Health care and Swiss equities revisited
Global health care equities troughed in April after a tough year. The drop started in 2020 as seen in the sharp correction in relative price-to-earnings ratios, from a 16% premium in March 2020 to a 10% discount in just five months. The sector is now trading on par with market PEs, but still one full standard deviation below the relative 10-year average. In the past decade, it had only once traded below these levels, in late 2016, when US 10-year yields rose by around 100bps and equity markets rallied after Trump was elected. Back then, the weight was heavy on long-duration equity sectors, such as health care, similar to the past 12 months, with nominal yields rising and defensives underperforming.
Any certain segment of the equity market obviously could not be expected to do well just because of attractive valuations, in fact that may just point to forthcoming earnings downgrades. For the health care sector though, it appears that relative earnings revisions are at an inflection point. Firstly, earnings revisions for global equities are likely to retreat in the coming weeks as macro momentum weakens. Given its relatively more stable earnings, health care equities’ relative revisions should move higher. Secondly, headwinds from a weak US dollar may well fade somewhat, which would support global earnings of a sector which has an outsized US revenue and earnings footprint.
After strengthening briefly during the first quarter, the US dollar has pulled back again lately, revisiting its 3-year lows. Given that the trade-weighted US dollar typically follows the relative cycle of global services to global manufacturing, which has recently seen a turning point, the US dollar may climb higher in the short term. The relative gain of services PMIs vs. manufacturing PMIs may be an indication of a cycle maturing, paired with the roll-over of various pro-cyclical trades.
Putting all these arguments together, it appears that there should be potential for global health care equities to outperform: valuations are still looking attractive, yields have lately been moving in the right direction, and still a little shy of the current yield levels. The weak US dollar has been a major headwind for the sector, but further material short-term USD decline would require a shift in the current macro environment, with the manufacturing cycle re-accelerating again fast to new all-time highs – a scenario which cannot be excluded, but does not appear overly likely.
Since the Biden administration took power, taxes have been a threat hanging over the sector. If major corporate tax hikes have become more unlikely over recent weeks, with opposition in Congress mounting and signs of the Biden administration using the planned hikes as a bargaining chip to assure support for other projects, such as those on the infrastructure agenda. With strong opposition from Republican lawmakers, it is not even sure anymore whether the global minimum tax threshold would be enacted. Given that the health care sector is a key beneficiary of global tax arbitrage, these developments may explain why the sector’s performance has come to life recently, after underperforming key driver for some time.
The arguments which can be made for global health care, also broadly applicable to Swiss equities, with dominant presence in the health care sector. Their valuations have somewhat recovered – as a result of the Swiss market’s recent outperformance and the promising prospects including valuations of global health care equities – but are still below the long-term average. Their earnings momentum is stronger though than that in any other major markets. More importantly, with macro momentum slowing, and rates are range-bound and vulnerabilities are more pronounced in other more expensive markets (e.g. the US), Switzerland should continue to deliver above market returns in a moderate upside and even more so in a downside scenario.
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