Three health care trends investors should watch

Three health care trends investors should watch

by John Manley, CFA, Wells Fargo Asset Management

July was a very good month for the equity market, but it was an even better one for the health care sector. The S&P 500 Index rose about 5%, and health care beat that by 200 basis points (bps; 100 bps equals 1.00%). That’s not bad, but it is a bit slow in coming, in my opinion.

In retrospect, we’ve been seeing a valuation correction. The health care sector has moved to a very high price/earnings premium to the market based on what I still think are very good fundamentals. It took only a whiff of political risk and a few bad headlines to turn investors’ attention elsewhere.

Now, however, the valuation has returned to middling levels by historical standards and the history of steady growth seems to be unchanged.

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The political situation remains interesting (and there are, as always, some legislative or regulatory risks). But that looks to be somewhat priced into the area. We know who the presidential candidates are, and the fighters have entered the ring. Expect some unkind words for the industry, but remember that unkind words about health care companies are a permanent part of the political process and, in the past, have not gone far beyond words or the elections.

Three health care trends investors should explore

When it comes to health care, I think what I have thought before (to my disadvantage until recently): This sector may be the true growth area of the American stock market. Three forces are combining to produce interesting opportunities.

The first opportunity lies in the new generation of technology that sprang from the past decade’s genetic advances, which have reached commercial viability. Scientists are now able to sequence a genome and then examine or even reconstruct it. In turn, advances in research have allowed physicians to target diseases with very specific medicines. Reports indicate they are closing in on cancer and diabetes. Meanwhile, more prosaic drugs that have been on the market for some time are being improved upon (for example, blood pressure and heart medications).

The second opportunity is the rising demand for health care that should come from aging Baby Boomers (I’m with them—medications keep me alive longer to consume even more medications. This is a virtuous cycle for the health care companies and a happy one for me.)

The final opportunity stems from the inflow of government money into the health care industry. People want and need health care, whether they can pay for it or not. This is almost certainly very high on their list of priorities as they head to the polls in any election. Whether it’s called Obamacare or something else, I suspect that the government will continue to subsidize many of us in our health care needs. One only has to look back on what government-sponsored student loans have done to the higher education industry in the past 25 years to imagine what government money can mean for health care companies in the years ahead.

Prognosis: An entry point brought on by improved valuations

Together, these three factors provide the strategic foundation for my health care sector outlook. The sector has always been attractive to me because of the technology, the demand, and government intervention. And if that’s the strategy, then the main tactic is the health care sector’s return to a more normal valuation, without any sign of a break in what has been abnormally strong relative growth. I believe that valuation corrections in growth industries—if there is no interruption to the growth—are buying opportunities. And I think that may be the case here: A more reasonable valuation may be giving us a better entry point.

Copyright © Wells Fargo Asset Management

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