Looking Forward: Healthcare

Today’s announcement by the Obama administration that they are looking to bring a comprehensive healthcare overhaul bill to vote through the House as soon as July 31st has been garnering a lot of attention to the sector. Wall Street has recently spurred an industry-wide selloff on worries that the plan could undermine the private health care market and therefore hurt profits, but now some investors are betting that the selloff was a knee-jerk response, and that healthcare could be poised to make a comeback.

First, let’s put things into perspective:



The table above (rightfully credited to Bespoke Investment Group) shows the S&P 500 healthcare sector cumulative advance/decline line. The sector bottomed out in 1994 following fears that the Clinton Health Plan would nationalize health care, but since then has bounced back quite nicely. Fast-forwarding to today, investors are now starting to believe that the markets are overreacting in a similar fashion to Obama’s proposed healthcare reform. If anything, the administration’s plans might actually stimulate the industry, not stifle it.

Recent figures show that total US healthcare expenditures are sitting around $2.39 trillion, and are expected to increase to $2.72 trillion by 2010, with annual increases averaging about 7% for the next 10 years. In 2008, federal spending on Medicaid and Medicare accounted for over 21.9% of all federal government expenditures.

Medicare, which currently provides coverage to 44.8 million American seniors, is expected to grow to about 78 million by 2030 due to the massive number of Baby Boomers who will be entering retirement age. Federal Medicare expenditures grew from $432.6 billion in 2007 to $457.5 billion in 2008. Federal government expenditures on Medicaid increased to $203.8 billion in 2008 from $190.6 billion in 2007. Even with reform in place, health spending in the US is expected to grow from about 16.5% of GDP to close to 20% of GDP by 2016.

As far as proposed plans go, the government’s economic stimulus package provides several provisions that should prove favorable for the healthcare sector over the coming 10-year period. I will discuss these individually below:

1. The plan will provide the National Institutes for Health, the US medical research agency, with an estimated $10 billion in extra funding which will consist of $9.5 billion for medical research and $0.5 billion for facility repairs and renovations. To quote a report released by S&P market researchers, this basically means that more scientists will be hired, more projects will be funded, and more grants awarded. Companies that sell products and services directly to NIH-funded facilities, such as Affymetrix (AFFX), Illumina (ILMN), Life Technologies (LIFE), Waters (WAT), and Millipore (MIL) are likely set to profit from this.

2. The package also includes approximately $87 billion to states in additional Medicaid funding over a 27-month period through December 2010. This extra funding is expected to reduce cuts on Medicaid reimbursement to hospitals from states facing Medicaid budget shortages. In addition, the bill provides another $25 billion to subsidize 65% of the cost of continuing health insurance coverage via COBRA. This should benefit the hospitals and managed care facilities, as it should limit the increase in the growth of uninsured.

3. Finally, the American Recovery and Reinvestment Act of 2009 (ARRA) is expected to result in the direct hiring of 1.5 million workers for projects financed by the program, one of which is the health information technology (HIT) project which will receive $19 billion in funding. Health-related technology stocks dealing with medical diagnostics lab equipment, digital medical records and medical imaging technologies are set for future gains as a result.

That isn’t to say that there won’t be any hurdles to overcome, particularly in the pharmaceutical and biomed sectors. Dr. Joshua Sharfstein, who was appointed Deputy Commissioner under the Obama administration, has a history of hostility to the pharmaceutical industry. Industry experts believe that Dr. Sharfstein is likely to apply more rigor to pharmaceutical oversight, raising the bar with respect to safety and efficacy in new product approvals and applying increased surveillance of marketed products. This, of course, would have negative implications for branded drug makers, but could potentially prove favorable for manufacturers of generic drugs. In addition, President Obama’s choice to head the Federal Trade Commission is another appointment that is not friendly to branded pharmaceutical interests. Standard & Poor’s recently added the following:

“Mr. Leibowitz is staunchly opposed to deals whereby branded drug makers pay generic companies to delay entry of their cheaper generics into the market for several years. Eliminating these “pay-for-delay” settlements is expected to be a key focus of the FTC under Mr. Leibowitz. These deals have become commonplace in the industry in recent years, and removing them would, in our opinion, hurt profitability.”

As usual this means that caution beats optimism when entering the healthcare sector, especially in such a volatile market. However through careful planning and selection, investors looking into healthcare as an alternative to the financial and retail sectors might find themselves beating the pack when the current rally inevitably dies down.