Why healthcare stocks are recession resistant

Come the next recession, nothing will be immune from the downdraft, so the best you can do is position your portfolio now to contain high quality, dividend-paying, diversified holdings.

Healthcare is one sector that tends to perform better in a recession. That’s because the companies offer things we need all the time and purchase repeatedly. These include drugs and over-the-counter remedies, medical equipment, health insurance, hospital supplies, and retirement home services. New technologies including robotic aids, the interconnectivity of devices, and learning software, are creating new products and services that are making treatments more widely available. This brings prices down and acts as a catalyst for more sales.

So, when conditions change, share prices of healthcare firms often fall least and recover first. The companies will continue to pay dividends throughout and the best of best will increase them.

For example, Medtronic (NYSE:MDT), the world’s largest medical device company, raised its dividend in July for the 42nd year in a row. That means it has weathered every market setback from the Crash of ’87, through the dotcom bust of 2000 and the 2008 financial crisis.

Medtronic is the largest component of the U.S. Medical Devices iShares ETF (NYSE:IHI.The next biggest component is Abbott Labs (NYSE: ABT), another dividend champ. Abbott has raised its dividend for 48 consecutive years.  Stryker (NYSE: SYK), a third component of the ETF has a 25-year unbroken record of increases.

It adds up to well-run companies, with established global businesses, deep pockets, and staying power. Over the medium to longer term, they will benefit from three important energizers:

• Developed world aging populations need more drugs, more surgical treatments, and more managed care.
• New technologies are creating new ways to do things. Less invasive surgeries are shortening recovery time and so reducing hospital costs. The innovations include surgical robot aids which use software on phones and iPads to monitor things like pacemakers. Biotechnology, including stem cell research and regenerative therapies, are creating ways to tackle previously untreatable diseases.
• As emerging markets mature, their healthcare systems are expanding. The areas of growth include preventative and public health, expanding health insurance in the workplace and a broader array of surgical procedures.

Here are a few examples of the themes:

• Emerging market growth: In November, Amgen, (NDQ: AMGN) the biotechnology multinational, paid US$2.7 billion for a 20% stake in BeiGene, a Chinese biotech. BeiGene will sell Amgen’s cancer drugs in China and Amgen will help sell BeiGene cancer drugs outside China. Device maker Boston Scientific (NYSE: BSX) reported 20% quarterly growth for heart products in emerging markets, with robust sales in China and Latin America.
• New technologies: In 2019, pharmacy giant CVS teamed up with shipper UPS (NYSE: UPS) to test the delivery of prescription drugs by drone. Separately, UPS is using drones to deliver drugs in remote parts of Africa and received approval to use drones to move blood and tissue samples between labs in Raleigh, North Carolina. In the fall, it received wider approval from the U.S. Federal Aviation Authority (FAA) for a ‘drone airline’ to use unmanned planes to more widely deliver goods.
• Medical devices: A study published in the Journal of the American Medical Association (JAMA) Open Network on Jan. 10 finds that robot-assisted procedures accounted for 15.1% of all American general surgeries in 2018, up from just 1.8% in 2012. The U.S. is the biggest market, followed by western Europe, Japan, and China. In terms of the number of procedures each year, the one-two is U.S. and China.

Investment choices in Canadian companies are limited, in part due to the nature of our publicly funded system. The S&P/TSX Capped Health Care Index has 10 companies, of which five are cannabis companies, up from three a year ago. The median market capitalization is $3 billion.

There’s plenty more to choose from south of the border. The S&P 500 Healthcare Index has 61 constituents with a median market capitalization of US$30.8 billion.  Globally, the U.S. ranks highest in overall healthcare spending.

The U.S. industry was under pressure in the first half of 2019, but the outlook improved as the year went. The healthcare sector ended the year as the second worst performing S&P sector behind energy, though ‘worst’ wasn’t so bad. Healthcare was up 16.23% for the year compared with 26.41% for the S&P 500.

Insurers and pharmaceuticals were most affected and so may be among the places to look in 2020.

In early 2019, Medicare became a hot topic among Democrat contenders for president. The commentary talked about a radical rewriting of the U.S. healthcare system. The use of the word ‘socializing’ sent shivers up the spine of the investment community.

So, as quarterly earnings rolled out early in the year, the stocks of companies with strong results and good guidance struggled to rally. Those that missed saw painful sell-offs. What we saw then was what you might have expected about now.

The reality is that the American healthcare system is extraordinarily difficult to change. There are too many vested interests. Incremental change for sure. Squeezing of costs, yes. Applying new technologies to treatments, absolutely. But nothing radical – and no dreaded Canadian system in sight!

The Trump administration, long a critic of high drug prices, offered an example of incremental change just before Christmas.  The Food and Drug Administration will allow Americans to import lower-cost prescription drugs from Canada, weakening a longstanding ban that had stood as a top priority for the politically powerful pharmaceutical industry. Previous administrations had sided with the industry on importation, echoing its concerns that it could expose patients to risks from counterfeit or substandard medications.

By year-end the market was accepting that view and strong earnings were rewarded with rising share prices. The trend has continued in the early part of this year, along with the general market rise.

In summary, the healthcare sector is benefiting from trends and new technologies that are creating products and services we all need. As these products become more widely available, their prices drop, and they become more affordable in a virtuous circle. The companies have staying power and pay dividends that tend to rise. If the sector is out of favour, the stocks are that much cheaper.

3 ways to invest in healthcare

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(This article appeared in the Jan. 27, 2020  issue of the Internet Wealth Builder newsletter)