OCEAN CITY — Most investors’ first impression of the Affordable Care Act (ACA) was that it would be a negative for the Health Care sector. Despite the rancor surrounding the law, however, it has driven a reduction in the percentage of uninsured Americans from 18% to 13.4%, according to the New England Journal of Medicine 2014 Progress Report. And since the U.S. Supreme Court upheld the constitutionality of the ACA in June 2012, Health Care has been the best-performing sector of the S&P 500, nearly doubling the return of the broader market.
Five years after the passage of the ACA, we think this outperformance can continue well into 2016 as the sector continues to transform under the law and on the back of accelerating innovation in medical technology. Looking further ahead, aging populations in the U.S. and abroad and the continued prevalence of chronic diseases and disabilities suggest Health Care could be a favorable sector in the long run.
Savita Subramanian, head of U.S. Equity & Quantitative Strategy at BofA Merrill Lynch (BofAML) Global Research, is positive on the Health Care sector on the basis of both the strong near-term prospects and longer-term demographic trend. In a recent report, she highlights the opportunities based on growth, earnings and relative valuations.
Since the market bottomed in 2009, Health Care has been a standout in both top-line and bottom-line growth. In fact, since 2009, it’s had the fastest revenue growth of the S&P 500 sectors. According to BofAML Global Research, earnings growth for the sector was more than double that of the overall market last year, and expectations are for that relative strength to continue through 2016. As it has in many industries, the strong U.S. dollar has weighed on healthcare companies’ growth, as earnings from abroad are converted to fewer dollars. Despite this, the sector should see revenue growth of more than 9% and earnings growth of 10% in 2015, according to FactSet Research Systems.
One of the more important long-term trends driving the healthcare industry’s revenue growth has been the longevity boom. Americans are living longer and healthier lives, and contributions to the medical field are continuously expanding the scope of both disease prevention and treatment. A key driver of the trend is advances in medical technology, from rapid blood tests for viral diagnoses to hand-held skin cancer detection devices that are 98% effective, to cataract surgery using robots.
A handful of subsectors are driving much of the strength in Health Care. Life Sciences Tools and Services, Biotechnology and Health Care Providers all have averaged double-digit growth in revenue and earnings since 2009, according to Bloomberg.
Valuations for these subsectors vary. In general, Life Sciences stocks look cheap relative to recent history, while those for both Providers and Equipment seem inexpensive relative to the rest of the sector. Health Care Technology, on the other hand, looks overvalued both relative to history and to the rest of the sector. While this segment has exhibited above-average growth in recent years, stock prices seem to have gotten ahead of themselves.
For investors seeking more growth-oriented names, Biotechnology is one of Savita Subramanian’s preferred segments within the industry, although it is important to differentiate between companies with established earnings and those trading more on speculation.
(A Merrill Lynch Wealth Management Advisor who can be reached at 410-213-8520.)