Healthcare sector driven more by theme than fundamentals

February 05, 2020 14:48
The coronavirus outbreak has prompted investors to look for theme stocks that could benefit from the crisis. Photo: HKEJ

Since the outbreak of the novel coronavirus in central China's Wuhan, investors have been looking for theme stocks that could benefit from the crisis. Stocks of companies that make or distribute masks and medicines, for example, have skyrocketed.

We should remember, however, that while the speculative concept is one thing, earnings performance is another.

Ultimately, there could be only a few inventions to kill the virus. Also, it is entirely possible that the epidemic might end by this summer even before relevant medicines become available.

In general, the chase for medical plays reflects investors’ hopes for a breakthrough in drugs to cure deadly diseases. But there are many more fatal diseases than medical breakthroughs.

Most firms in the medical and healthcare sectors are actually not chasing breakthroughs but manufacturing drugs for daily use. Their profit margins are not high, given the lack of valuable patents.

In that sense, the value of the industry lies in the production of daily necessities. Its products look more like common goods than high-tech ones.

As such, the sector’s cyclical behavior should mimic economic booms and busts rather than exhibiting long but large-amplitude up and down cycles.

Let’s take a look at some data to see if that is the case.

From the industrial production index (IPI) compiled by the Federal Reserve Board, there is a category called the pharmaceutical and medicine sector (blue line). The business cycles are of standard frequency where the peak-to-peak or trough-to-trough time gaps are mostly of a few years at most.

In the longer run, the trend growth has been much lower this century than in the previous one, thereby presenting a contrast to the booming technology sector and suggesting that the extent of innovation in the pharmaceutical and medicine sector lags behind that in the tech industry.

Also shown in the chart is the Consumer Price Index (CPI) component of the medical drug sector (red line), as compiled by the Bureau of Labor Statistics. The CPI measures the price level paid by consumers, which also indicates roughly the level of industry revenues.

Presumably, if there is a Producer Price Index (PPI) for the sector that measures the cost side, the growth of CPI minus that of PPI should reflect the profit trend of the sector. Yet there is no such corresponding breakdown for PPI.

But we will notice that the growth pattern of CPI for the sector roughly tracks that of IPI with a delay of five years. The IPI trend suggests the earnings outlook for the sector is not very bright.

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Data: Federal Reserve Board

The author is Adjunct Professor in the Department of Economics and Finance, City University of Hong Kong and previously the chief economist of a bank. (, [email protected])