Goldman Says How to Avoid Policy-Risk Woes in Health Stocks

(Bloomberg) -- U.S. health-care stocks have shown that potential policy changes from the 2020 election are already on the minds of investors. Goldman Sachs Group Inc. has a few ideas about how to navigate such a tricky environment.

Investors who had been putting concerns about policy risk on the back burner, thinking election season was too far in the future to matter yet, all of a sudden had to focus on it again as of last week.

Health-care stocks in the S&P 500 tumbled 4.4 percent last week versus a drop of 0.1 percent for the broader index, fueled by comments from insurer UnitedHealth Group Inc.’s CEO about the “Medicare for All” idea advocated by some progressive Democratic presidential candidates. They have bounced back somewhat this week with a 1.5 percent gain, helped by hedge funds, but it’s still the worst-performing sector year-to-date.

“Policy risk will likely continue to weigh on health-care stock valuations during the remainder of the run-up to 2020 elections,” Goldman strategists led by Ben Snider wrote in a note April 24. “Investors should focus on relative value opportunities in the wake of the drawdown rather than taking a view predicated on the broad sector rerating higher.”

Examples of relative-value trades suggested by Goldman:

• If the focus of the policy debate turns to drug pricing from Medicare for All, managed-care stocks should outperform health-care peers
• Both biotech and pharma stocks are at risk from potential drug-pricing regulations, but biotechs have underperformed in 2019 and have lower valuations than pharma “despite faster expected earnings growth and stronger recent earnings revisions”
• Some other industries that face potential policy headwinds, such as companies related to student loans, for-profit education, coal and firearms, have outperformed health care this year

Health-care stocks often reflect policy uncertainty ahead of elections, and since 1976 have had the weakest median excess return versus the S&P 500 of any sector, the strategists wrote. But apart from that concern, fundamentals in the sector “look healthy,” Goldman said, citing strong earnings-per-share revisions and results from the early part of this earnings season.

In addition, political risk at this point is hard to measure. The Democrats vying to face President Trump in the general election have disparate views on health-care policy. Then they have to beat an incumbent who appears to have a decent chance of being re-elected. And control of both the House of Representatives and Senate will be in play as well. How all those things turn out will have a major impact on what type of health-policy changes would be considered.

That’s even before one tries to imagine how any legislation would take shape, how long it would take to win passage, and the timetable to get everything running.

“The combination of some health-care stocks’ depressed valuations and otherwise healthy earnings growth prospects should encourage investors to reevaluate whether the recent underperformance is warranted given the actual likelihood of policy reform and the amount of time such reform would take to be implemented,” the strategists said.

To contact the reporter on this story: Joanna Ossinger in Singapore at jossinger@bloomberg.net

To contact the editors responsible for this story: Christopher Anstey at canstey@bloomberg.net, Teo Chian Wei

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