Key takeaways
As the third largest industry represented in the S&P 500 Index, healthcare stocks play an important role in today’s capital markets.
After significantly underperforming the broader S&P 500 in 2023, healthcare stocks are only slightly lagging the market in early 2024.
There’s a significant disparity between “winners” and “losers” among healthcare stocks, which creates opportunities and risks investors need to take into account.
Healthcare stocks have enjoyed a solid start to the year, nearly keeping pace with the broader S&P 500 after a more challenging 2023, when healthcare stocks significantly underperformed the stock market. Through March 15, 2024, the S&P 500 Health Care Index gained 6.69%, about 1% below the return of the S&P 500. By comparison, in 2023 the Health Care Index badly lagged the broader market rising just 2.06%, compared to a 26.29% return for the S&P 500.
Healthcare plays a significant role in American society. “It’s at the core of our daily lives,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “Health is important to our quality of life. Companies that provide healthcare products and services are also vital to our national economy,” says Haworth.
Over the past 50 years, healthcare has become a more notable component of the U.S. economy. Significant expenditure growth occurred between 1960 and 2005. The growth in expenditures as a percent of the nation’s economy (measured by Gross Domestic Product or GDP) moderated since 2005, except for a spike in costs in 2020, the year that COVID-19 emerged.1 The rise in healthcare spending is attributable at least in part to the aging of America’s population, as older Americans represent the largest users of healthcare services.
Investment opportunities in the healthcare sector are varied. They range from pharmaceutical companies to medical technology firms to insurers and operators of healthcare facilities such as hospitals and senior care centers. “An understanding of the underlying opportunities in the sector and an active management approach can play an important role in achieving success with healthcare investments,” says Haworth.
Haworth says the frequently wide gap between winning and losing stocks sets healthcare apart from one of the largest sectors in the S&P 500, information technology. “When some major technology stocks benefit, it seems to lift up the rest of the sector,” says Haworth. “The environment is different for healthcare stocks.”
“An understanding of the underlying opportunities in the sector and an active management approach can play an important role in achieving success with healthcare investments,” says Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management.
Haworth cites pharmaceutical companies as a prime example of how prospects can vary. In a nearly 15-month period dating to January 2023, Eli Lilly & Co., currently the largest stock in the S&P 500 Health Care sector, generated outstanding performance. Its stock price appreciation far outpaced the five other pharmaceutical stocks in the sector index.
Lilly & Company benefited from its key products in diabetes and obesity treatment, which captured significant market activity in recent years. Lilly is also awaiting approval from the Food and Drug Administration for its new Alzheimer’s treatment, although the FDA recently took steps that lengthened the approval process.
By contrast, Pfizer’s stock soared beginning in late 2020 and through 2021 on the strength of its COVID vaccine development. However, the company’s stock has struggled more recently as the company awaits its next big breakthrough.
“This demonstrates how much turmoil there is beneath the surface of the healthcare sector,” says Haworth. “In the pharmaceutical space, all of the spoils tend to go to the winner and aren’t spread to the industry as a whole.”
The important role that healthcare stocks play in the broader market is evidenced by their positions within key stock indices. Healthcare represents the third largest sector in the large-cap S&P 500 Index, behind information technology and financials.2 It is the fifth-largest sector in the Russell MidCap Index (an index of about 800 stocks). Within the small-cap Russell 2000 Index, healthcare is the second largest sector, trailing only industrials.3
On a year-to-year basis, healthcare stock performance tends to vary from that of the broader stock market. From 2014 to 2023, stocks in the healthcare sector of the S&P 500 outpaced the primary S&P 500 Index in four years, while underperforming in six years. However, performance is reasonably aligned in the longer term. Over the ten-year period ending Feb. 29, 2024, the S&P 500 returned 12.70%, compared to a return of 11.27% in the healthcare sector of the index.2
“Investors gain exposure to the healthcare sector by owning the S&P 500 through a passively managed index fund or ETF,” says Haworth. “There are also opportunities with a selective approach for those who are in a position to take advantage of active management of individual stocks.”
One potential constraining factor for the sector is the increasing emphasis placed on controlling healthcare costs. “The aging of our population indicates a strong demand for healthcare services, but there are constraints on what can be delivered,” says Haworth. He notes that since the COVID-19 crisis, elective surgeries have declined significantly. “This was a profitable business for providers, so the slowdown in elective procedures has a bottom-line impact,” says Haworth.
To an extent, says Haworth, healthcare must be rationed due to cost constraints. For example, Medicare and other insurers set payment schedules, determining the amount that healthcare providers are reimbursed for various services and treatments. In addition, under terms of the Inflation Reduction Act of 2022, Medicare can negotiate prices for 10 popular drugs paid for, in part, by the program. That can potentially limit revenues to pharmaceutical companies. However, this plan has yet to take effect. The ability for Medicare to negotiate drug prices is being challenged in court by the pharmaceutical industry.
Haworth notes that cost containment, in essence, occurs in other ways as well. “For example, as new drugs come to market, they can provide a more cost-effective means of treating a medical condition.” Haworth says when this occurs, it can be a boon for the company that developed and distributes the new drug, while taking away from the success of other companies that provided now outdated treatments. “While drug and medical technology advancements might appear to be beneficial in raising revenues and earnings for the entire industry,” says Haworth, “the difference between the winners and losers in these situations can be striking.”
Healthcare plays a critical role in our day-to-day lives. On that basis alone, publicly traded companies that address the demand for healthcare products and services offer intriguing investment potential. Advancements in life-changing drugs and medical devices can significantly enhance our quality of life. They also create potential to generate new revenue and profits for innovative companies that deliver those products.
Nevertheless, the disparate fortunes of healthcare companies, which can change significantly over time, create some challenges for investors. “There are clear opportunities in more active management of healthcare investments given the push-pull dynamic of demand relative to the winners-and-losers system in the pharmaceuticals field,” says Haworth. “For others, relying on a passive management approach, an S&P 500 Index fund or ETF may be the best way to access the investment potential of the healthcare sector.”
As you explore investment opportunities in the healthcare sector, be sure to discuss it with your financial professional. You’ll want to consider how healthcare investments can work within the context of your overall financial plan and investment strategy.
Healthcare represents one of the largest sectors of the major market indices. As of February 29, 2024, it was the third-largest sector in the large-cap S&P 500,2 and the second-largest industry sector in the small-cap Russell 2000 Index.3 With healthcare services representing more than 17% of the economy,1 investors can expect that healthcare should play an important role in their portfolios.
According to S&P Dow Jones Indices, the healthcare sector contributed approximately 13.5% of corporate earnings generated by S&P 500 companies in the fourth quarter of 2023. Healthcare ranked behind only the information technology and financial sectors in terms of contributions to the S&P 500’s earnings. In the fourth quarter of 2023, 49 of 64 healthcare companies beat earnings expectations, four companies matched expectations and only 11 companies came up short of earnings expectations.2
Over the past 50 years, healthcare has become an increasingly visible component of the U.S. economy. Significant expenditure growth occurred between 1960 and 2005, growing from 5% in 1960 to 15% of the economy in 2005. Expenditure growth as a percent of the nation’s economy (using Gross Domestic Product or GDP) has moderated since, except for a spike in costs in 2020, the year that COVID-19 emerged. In 2022, healthcare spending represented 17.3% of the economy.1 The rise in healthcare spending is related in part to the aging of America’s population, as older Americans represent the largest users of healthcare services.
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