Friday, July 16th, 2021

Saviours of the World

It’s been a long time since we last wrote about the Healthcare sector in any detail, mainly because there has been nothing to say. The pharmaceutical industry has always been difficult for non-specialists – trying to estimate the probability of regulatory approval for a new drug, in maybe five years’ time, but worrying all the time that there may be a class action about the side effects of a best-selling drug. In reality, it is no less transparent than the Technology sector, but the valuation depends crucially on giving the companies within it the benefit of the doubt. In recent years, Technology has enjoyed this, but Pharma hasn’t.

The best way of showing this is to look at the 10-year chart of our recommended weighting for the two sectors. The data series relate to the World ex China, but we would get a similar story for each of the individual regions. Technology has had two extended periods when it was rated overweight and was almost never rated underweight. By contrast, Healthcare has had more visits to overweight territory, but they have never lasted as long and rarely reached the same highs. They were also offset by extended periods when the sector was rated underweight. Over the last 5 years, the average recommended weight for Healthcare has been -4% (i.e. neutral), whereas for Technology is has been +32% (i.e. a permanent overweight).

In April 2021, Healthcare hit an all-time low in terms of its recommended weighting. Part of this may have been a reaction to the all-time high in April 2020, but it was always hard to find a convincing narrative for the scale of the relative sell-off and we think that simplest explanation is that it was just overlooked. It does not benefit from a cyclical economic recovery and has no known relationship with the slope of the US yield curve. It can be regarded as a long-duration growth play, but only if investors give the companies and their regulators the benefit of the doubt. If they don’t, it gets lumped in with other defensive sectors such as Utilities and Staples and ignored.

If this is right, then the question is what has changed to cause the rally since then. Attractive valuations are always useful, but in our experience, there needs to be a catalyst as well. As Sherlock Holmes would say, this may a case of the dog that didn’t bark in the night. For the last 10 years at least, the industry has been haunted by the fear that a Democrat-controlled Congress might legislate for price controls on US prescription drugs. This may still be on their wish list, but if we look at the legislative timetable between now and November 2022, it is hard to see when they would bring this Bill forward. The first priority is the infrastructure plan, followed by an ambitious reform of family support, an environmental stimulus package and maybe an international treaty covering corporation tax. After all this, the Democrats may lose control of at least one house of Congress at the next mid-terms elections. If this is correct, the danger of price controls for the next few years is much lower than previously feared.

There is also another possibility. US politicians, and their counterparts around the globe, may actually be grateful to the industry for saving the lives of a large number of their constituents and the health of the global economy. Perhaps public opinion no longer regards all drug companies as evil price-gougers, but views them instead as highly innovative saviours of the world.

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