There’s Eli Lilly (LLY), and then there’s everybody else. That’s a simple way to describe the performance of the Club’s health-care holdings so far this year, in what’s been a challenging period for the industry overall. Of the 11 market sectors year to date, health care is the fourth worth-worst performer, falling 4%, followed by consumer staples (down 4.2%), real estate (down 5.8%) and utilities (down 10%). Our standout is unquestionably Eli Lilly, which has soared 50% in 2023 on the promise of its experimental weight-loss and Alzheimer’s drugs, making it the most-valuable health-care company in the world. Lilly’s run really started in last year’s terrible market, soaring more than 30% compared to the S&P 500’s nearly 19.5% plunge in 2022. That’s a nearly two-year return of almost 100%.
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Lilly’s shadow looms large over the likes of GE Healthcare (GEHC), Humana (HUM) and Danaher (DHR) — three companies whose futures remain bright, but whose stocks have nonetheless been drags on our portfolio this year for reasons that include post-Covid pandemic normalization. Bausch Health (BHC) is a different case. While bouncing more than 30% in 2023, shares of the troubled Canadian pharmaceutical firm had a brutal 2022 — and, for now, remain stuck in the legal mud. Its stock price is about a third of what it was less than two years ago.
The health-care sector’s underperformance in 2023 can be chalked up to a variety of factors — among them its relative success last year, when it fell less than 4% compared with the broader S&P 500, which had its worst year since 2008. In 2022, as Federal Reserve commenced an aggressive interest-rate-hiking campaign to try to slow down red-hot inflation, health care benefited from its limited sensitivity to swing in the economy. That defensive trade, however, lost its luster in 2023, as concerns subsided about an around-the-corner recession and investors began anticipating the end of the Fed’s tightening cycle. Add in the artificial intelligence optimism, and the conditions were ripe for investors to buy last year’s losers — such as technology stocks and other economically sensitive sectors — and take profits in their relative winners, like health care. “That helps to explain a big portion of the reversal we’ve seen this year” in the health-care sector, said Ryan Issakainen, an exchange-traded fund strategist at First Trust Advisors, which has a health-care ETF.
Key points
- Health-care stocks outperformed the broader U.S. stock market last year, but this year it’s been much-tougher sledding for the sector due to a variety of headwinds.
- Eli Lilly has been the best-performing Club health care stock by a substantial margin, driven optimism around its experimental weight loss and Alzheimer’s drugs.
- We feel comfortable owning our three other primary health care stocks: GE Healthcare, Humana and Danaher.
After this sector-level rotation emerged early in the year, individual corners of the health-care industry have also contended with their own mix of storm clouds. For example, the Inflation Reduction Act of 2022 weighed on the stocks of pharmaceutical companies whose drugs might be selected for Medicare’s new price-negotiation program, which kicks in 2026. That uncertainty lingered until late August, when the agency that runs Medicare announced the 10 chosen drugs. “Even if we’re not talking about the individual impact on revenue for individual pharmaceutical companies, there’s a sentiment overhang that also impacts the sector as these sorts of provisions become a reality,” Issakainen said. “It impacts investor psychology and sentiment, as well.” One of Eli Lilly’s type-2 diabetes treatments, Jardiance, was selected. However, the drug isn’t a primary reason for bullishness on the company’s long-term prospects. Favorable developments around Alzheimer’s and weight-loss drugs carried more importance for its stock price and our investment thesis.
For Danaher and its peers that sell products, tools and services used in the drug development process, business this year has been impacted by pandemic-related inventory build-ups and a slowdown in biotechnology activity, especially in China. The latter factor, in particular, has worsened lately and contributed to Danaher in July cutting its full-year sales growth outlook for the second time this year.
A regulatory decision on Medicare Advantage overpayments was among the early hurdles for managed care stocks — which includes the likes of Humana and Dow stock UnitedHealth Group (UNH) – then months later, in mid-June, the group got slammed again on concerns about rising medical costs, as patients started getting procedures that had been put off during Covid.
The other side of that coin, though, is medical-technology companies such as GE Healthcare, orthopedic device maker Stryker (SYK) and Steris (STE), which sells surgical instruments and sterilization equipment. The increase in procedures and improved staffing in hospitals has benefited these companies, making their stocks relatively strong performers compared with the health-care sector overall. Indeed, the health-care equipment and supplies industry index — home to GE Healthcare and the other two — has fallen only 1% so far this year. Shares of GE Healthcare have outperformed, with a 9.4% year-to-date gain.
Considering all the industry crosscurrents, we feel comfortable with our health-care exposure (with BHC as a question mark), particularly after locking in substantial profits on part of our Eli Lilly position last week. Simply put, Eli Lilly’s magnificent run this year prompted our discipline to kick in despite remaining confidence in its growth prospects driven by its type-2 diabetes drug Mounjaro, which could see U.S. regulator approval for weight-loss later this year, and its Alzheimer’s treatment, which may be approved by regulators before year-end. “Now we have room … to buy it if something short-term goes wrong that we don’t think is that horrible,” Jim Cramer added Thursday during the September edition of the Club’s Monthly Meeting.
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