MONTHLY COMMENT

After a strong start to the year for the healthcare sector, sentiment turned sour in February, which was characterized by political and macroeconomic uncertainties. Equity flows favored defensive stocks, with rotation benefiting the larger pharmaceutical companies, among others. Medtech and biotech were caught on the other side of said rotation while healthcare services struggled due to the political headlines.

”One big, beautiful bill”

During the month, the House of Representatives narrowly voted to pass a budget resolution in dramatic fashion. After almost cancelling the vote, Speaker Johnson and President Trump managed to rally their party behind the proposal with only one representative breaking ranks. The representatives tried until the very last to defend their areas of interest from cuts. However, Trump’s influence over the party was too strong, and many moderate republicans finally agreed to support the budget resolution.

The budget resolution gives instructions for the House to begin the reconciliation process. The instructions allow for up to $4.5 trillion in tax cuts and $2 trillion in spending cuts over a 10-year period. Importantly, the House and the Senate must agree on a common budget resolution before the work on the committees can begin. At the end of the month, the Senate approved a different version of the resolution. The Senate seemingly preferred to split the process into two separate bills, while Trump and the House of Representatives wanted, to quote the president himself, “one big, beautiful bill.” For healthcare stocks, one single bill, rather than two, would be preferable, as it would avoid a prolonged process and a possible lingering overhang which might extend into the end of the year if two bills were pursued.

After the committee process, the initial text of the bill will be drafted with detailed provisions. Following this, it will be assembled for consideration in both chambers of Congress, where further negotiations and scoring of the bill will take place. The Trump administration wants to complete the process as soon as possible, and the House of Representatives has set Memorial Day (May 26) as the deadline. However, this timeline is widely questioned.

The area within the healthcare sector that appears to be most affected is Medicaid. Republicans have set their sights on $880 billion in cuts to the program which provides health insurance for half of all children in the US as well as those people with the lowest incomes (typically, individuals earning below the federal poverty line qualify for Medicaid).

Medicaid cuts look likely

The three largest areas of the US budget are discretionary spending, Medicaid and Medicare, and Social Security. Trump has promised not to touch defense spending (which accounts for half of all discretionary spending), Medicare, or Social Security. This leaves Medicaid, non-defense discretionary spending, and other areas, the largest of which is interest payments. Inevitably, the conclusion is that Medicaid is at risk for cuts.

To assess the impact on healthcare equities, several factors should be noted. Medicaid-eligible patients are not an important profit stream for pharmaceutical companies, as they receive discounted drug prices and consume generic drugs to a greater extent. Similarly, medical device companies receive the lowest reimbursement rates from Medicaid among all payers and would only be marginally affected. Moreover, Medicaid is less likely to provide coverage for innovation. The most impacted sectors would be hospitals and insurers, as these patients have become significantly more profitable over the past four years due to directed payment programs and re-verification provisions during the pandemic.

Higher inflation expectations led to lower US treasury yields

The pace of job growth in the US slowed following two months of robust figures. Unemployment fell slightly, while wage growth remained solid. Inflation came in slightly higher than expected, making it increasingly likely that the Federal Reserve will hold off on further rate cuts. Following Trump’s order on tariffs, inflation expectations rose further. Overall, the US 10-year Treasury yield declined by 33 basis points during the month.

REFLECTIONS FROM THE MANAGERS

Despite a fundamentally strong earnings season, with robust growth in sales and earnings as well as promising full-year outlooks, the fund posted a weak performance in February. On average, healthcare companies exceeded analysts’ expectations by 1.5 percent for revenue, and 6 percent for earnings. However, the combination of the challenging macroeconomic environment and the continued lack of interest from generalists, meant that the sector still faced significant challenges. The first month of the year started with increasing investor appetite and inflows into the sector, but this sentiment faded in February. Innovation- and growth-oriented companies were particularly affected by the lower risk appetite. However, we observed encouraging signs of gradually increasing interest in the sector, albeit from a low base. As such, we chose to see the glass as half full rather than half empty.

Potential increase in geopolitical uncertainty

Executives have voiced growing concerns about the macroeconomic and political landscape. One key issue is the potential impact of tariffs. Some analysts expect that medical devices could be largely exempt from tariffs, as was the case during the Trump administration’s previous period in office, but it is too early to draw any definitive conclusions. The pharmaceutical industry, however, could face greater challenges if Trump pursues a more aggressive drug-pricing policy or implements legislative changes affecting this part of the sector. Furthermore, potential cost-cutting measures within government-funded healthcare programs to finance tax cuts could create additional uncertainty and reduce healthcare spending, particularly regarding capital-intensive products. Historically, market concerns about political changes have often been overstated, and we believe it is likely that any reforms will be less extensive than initially proposed. Simply put, it would be too politically costly ahead of the 2026 midterm elections.

M&A and innovation

As we have previously highlighted, there is a substantial need for acquisitions within the sector, given the significant number of patent expirations scheduled over the next five years. Analysts estimate that pharmaceuticals with a combined revenue of over $180 billion will lose patent protection, creating a substantial need for new revenue streams. Relying solely on internal pipeline development will not be sufficient to bridge this gap, and we therefore expect M&A activity to accelerate. The sector’s level of innovation remains high, with several planned major product launches and increasing investment in research and development.

We expect 2025 to be characterized by heightened M&A activity, continued improvements in healthcare productivity, and stable underlying demand for both pharmaceuticals and medical technology products. Additionally, we foresee key product launches, critical clinical trial data, and geographic expansion during the year, which, based on current consensus estimates, is expected to drive earnings growth of 17 percent for the sector – twice the rate of a broad global equity index.

With the earnings season now behind us, we enter a period where macroeconomic factors, geopolitics, and several key medical and scientific conferences will set the tone and sentiment in the sector. In our view, expectations for the healthcare sector from generalist investors remain low, which should provide a favorable starting point for the sector.