We are looking for a potential opportunity in healthcare stocks

While healthcare has underperformed the broader market, Julien Nono-Womdim, VP, Portfolio Research at TD Asset Management, tells MoneyTalk’s Greg Bonnell that there may be pockets of opportunity.

Transcription

Greg Bonnell – There was a lot of excitement in health care space around weight loss drugs. But investors may be surprised to learn that healthcare stocks have outperformed the broader market. Joining us now to discuss whether the trend will change and the potential opportunity is Julien Nono-Womdim, VP of Portfolio Research at TD Asset Management. Julian, welcome back to the program.

Julien Nono-Womdim – Hi Greg. Thank you for having me. You’re right, it’s surprising. Healthcare underperformed the broader market early in the year, down 200 to 300 basis points against the S&P 500 at the start of the year. And if we extend that time frame over the past year, the healthcare sector has underperformed by approx 10%

Greg Bonnell – what’s going on That’s the thing, right…I’ve seen the headlines, the weight loss pills getting so much hype out there. But healthcare is a pretty big basket. So when we talk about that underperformance, what are we really talking about?

Julien Nono-Womdim – Yes, I think it’s important to step back and think about what the market is. And the way I like to think about it is that the market is like a marathon, only it’s an infinite one. And there, you have companies, industries, sectors competing for performance.

So right now the health sector is kind of at a standstill. Last year, earnings fell by about 15%. This year the gains will be almost flat, so they won’t be fast at all. In comparison, the technology sector and other parts of the market have grown their earnings quite substantially. So, on a relative basis, you’re not running as fast as you should. And so the relative underperformance is a reflection of that.

Greg Bonnell – So that means splitting the healthcare space into different names– weight loss drugs, pharmaceuticals, developers. Just some of the pockets of opportunity, I think, there. Let’s start with medical technology.

Julien Nono-Womdim – Yes. Yes. And so you are right. Healthcare is broad. There are different parts of the market. The way I like to think about it is pharma, biotech, drug companies, medtech companies, medical device companies — you have life sciences companies, drug manufacturing equipment companies, and of course of services — hospitals, insurers, etc.

And in the wider sector, there are parts that are doing relatively well. And this goes back to my running analogy. Companies that are able to run faster than the market are rewarded.

Take a company like Intuitive Surgical (ISRG). They recently released the fifth generation of their Da Vinci robot. Earnings are growing at a rapid rate. The volumes of procedures are very high. And the stock is up substantially against the market, both year-to-date and year-to-date.

This is just an example. But there are other examples of companies in tech and elsewhere where innovation, which leads to demand and therefore increased earnings, is rewarded.

Greg Bonnell – Is medtech one of those spaces as well where it’s a bit of a demographic play? I’m thinking, as I get older, my knees don’t feel as good as they used to. And maybe at some point a robot will go to work for me.

Julien Nono-Womdim – Well, I guess it’s not just medical technology. It’s the broader health ecosystem. I talked about this marathon analogy. Well, in the short term, the market rewards the companies that operate the fastest. In the long run, the market rewards the companies that can perform the most, right?

And so healthcare, you’re right, has secular winds. Every day in the United States, 10,000 people turn 65. And you’re right, people need hip replacements. They need knee replacements. There is a lot of innovation in cardiology that a company like Boston Scientific benefits from.

And so, in the long run, healthcare can continue to function. And I think the question investors have to ask is, maybe the tech sector or the Magnificent Seven, can they run a marathon at a sprint pace? Because they’ve been sprinting for the last 12 months or so.

Greg Bonnell – Very interesting stuff. So medical technology, some opportunities, maybe, there. What about the life sciences space? How do we think of these names?

Julien Nono-Womdim – Well, the life sciences space is quite interesting. This is interesting for two reasons. First of all, these are the companies that manufacture the equipment used to manufacture the drugs. They help in drug discovery. They also manufacture diagnostic supplies. So when you go into a hospital, you have to be tested for something, they supply a lot of those supplies.

And the industry has been through some challenges over the last couple of years, namely during COVID and beyond, there’s been a lot of stockpiling of these different consumables, number one. Number two, back then, the biotech funding environment was so strong that the demand for equipment was also strong. Another dynamic was that demand for life science equipment in China was also very strong.

All those things have receded. We went through a stock reduction. Biotech funding has been weak for the past year or two. It’s coming back, slowly but surely. And China’s economic growth has been a bit slow. So all those headwinds are starting to fade and the industry is starting to show signs of life.

We’re seeing with companies like Thermo Fisher (TMO) and Danaher (DHR) that their order books are improving. Behind them appears the storage of stocks. And more importantly, global growth looks like it may be recovering.

Greg Bonnell – Replay because obviously there was concern… I think throughout the whole summer, everybody keeps shifting back and forth, are we headed for a soft landing or a hard landing? Is global growth slowing? Or do we stand still?

Greg Bonnell – Aside from all those concerns about the broader global economy and the domestic economy, when we talk about healthcare, do we think of these as defensive names? Or is it the same when we dig below the surface and there are different pockets?

Julien Nono-Womdim – There are different pockets. Broadly speaking, the sector is defensive. It’s defensive because regardless of the economic environment, if you and I get sick, we have to go to the hospital. We have to be tested for various… you have to go through various diagnostics. And I think that adds a level of resilience regardless of the environment.

However, there will be pockets that will be more cyclical. And the life sciences, somewhat more cyclical. Pharma, something less cyclical. In general, the sector is less cyclical than the broader market.

Greg Bonnell – Is that the risk there, the cyclical forces at play in some parts of it? If someone is looking at the healthcare space, what do they have to weigh in terms of risk?

Julien Nono-Womdim – Well, they have to weigh a few things. First, on the pharmaceutical side, they have to weigh the loss of drug exclusivity, right? And that’s a headwind for a lot of pharmaceutical companies. On the medical technology side, they must effectively weigh the competition. Because the way doctors work is usually they try to choose the best alternative when it comes to a procedure.

So if a company makes a heart valve or designs a heart valve superior to one of the incumbents, they lose market share very, very quickly. And in fact, we see this all the time. As for the life sciences, you’re right… I think part of it has more to do with economic cyclicality.

If the economy slows, that part of the medical space will be adversely affected. I would say, however, in general, the industry is more resilient to the economy. And to your previous point, there are secular headwinds driving the continued demand for healthcare.

And is this an industry that I think can continue to operate at a sustained rate for a very long time? The answer is yes. Will it be ahead of the market in a given year? Obviously not.

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