Yuichiro Chino/Moment via Getty Images
Last December, I wrote an article in which I stated that the 30-month bear market in biopharmaceutical stocks had ended and that a rally had begun. I discussed the standard underpinnings of the rally, namely attractive valuations accompanying several acquisitions at generous premiums.
The rally in the sector persisted until early January, and this was followed by a mild correction. I now believe that the next leg of the rally, which should be the most profitable, may be about to unfold. Money managers have been under-invested in the sector, yet they are cognizant of the tremendous opportunities for stock price appreciation from new drug discovery.
The fundamentals of the healthcare industry remain favorable. US healthcare expenditures were $4.5 trillion in 2022, accounting for 17.3% of GDP. I forecast them to increase by an average annual rate of 6% through 2030, at which time they will approximate $7.3 trillion and represent 25% of GDP. This will be driven by age demographics, as more of the baby boomers will be entering their 70s and 80s, which are two decades of significant healthcare needs. Per person personal health care spending for the 65 and older population was $22,356 in 2020, over 5 times higher than spending per child ($4,217) and almost 2.5 times the spending per working-age person ($9,154). Additionally, there remains a widespread prevalence of chronic diseases, which require more intensive medical care. It is estimated that nearly half of Americans suffer from at least one chronic illness, and 20% have at least two. People with chronic conditions account for over 90 percent of prescription drug use and are more likely to be hospitalized and stay longer than individuals without chronic conditions. Three of every four healthcare dollars are spent to care for individuals with chronic conditions. Between 1987 and 2002, two thirds of the growth in Medicare spending was accounted for by ten chronic conditions. The greater use of GLP-1 therapeutics, given the association of obesity with several chronic conditions, will mitigate these expenditures in the 2030s and beyond.
As to my rationale for near-term price gains, I note that investors have been underweight the biopharmaceutical sector for the past two years, as this group of stocks has dramatically underperformed. The rally last fall, driven by several acquisitions that shed light on the attractiveness of the stocks, resulted in the Relative Strength Rating of the group rising from 63 in early December to 96 in early January. Furthermore, the Investor’s Business Daily ranking improved from 73 to 12 during this timeframe, and it is currently ranked 2 of 197 groups tracked. If the next stage of the rally ensues, money managers will be forced to allocate more dollars to these stocks, which will further drive price gains. I expect the focus to be disproportionately on the small and mid-cap stocks, which have remained laggards.
From a fundamental standpoint, I have previously discussed the research renaissance in the pharmaceutical industry that is unfolding. I continue to find opportunities in oncology, cardiometabolism and gene therapies. Regarding oncology, the advances in immuno-oncology should continue for at least the next twenty years, and more cancers will become chronic diseases. As for cardiometabolism, while the consensus 2030 US revenue forecast for the GLP-1 class has increased from $45 billion to a range of $75-100 billion, it is still well below my estimate of $150 billion. At the December American Society for Hematology conference, favorable data was presented on menin inhibitors, CAR-T therapy and protein degraders, yet the relevant stocks are 20-70% below their respective highs. Acquisitions will continue to occur at solid premiums, given the need for several of the larger drug companies to augment their pipeline.
In using the XBI ETF (XBI) as a proxy for the group, I have identified the 94.75 level as resistance, which, if exceeded and held, should result in it rising to at least 115.
