Everyday is a new high in global equities as central banks easing and hopes of a US-China trade deal have created a very strong narrative that nobody wants to sell short. But the strong momentum rally sets the equity market up for a potential powerful decline should reality turn out to be that of an even weaker economy with signs of spill over effects into the broader labour market. The next two months are crucial in the assessment of the “soft patch” scenario that equities are basing their price action on.
The global economy according to OECD’s global leading indicators (CLI) the economy is growing below trend growth and slowing down which is what we define as the contraction phase. Historically this phase is not good for equities vs bonds and we also observe across most industries that they underperform relative to the risk-free rate. One of the industries that tend do reasonably well on a relative basis is the Pharmaceuticals, Biotech & Life Sciences industry. Given the rising macro uncertainty we have a lot of clients asking for our view on the general health care sector so in today’s equity update we will provide our view on the sector.
As our business cycle map shows the health care sector consists of two industries; 1) Healthcare Equipment & Services and 2) Pharmaceuticals, Biotech & Life Sciences. They are both defined as defensive industries as they exhibit lower volatility than the general market and provide excellent risk-adjusted returns during the critical Slowdown phase. According to our business cycle map the Pharmaceuticals, Biotech & Life Sciences sector is worth having exposure to in the current business cycle phase but investors have to be prepared to reduce exposure when the economy swings into the Recovery phase where other industries such as Semiconductors, Real Estate and Consumer Durables & Apparel are more high beta plays. One key observation is that the Healthcare Equipment & Services industry tends to do well in the Recovery phase so investors should do a rotation within the health care sector during the phase transition.
One thing
is history and while it often rhymes it does not predict the future with any
high accuracy. The upcoming US election in
2020 has the potential to be a significant factor for explaining health care
returns. The chart below shows the relative performance between the S&P
500 Health Care Index and the S&P 500 Index since mid-April and the PredictIt’s probability of Elizabeth
Warren becoming the Democratic presidential nominee. During the month of May
when US equities lost 7% the health care sector outperformed the market
delivering the promised downside hedge. At this point Elizabeth Warren was a
distant possibility in the political race. As
her momentum accelerated into early October the “Warren factor” became more and
more dominant dragging down health care relative performance. Likewise, the
reversal of her probability for being nominated has seen health care stocks surge
relative to US equities in general. The key message is that Elizabeth Warren
should be on the radar of investors with exposure to health care. It might be
that Trump will surpass Warren on changing the health care system, but for now
the Warren factor matters to health care
stocks.
factor to consider if one’s investment horizon spans multiple years is the valuation of health care stocks reaching
its highest level since late 2001 and is now flirting with dot-com valuation
levels. As we have talked about in multiple equity updates there seem to be
a substitution effects from bonds into safe stocks with robust cash flows as
rates decline. If US rates go even further from here, it’s plausible that health
care sector valuation could reach the dot-com levels. But remember that
valuation has a good historical track record of predicting future returns in
the sense that the higher the valuation starting point of an investment the
lower the future expected return is.
The Saxo Bank Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Bank Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Bank Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Bank Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Bank Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Bank Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.
Please read our disclaimers:
– Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
– Full disclaimer (https://www.home.saxo/legal/disclaimer/saxo-disclaimer)
– Full disclaimer (https://www.home.saxo/en-mena/legal/disclaimer/saxo-disclaimer)
![Peter Garnry](https://www.home.saxo/-/media/content-hub/images/general/author-profile-pictures/peter-garnry-400x400.png?mw=48)