What happened to healthcare stocks in 2023?

CIO talks through underperformance, long-term trends, and weight loss drugs as he looks ahead to 2024

What happened to healthcare stocks in 2023?

Investors might be forgiven for thinking the healthcare sector would perform better in 2023 than it did. The traditional defensive sector should outperform in choppy markets and provide safe haven to investors when economic news gets more dour. However, US healthcare companies have underperformed somewhat this year. The MSCI USA Health Care Index is down around 2.5 per cent YTD as of November 30th. The portfolio manager behind Canada’s largest US healthcare ETF, however, believes that one number glosses over a complex web of opportunities and challenges in the healthcare sector.

Paul MacDonald, Chief Investment Officer and Portfolio Manager at Harvest ETFs, told the healthcare sector’s story in 2023. The portfolio manager behind the Harvest Healthcare Leaders Income ETF (HHL), noted that there are a wide array of subsector stories that have driven healthcare performance. Chief amongst them was the rise of GLP diabetes drugs like Ozempic, which have opened up opportunities and risks in specific subsectors. Despite somewhat disappointing sector performance on the year, MacDonald stressed that the underlying driving forces behind the healthcare sector remain in place for the long-term.

“Permanent, non-cyclical drivers like aging populations, technological innovation, and developing nations continue to drive demand for healthcare,” MacDonald says. “Following relative outperformance for healthcare in 2022, it’s been a bifurcated market with concentrated tech as the outperformer. But for people to think that healthcare is just pure defense and no growth, is a bit one-sided.”

MacDonald notes that some of the large established healthcare companies in the HHL portfolio should perform well during economic slowdowns, and that some large pharmaceuticals should have done better this year, the US slowdown has been more narrative than real so far. In fact, US resilience against economic headwinds has been key to the continued outperformance of growth stocks against some of the more value plays in healthcare.

Are GLP drugs a game changer?

Healthcare also comes with a significant growth element to it as well, driven largely by R&D and the development of new drugs, treatments and devices. The biggest R&D narrative of the past year in healthcare was the launch of new glucagon-like peptide (GLP) drugs to treat diabetes. These drugs like Novo Nordisk’s Ozempic or Eli Lilly’s Mounjaro are designed to reduce patients’ appetites. Their clinical success in treating both diabetes and obesity have been greeted as a game-changer by healthcare investors.

While the drugs are currently only approved for diabetes treatments, the possibility of meaningful and effective weight loss drugs had an immediate impact on the healthcare sector. Rather than just a driver for pharma stocks, however, some investors began to discount the utilization of other treatments for diabetes or weight-related conditions. Many medical devices stocks sold off on the expectation that these drugs would remove the need for glucose monitoring or bypass surgeries.

While MacDonald believes these drugs have opened up a potential $100 billion market, he thinks the narrative of a complete overhaul in the whole healthcare industry was overstated. He notes the absurdity of one analyst commentary saying that as these drugs will prompt huge demand for new clothes as consumers lose weight, so investors should be buying shopping mall REITs.

While the impact of these drugs is expected to be huge, the fundamental realignment of the healthcare industry that some investors priced in earlier this year has been largely dispelled. MacDonald notes that over the past few months many of those medical device names have recovered significant value as investor expectations reset. 

What will 2024 hold for healthcare

MacDonald sees the continued uptake of these GLP drugs, and their potential application beyond diabetes treatment, as a major theme to continue next year. Moreover, he reiterates the ongoing demand for healthcare that will emerge from aging populations in the developed world and richer populations in the developing world.

Innovation, too, will drive some growth and MacDonald is paying particular interest to the tools and diagnostics companies that manufacture key components of the R&D process. Companies like Danaher and Agilent, he says, do significant business making diagnostic equipment and the reagents and reusables required to run them. As the pace of R&D continues, he expects demand for those companies’ products to grow considerably.

The US is heading for an election year in 2024, which in past cycles has been perceived as a headwind for healthcare overall. MacDonald, however, cites a relative lack of correlation between healthcare performance and elections. The only areas that sometimes face challenges are pharmaceuticals and managed care, but MacDonald says that savvy oscillation between the two subsectors can help ameliorate any issues. Moreover, while we don’t yet know the issues that will come into focus during the election, many of the policies that could be considered headwinds to healthcare have already been implemented. As of now, neither party is pushing for drastic overhauls to the US system.

The recent Fed decision to hold, and prediction of three rate cuts next year, has been greeted by investors as a catalyst for some growth stocks. MacDonald highlights, however, that we aren’t out of the woods quite yet. Geopolitical and economic risks prevail, and many analysts are predicting recessions in the US and Canada. He believes that in any environment, a US healthcare allocation is prudent.

“You have to be there,” MacDonald says. “The valuations are supportive, the consistency of the growth is attractive. When I look at the type of innovation that’s happening, we see significant growth potential. Given the fairly tough environment we’ve come through in 2023, I think we’re setting the stage for capturing a little bit of breadth on a sectoral basis, and we could be shaping up to see healthcare as one of the better performing sectors.”