The number of people using government health programs like Medicaid and Medicare has increased from 43% in 2019 to 45% in 2023, which has limited how much healthcare providers can earn.
Over the past two years, healthcare stocks have experienced significant outflows and underperformance relative to the broader market, despite positive catalysts like innovation and weight-loss drugs. Since early 2023, the S&P 500 healthcare index has risen just 4%, while the S&P 500 surged 52%. Few sectors could compete with the Mag 7 during this time, which now account for nearly 40% of S&P market cap, but several factors contributed to weak earnings delivery and diminished sentiment for health care stocks specifically.
The recent J.P. Morgan Healthcare Conference offered a more optimistic outlook, highlighting significant developments in the anti-obesity drug wave, increased M&A activity and the promising impacts of AI technologies. After lagging the market significantly, investors must consider whether current valuations present attractive entry points for the sector.
Indeed, many factors that have driven recent underperformance appear to be easing.
- Easing profit margin pressures: Healthcare providers have faced labor shortages and pandemic-related inflation, compounded by long-term contracts limiting their ability to raise prices. As these contracts renew, pricing power should improve, and technological investments and better retention strategies are expected to alleviate labor tightness.
- Shifting payer mix: The number of people using government health programs like Medicaid and Medicare has increased from 43% in 2019 to 45% in 2023, which has limited how much healthcare providers can earn. However, this trend is expected to improve in 2025 as the commercial segment rebounds and certain government subsidies end.1
- Policy uncertainty: The Pharma, Biotech, and Life Sciences industries have been among the worst performers since markets began pricing in a Trump victory last fall. The new administration is expected to push for lower drug prices, and changes in Medicare plans may add to challenges. However, we might be at peak uncertainty and expect a clearer picture of the new policy direction in the coming weeks.
Meanwhile, key tailwinds are gaining momentum.
- Partnership and M&A opportunities: The industry is ripe for partnerships, and M&A activity is expected to increase in 2025 as companies have deleveraged from 2023 transactions and the patent cycle approaches.
- Obesity and specialty drugs: Obesity remains a key theme for the sector, alongside the growing use of specialty drugs.
- Technology-driven efficiency: Advances in technology are driving the expansion of home health and creating opportunities across software platforms, medical devices and advanced data analytics businesses.
- Demographics: An aging population is expected to drive increased healthcare spending in the long-term.
An active management approach with a keen understanding of the risks and opportunities in the space will still be crucial going forward. The opportunity set is vast, and within-sector performance can vary significantly. Healthcare is the third-largest sector in the S&P 500, behind tech and financials, and the fifth-largest sector in the Russell Midcap. Notably, Eli Lilly has been the best-performing stock in the index, while Pfizer, once a leader in COVID vaccines, has seen its stock fall by over 50%.
As such, security selection will be critical, but for investors looking to rebalance mega-cap tech exposure, the defensive properties and long-term growth potential of the healthcare sector warrant a closer look.
Healthcare has underperformed the broad market, leaving valuations particularly depressed
Next 12m P/E
Source: FactSet, J.P. Morgan Asset Management. Data are as of January 13, 2025.