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 starting 2024 with more competitive returns relative to the broader S&P 500 Index, health care stocks gave up some ground by mid-year.
There’s a significant disparity between “winners” and “losers” among healthcare stocks, which creates opportunities and risks investors should consider.
n 2024’s early months, health care stocks generally kept pace with the broader S&P 500 index, a contrast to 2023 when health care significantly underperformed the market. However, by mid-year, technology stocks re-asserted their market dominance. Through July 11, 2024, the health care sector of the S&P 500 is up 8.98% year-to-date, lagging the S&P 500's 17.96% upswing.
“Health care stock performance year-to-date is reasonable,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “However, it isn’t able to keep pace with soaring returns driven by the technology sector.”
Despite its lagging performance, there’s little question about the significant role healthcare plays in American society. “It’s at the core of our daily lives,” says Haworth. “Health is important to our quality of life. Companies that provide healthcare products and services are also vital to our national economy.”
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 vary. 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 healthcare sector is far from a monolith. It’s common to see wide gaps between winning and losing stocks. That 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. Dating back to the end of 2022, 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 generated 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 it 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 its 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
Healthcare stocks ran into earnings challenges in 2024’s first quarter. Quarterly earnings for healthcare stocks were down 25% compared to first quarter 2023 earnings. Nevertheless, the sector continued to generate positive returns year-to-date, and is the second largest contributor to S&P 500 earnings in 2024, trailing only the technology sector.2
From 2014 to 2022, the healthcare sector modestly outpaced the broader market. Since that time, as technology stocks soared, healthcare stocks fell back, and for the 10+ years dating back to 2014, healthcare stocks are underperforming the index.2
“Investors can gain exposure to the healthcare sector by owning the S&P 500 through a passively managed index fund or ETF,” says Haworth. “Investors may also want to take a more selective approach, as the record demonstrates there can be varied performance within the healthcare sector.”
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. “Now that facilities are open and able to conduct procedures, healthcare providers face staffing shortages that may limit the amount of activity they generate.”
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, the plan is not yet fully implemented due in part to court challenges 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.”
Haworth also anticipates that healthcare costs could become a campaign issue in this fall’s presidential election, though no major proposals are yet on the table. “To this point, no candidate seems poised to put further pressure on pharmaceutical prices.”
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 such investment opportunities, 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 13.3% of estimated corporate earnings generated by S&P 500 companies in 2024’s first quarter. Healthcare ranked behind only the information technology in terms of contributions to the S&P 500’s earnings. S&P’s estimates project healthcare stocks will generate earnings growth of 14.8% in 2024, closely in line with growth expectations for the broader S&P 500.2
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 2024, healthcare spending is projected to represent 17.7% 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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