The best outcome of the recent U.S. election that health care investors could have hoped for was a divided government, and they got it (or so it seems). And while common wisdom has it that divided government usually provides the best investment environment for equity investors in general, this rings particularly true today for health care investors given the election’s unique dynamics and the rhetoric surrounding the sector.
For starters, President Trump was very vocal in the lead up to the November 3rd election about his administration’s plans to impose price controls on pharmaceuticals in the U.S. and on importing prescription drugs from overseas for many of the drugs currently available in the country, which are sold at rates typically negotiated between large insurers and the large pharmaceutical companies that produce them. Regardless of the merit of such policies from a public policy perspective and given the President’s track record in pursuing unorthodox economic practices (tariffs, in particular), it was very likely that a second Trump administration could have pursued such policies in earnest. The collective sigh breathed by large pharmaceutical stocks in recent days is in no small part attributed to this.
This is not to say that a President Biden will be any cozier with large pharmaceutical companies; on the contrary, his administration is likely to pursue even greater wholesale changes of the U.S. health care system, especially considering that, as candidate, Biden agreed to a pretty radical economic platform in order to gain the support of the self-described socialist Bernie Sanders, his erstwhile contender for the Democratic nomination. Under such platform a President Biden, with the support of a Democratic-controlled House of Representatives, would very likely propose and sign into law the implementation of a “public health insurance option,” which is usually the path policymakers take towards a single-payer system such Britain’s National Health Service (NHS). Such legislation has almost zero chance of clearing a Republican Senate. Thus, had Democrats been given a mandate to pursue such radical changes in addition to winning full control of Congress, such outcome could have proven quite devastating to health care stocks, especially among Pharmaceutical companies and Managed Health Care providers. However, Democrats not only failed to gain control of the Senate but also lost enough seats in the House to make any future legislation, especially one seen as too far to the left by voters, to be anything but a foregone conclusion. This rebuke of Democrats’ most progressive policy ideas and a path to legislate them into law is, in our view, the primary reason for the stock market to rally following the outcome (so far) of the election. [Readers should note, by the way, that Republican control of the Senate will, in fact, depend on the outcome of two runoff elections in Georgia on January 5th; however, both Republican candidates, running as the incumbents, are favored to win those races in what has been a traditionally Republican state].
A President Biden can nonetheless prove treacherous to the Health Care sector even absent wholesale change such as what we outlined above. More specifically, the Biden campaign has long favored two particular policies that could prove damaging to the health care sector. The first proposal would allow Medicare (the federal health care program for the elderly and the single largest driver of higher health care costs in the U.S.) to directly negotiate drug prices with manufacturers, giving the federal government outsized leverage with the pharmaceutical industry. The second one would create a government panel to review prices of new prescription drugs with no market competition. Both of these would be largely pernicious to large swaths of the heath care sector, especially for pharmaceutical and biotechnology companies and would, in the long run, probably result in much lower R&D spending in the development of new drugs. And while it’s still possible that a Biden administration may partially implement some of these ideas through the federal bureaucracy or through executive orders, Democrats’ losses in the House and failure to take control of the Senate will act as a break on their most progressive instincts.
Another important factor health care investors are probably assessing as of this writing is the likelihood that a Biden administration might sign into law a large tax increase, especially in corporate tax rates, without full control of Congress. So, while a centrist approach to taxes between a moderate Biden administration and a slim Republican majority in the Senate might yield marginal changes in tax policy, the election’s outcome means, in our view, that a complete undoing of Trump’s tax cuts should be mostly off the table. Recall that among the most notable aspects of Trump’s tax cuts was the lowering of the corporate tax rate from the statutory 35%—at the time among the highest in the OECD—to 21%, now among the most competitive in the industrialized world. Furthermore, under his tax reform, the U.S. moved to a territorial tax system under which corporations are no longer penalized when repatriating profits earned overseas, on which taxes have already been paid in the jurisdiction where they were earned. Any undoing of such structural tax policies would result not only in higher corporate tax bills but also lower levels of capital expenditures and corporate spending, which helped propel the U.S. economy before the Covid-19 pandemic. Health care companies, especially pharmaceuticals and biotechnology companies with large R&D budgets (and the providers that manage much of such R&D) would likely be among the industries most affected by such changes.
Assuming our logic above holds, the lifting of political and regulatory clouds that have hung over health care stocks all year might lead investors to once again focus on company fundamentals and what we believe is a very positive macroeconomic background for the sector (aging demographics, prevailing chronic diseases, underinvestment in health care by emerging economies). The timing of this could be quite propitious given how quickly the picture for such companies has been brightening, as most of the large health care companies that have reported earnings recently seem to have put behind them the worst of the Covid-19 crisis. Johnson & Johnson (member of our Developed Markets Health Care Index), for example, reported a 3% drop in medical device sales during its recently reported third quarter, a dramatic improvement from the 30% drop it experienced during the second quarter. United Healthcare, the largest managed care provider in the U.S. (and also a MarketGrader Developed Markets Health Care constituent), reported modestly lower results also for its third quarter, following a precipitous decline in care-utilization rates in the second quarter. This last point is important, as most people postponed or canceled elective procedures earlier this year as health care systems globally coped with the pandemic and patients avoided health care facilities either by choice or government mandate. This decimated the business of large swaths of health care providers including hospital operators, diagnostics providers, medical device makers and medical specialties companies. Yet, the worst of the adverse financial effects of this situation have already been reported by most public companies in the sector and have been incorporated into most investors’ calculations while now, the same companies that reported abysmal drops in client visits and overall business activity earlier in the year, are reporting a massive amount of pent-up demand for non-Covid health care services, from which private providers are now starting to benefit. Unfortunately, it is also now clear that missed screenings, postponed elective procedures, and reduced visits to the doctor and health care facilities are leading to significantly higher adverse diagnoses, mental health problems, and overall poorer outcomes than would have been the case in a normal year. And despite the terrible human consequences of this, such trends also mean health care providers will see a sustained demand for their goods and services, which for many companies will be augmented by new Covid-related business (vaccine manufacturers, distributors, therapeutics providers, etc.).
Lastly, investors should not overlook the role that overall investor sentiment and market momentum could play in propelling health care stocks higher. For one, health care stocks have mostly lagged the broad market, especially in the U.S., where large cap tech has led all sectors since the spring. Additionally, health care valuations are still largely in line with historical multiples and have ample room to grow. We thus see clear signs of a change in market leadership and believe health care could be poised to assume part of that leadership along with a few other sectors that have fallen behind the large benchmarks since the March rebound. We also believe that the storyline presented in this column is not unique to our thinking but could have widespread momentum globally, especially with the U.S. election behind us and much of the regulatory overhang mostly in the rearview mirror. Furthermore, any positive news on the Covid-19 front (like Pfizer’s recent announcement about how effective its vaccine candidate appears to be) are likely to act as catalysts not only for the entire health care sector but also for many of the segments of the market that have lagged large cap growth so far this year.
