Healthcare stocks have certainly caught a nasty cold recently. Investors have fled as if they fear an infection. But as with humans, so with stocks – a brief bout of the sniffles does not mean the patient has caught terminal pneumonia.
"It is possible that one or two of them decided to devote their time to the health and welfare of the tribe"
The MSCI Health Care sector has been the best performing of MSCI's 10 main sector indices in the past 20 years, returning 10.2% a year in US dollar terms versus 6.5% for the MSCI World index. Furthermore, investment returns have been quite steady - the annualised standard deviation of returns in the period has been 13.2% compared with 15.3% for the MSCI World index. Can this continue? If it can, the recent declines in share prices across the sector could well represent a good buying opportunity.
If there is a threat to the industry, it could be from regulation of pricing, though politicians will be aware that without profit incentives, companies' expenditure on research and development would decrease, perhaps substantially.
On a longer view, let's not forget that looking after our health is perhaps one of the most basic of human instincts. Ever since the invention of the plough, successive increases in labour productivity have enabled humans, either individually or collectively, to spend more on health.
The plough did not necessarily mean that we humans ate more. It meant that we had more time to focus on things that were important to us. As Adam Smith wrote in The Wealth of Nations: "By means of the plough two men, with the assistance of three horses, will cultivate more ground than 20 could do with the spade."
Of the men not ploughing, it is possible that one or two of them decided to devote their time to thinking about the health and welfare of the tribe. So, it seems unlikely to me that our desire for good health is likely to diminish, which is what makes healthcare so interesting as an investment theme.
As nations become wealthier, they tend to spend a greater proportion of their total income on healthcare. According to a 2011 World Health Organization report entitled The Determinants of Health Expenditure: "Cross-section regressions of aggregate health expenditure per capita on GDP per capita consistently showed an income elasticity significantly above one, from about 1.20 to 1.50," meaning that if broad GDP growth is, say, 2%, growth in healthcare expenditure would be 2.4%-3%. If you are positive about global economic growth, the evidence suggests that you should be even more positive about growth in healthcare expenditure.
Indeed, it is this relationship that may explain the lower rate of growth in healthcare expenditure in OECD countries since the financial crisis. According to the OECD, real per capita spending for developed countries from 2005 to 2009 rose 3.4%, above the 1.4% that was registered for per capita real income as a whole. However, there has been a marked decline since then. From 2009 to 2013, real per capita spending on health rose by just 0.5% a year, compared with 0.2% for total spending. While there may be other factors, such as demographics and health system characteristics, that determine healthcare expenditure, it would appear that overall economic growth is the main one.
As for the prospects for global growth, two camps have emerged. One camp believes that growth is stagnating as scope for increased productivity declines, world population growth falls, and human plundering of natural resources reaches a limit. The other believes that scientific and technological advances will continue to drive human progress, in the same way the plough did.
I have sympathy for both viewpoints, but on balance I side with the optimists (the pessimists' logic seems increasingly to be that since the world economy is an almost infinitely complex system -it is innately unstable - whereas it may be that the opposite is true: that it is the complexity that provides the stability).
Recently, I attended an event that featured a series of short talks on the subject of space. Among the speakers were Lars Blackmore of SpaceX and Barney Pell of Moon Express. Both talked of technologies that would help to transform the human race. In the case of SpaceX, it was reusable rockets that could land vertically, useful for colonising planets that do not have their own airstrips then returning to land gently on Earth. Video evidence of rocket tests suggested that the company was very close to perfecting the technology. As for Moon Express, the company in 2013 unveiled a lunar lander that could, among other things, be used to mine for resources, providing some relief for planet Earth.
Colonising other planets and mining the moon may be far-fetched ideas. But then the first notions of the steam engine, the internal-combustion engine, or the computer - all huge drivers of productivity growth at different times - must also at one point have seemed far-fetched. The point is that there is a healthy pipeline of crazy ideas belonging to apparently sane, intelligent people that might actually come to something.
Closer to earth, and closer to the sector under consideration, scientific advances also abound. It was recently announced that this year's Nobel Prize for Chemistry has been awarded to three scientists for their work in understanding how cells repair damaged DNA and safeguard genetic information.
As the Nobel Prize website notes, the scientists' work "has provided fundamental knowledge of how a living cell functions and is, for instance, used for the development of new cancer treatments". It would seem that the long-term prospects for economic growth in general and healthcare specifically are sound.
As for stock market valuations, they do not appear stretched. Of the subsectors that make up the MSCI Health Care Index, only Life Sciences Tools and Services on 30 times trailing earnings and Biotech on seven times book value appear to be fully valued in relation to their history and the broader market. However, the sectors accounts for just 19% of the broad healthcare index, leaving plenty of opportunities elsewhere.
Published in Financial News
The views expressed in this communication are those of Peter Elston at the time of writing and are subject to change without notice. They do not constitute investment advice and whilst all reasonable efforts have been used to ensure the accuracy of the information contained in this communication, the reliability, completeness or accuracy of the content cannot be guaranteed. This communication provides information for professional use only and should not be relied upon by retail investors as the sole basis for investment.