A healthcare solution for the decade

Markets operate as a discounting mechanism and plenty of bad economic and health news has been absorbed. Coupled with hefty central bank support and fiscal measures, the general view remains that the lows in broad terms for equities and credit were clocked back in March.

That does not rule out some very choppy swings in sentiment over the coming months before the likely trajectory of an economic recovery post-lockdowns becomes clearer. There are promising signs and my early morning walk today was brightened considerably by the sight of our local café reopening. For the first time in two months I purchased a coffee, chatted with the lovely staff behind a clear plastic screen, and felt a sense of normality stirring in this part of south London.

Hopefully the trend steadily escalates and nurtures a broader economic recovery. In this respect, the equity market narrative of a rebound from its lows in March does not seem excessive. But there remains a danger that any recovery is a prolonged journey and littered with many potholes. Chief among them are defaults and bankruptcies along with plenty of furloughed workers finding that their jobs are gone.

This places broad market sentiment in a potentially nasty place, where towards the end of the year, rather than observing an accelerating pace of recovery, the reality is rather more challenging. This is a scenario that permeated Jay Powell’s remarks on Wednesday and which cloaked market sentiment a day later. This week is shaping up as being the largest decline for global equities in nearly two months, even after Wall Street closed higher on Thursday. While a mini-correction is hardly a shock after a lengthy rebound, it may be the story for a while.

Seema Shah at Principal Global Investors highlights this risk:

“Markets may be right to look through Q2 numbers and look forward to a Q3 recovery. But it is entirely possible that there will be a Q4 reckoning, where a second wave of job losses and prolonged period of business failures tests equity sentiment.”

The current retreat in risk appetite is also being accompanied by a stronger US dollar, buoyed in part by the Federal Reserve kicking back against negative rates. A firmer dollar registers widely, particularly across emerging markets.

BCA Research highlight an important missing catalyst for risk appetite: carry trades in emerging market currencies. For now, EM carry trades are still being cut as shown below, and that argues BCA means “liquidity is not making its way to the corner of the global economy where growth is generated”.

Still no greenlight from EM carry trades

It adds:

“A rebound in the performance of EM carry trades is therefore needed before global growth, cyclical plays, and yields can durably rebound.” 

In the interim, this suggests sticking with defensive and quality stocks. Among such ranks are companies that populate the healthcare sector. Both US and global healthcare stocks have outperformed their respective broader markets during the coronavirus pandemic.

That may just be the start.

Vincent Deluard at INTL FCStone thinks healthcare may well stand out as the sector that becomes the investment theme of the current decade:

“One does not need to be an MD to understand that healthcare is at the intersection of all the strongest trends of the next decade.”

Vincent notes:

“Healthcare is the only sector which can replace the jobs lost to automation and to Covid-19 in retail and leisure” and he also highlights how the sector “is not as expensive as other parts of the market and valuations matter less in secular bull markets”.

For those worried about Washington taking on the healthcare sector, Vincent adds:

“Global healthcare stocks can provide a hedge against the very real risk of a socialisation of the US healthcare system.”

In terms of valuations, the S&P healthcare group is hardly cheap, with a dividend yield of 1.7 per cent (versus a long-term average of 1.8 per cent), while it trades at 20.5 times trailing earnings and 4.2 times book value.

Another way of looking at the group is via its blended normalised valuation score (using dividend yield, P/E ratios [trailing and forward], price-to-book ratio, and price-to-cash flow ratio).

As seen here, healthcare sits 0.2 standard deviations below the post-1990 normal, while the S&P 500 index trades at 0.4 standard deviations above its post-1990 average blended normalised valuation score, according to INTL FCStone:

A deeper equity market correction over the summer will not exclude healthcare stocks, but for investors the key point about any pullback is deciding what merits buying with an eye on the long term.

Healthcare fits the bill for some investors and that also has implications for the future performance of regional share markets, a point that Dhaval Joshi at BCA Research often highlights.

The reasoning is that major benchmarks tend to have big sectors and also those that are less represented in relation to each other. For example, the S&P 500 is dominated by a one-third weighting in technology, which goes a long way towards explaining its global leadership of the past decade. The US benchmark also benefits from a large healthcare sector, at about 13 per cent, a level it has held for the past two decades according to INTL FCStone.

In contrast, the UK FTSE 100 is dominated by financials and energy, while lacking tech. Europe’s Stoxx 50 is also led by financials, and lacks heft in the form of tech and healthcare. But as Dhaval notes, there are areas within Europe that will gain from a secular trend that favours healthcare:

“If healthcare outperforms then its over-representation in the stock markets of Switzerland and Denmark means that they must outperform too.”

Japan’s Nikkei 225 is led by industrials at the expense of financials and energy, while MSCI’s EM index is dominated by financials and lacks a weighty healthcare presence.

A brighter decade for healthcare may not end US equity leadership. In fact the push for vaccines and preparing for future outbreaks suggests the S&P 500 remains a global benchmark that has a new leadership candidate for the 2020s. I guess plenty rides on US healthcare effectively lobbying Washington.

Quick Hits — What’s on the markets radar?

Oil prices are on the up, buoyed by a less dire outlook for demand via the International Energy Agency, noted here by the FT. Lower stocks of US crude also helps, but oil prices face a tough time rising much beyond their current levels of $31 a barrel for Brent and $27 a barrel for WTI.

The UK pound has few friends at the moment, hit by weak economic data, Brexit jitters and a very dovish Bank of England. This leaves the pound at about $1.22 and at a level seen in early April. In spite of the BoE pushing back against negative rates, the market is not ruling out such a course of action and that hardly helps the currency. The yield on the two-year Gilt is now -0.035 per cent, a new record low according to Tradeweb.

A bleaker mood also shrouds eurozone banks and the single currency.

Stephen Gallo at BMO Capital Markets notes the health of eurozone banks is an important barometer and it is currently “flashing red” as shown here:

Stephen warns that for financials:

“Legacy issues in the eurozone are arguably bigger, and economic stagnation has demonstrated a tendency to take hold over longer periods.”

Source: Economy - ft.com