

Outside of the impacts of a successful vaccine, we believe non-hospital health delivery methods such as telehealth, in-home health, and ambulatory surgical centers will likely experience sustained growth over the long-term due to the shift in how care is delivered as a result of COVID-19. We believe there will be a movement towards reducing our reliance on the hospital system, resulting in reforms for telemedicine and in-home healthcare. In 2020, there were reforms to Medicare to expand coverage to include telemedicine services, but we expect continued reform for telemedicine and in-home care going forward.

Policy Outlook

With Joe Biden winning the US Presidential Election and the Democrats taking control of both houses of Congress, we believe there will be potential policy changes for the healthcare sector; however, ultimately we expect a muted impact. It is likely that President-elect Biden will pursue expanding healthcare coverage via strengthening the Affordable Care Act (ACA), which would be beneficial for the sector. Drug pricing reform could be a potential headwind for the sector in 2021, but we expect changes will be incremental as opposed to transformational.

Expanding healthcare coverage

We believe that the Biden administration will look to strengthen the ACA with higher subsidies and Medicaid expansion. Higher subsidies will lower premiums by increasing the value of tax credits, which provides more affordable access to more people. This expansion would be a benefit to insurers who provide coverage on the ACA marketplace. The expansion of Medicaid would be driven by increasing the incentives for states that have refused to abide by the ACA’s original expansion of Medicaid. For reference, Medicaid is run at the state level and provides healthcare coverage for low-income children, low-income seniors, and some individuals with disabilities. The ACA expanded this coverage to include all individuals with incomes up to 138% of the federal poverty level. 14 states opted not to expand their Medicaid offerings following the ACA expansion, which has resulted in an estimated 4.9 million uninsured adults1. If successful, this expansion would be a benefit for insurers and managed care providers that operate in the public segment.

Drug pricing

It is worth noting that drug pricing policy is a bipartisan issue, so it is likely that we may see drug pricing legislation under this administration. Drug pricing policies do face effectiveness and implementation issues so we expect any changes will be incremental as opposed to transformational. We expect the pharmaceutical industry will negotiate with the US government to help address out-of-pocket expenses for end-consumers. If the pharmaceutical industry can successfully reach a deal with the Biden administration, it could be meaningfully positive for the industry. If this occurs the pharmaceutical industry will have some increase in costs, but it would lead to the removal of a significant overhang for the sector and potentially increased profitability over the long-term.

Tax policy

Outside of healthcare policy, given the Democratic sweep in Congress, there is the potential for the rollback of Trump-era corporate tax cuts, which would provide a headwind for US-based companies within the healthcare sector starting in 2022. In general, the companies that will likely be most impacted are those that derive a large portion of their revenues from the US. From a sub-sector perspective, healthcare equipment and managed care providers will likely be most impacted by these proposed changes and pharmaceutical and biotechnology companies will likely be least impacted. The potential roll back would shift the corporate tax rate in the US from the current 21% to 28%, which would be below the previous 35% tax rate that was in place before the Trump-era tax cuts took effect. We believe that while stimulus and pandemic response will be the initial focus for President-elect Biden, tax changes will likely come into focus later in 2021, with implementation occurring in 2022.

Potential Affordable Care Act repeal

The Supreme Court is set to rule on the constitutionality of the Affordable Care Act (ACA) this year which could potentially lead to its repeal. However, the Supreme Court heard oral arguments in November of 2020, and their initial comments seemed to indicate repeal would be unlikely. Given the Court’s initial responses, our view is that the Supreme Court will likely uphold the ACA. Even if the ACA were to be repealed by the Supreme Court, the Democrat-led Senate could pass legislation to save the ACA, making any material negative event increasingly unlikely. A decision is expected by June 2021.

Beyond COVID-19

Continued innovation

While companies pursuing COVID-19 diagnostics, therapies, and vaccines have received much of the attention in 2020 as a result of the sheer magnitude of the COVID-19 pandemic, it is important to remember that there are many innovative areas of healthcare that are not pursuing COVID-19 related solutions. We see a great deal of innovation in both the medical devices and biotechnology sub-sectors.

Within, medical devices we favor companies pursuing minimally invasive implant technologies as these products improve patient outcomes and have the potential to replace old standards of care.

In the biotechnology space, the industry is benefitting from decades of genomics research which enables us to have a better understanding of the causes of diseases. One example is in cancer therapy, where next generation chemotherapy treatments, namely antibody drug conjugate technologies, are able to target cancer cells without adverse effects on healthy cells. The technology works by linking an anti-cancer drug to an antibody, and that antibody will target a specific cell-membrane protein which is found on the cancerous cells.

This approach improves effectiveness of the treatment while lowering potential adverse effects on healthy cells, which historically has been a major issue for traditional chemotherapy treatments. This type of technology, among others, is pushing a new wave of treatments for cancers, autoimmune diseases, and genetic diseases.

Technology continues to permeate the healthcare sector, as seen in the enabling of robotic-assisted surgery and telehealth. While there has been substantial growth in these areas in recent years, we believe that we are still in the early days for technologically driven trends in healthcare. This includes robotic-assisted surgery, smarter hospital beds, technology-enabled remote monitoring tools for patient data and, of course, telehealth which, as mentioned, has been accelerated due to COVID-19.

Given the wide dispersion of returns and idiosyncrasies within the sector, capitalizing on these opportunities is predicated on understanding the individual investment opportunities and the science that underpins the potential pipelines and products offered by these companies.

Secular trends

Beyond the innovation taking place in the healthcare sector, we believe the healthcare sector is underpinned by strong secular growth trends; in particular demographic change in both developed and developing countries. In the developed world, populations are aging and living longer which will lead to increased demand for healthcare products and services.

In emerging markets, we believe that the modernization of healthcare infrastructure and increased spending on healthcare from emerging market economies will lead to increased healthcare consumption over the coming decades.

Valuations

With the healthcare sector trading one standard deviation below its long run average relative to broad equity markets, we continue to view current valuations as representing an attractive entry point for the healthcare sector. In addition, we believe that healthcare offers access to long-term growth while providing durable returns in times of slowing economic growth. As we have seen with the current economic slowdown, one of the driving factors of the sector’s defensive characteristics is the inelasticity of demand for healthcare products and services regardless of stock market performance or economic growth.

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