Healthcare Stocks Are Just Starting Their Resurgence. Hold On to Them.

An aging population means increasing sales of medical equipment from companies such as Boston Scientific. (Courtesy Boston Scientific)

Healthcare stocks recently hit bottom after encountering serious problems. Their resurgence starting this summer is just getting started.

The Health Care Select Sector SPDR exchange-traded fund, which owns large market capitalization U.S. stocks in health insurers, biopharmaceuticals, and medical-device makers, dropped 6% for the year through early August, while the S&P 500 rose 8%.

Insurance stocks, lead by UnitedHealth Group, dropped spectacularly because impending regulations are expected to bring about higher reimbursement costs, pressuring the group’s profit outlook.

Meanwhile, pharmaceutical companies must confront regulations on drug prices and costs from tariffs. Separately, Eli Lilly stock has taken a hit from growing GLP-1 competition. That has pressured the broader healthcare fund because of Lilly’s almost $700 billion market cap.

The stocks became too beaten-down to ignore, and the first half of the adage “buy low, sell high” came to apply. We wrote in early August that the healthcare ETF was likely to bounce from its bottom. Indeed, it’s up almost 6% since then, outpacing the S&P 500’s nearly 2% rise. Its underperformance had become too extreme and, at the very least, was likely to see dip-buyers come in to send it higher in the short-term.

The best news: There’s reason to believe in more outperformance, as the sector has more catching up to do with the rest of the market.

The healthcare sector’s market cap weight in the S&P 500 bottomed in August at just under 9%, around the all-time low it hit in the early 2000s, according to Morgan Stanley’s chief U.S. equity strategist Mike Wilson. From there, the sector’s issues were fully reflected in the stocks, and the ETF went on to outperform for several years.

Now, healthcare’s weight in the index is just over 9%, which is still extremely low. Its range tops out at about 16%, so a continued catch-up trade appears in store.

Consistent with its weighting, the sector remains cheap. At just over 16 times analysts’ aggregate expected earnings for the coming 12 months, the sector is a little less than three quarters that of the S&P 500, at just over 22 times. Historically, healthcare’s average multiple is about in line with that of the S&P 500. Healthcare’s current valuation, relative to the index, is at the bottom of its range. So, as long as the market continues to trade at its current valuation, healthcare price/earnings multiples have room to rise, which means they can keep rallying.

That can happen as long as companies meet earnings expectations—and the bar is lower now: Analysts have already gotten their reduction to earnings estimates out of the way, with the sector’s expected earnings this year having dropped from peaks in August 2024, according to FactSet. Estimates are now up a tick from their lowest points in July. For pharma and medical equipment, there were more downward revisions just a few months ago, but a wave of upward revisions has come since, bringing the number of upward revisions above that of downward, according to Wilson.

These data points indicate the earnings picture likely won’t worsen and could easily improve. All of the challenges in the various areas of the sector are now well understood, so as long as companies meet expectations, the market will have confidence in continued sales and earnings growth.

The aging population of the U.S. means more people will be signing up for Medicare—a tailwind for health insurers—and more sales of medical equipment to hospitals for surgery—a tailwind for the likes of Boston Scientific, Medtronic, and Stryker. Eli Lilly will keep growing because, even with competition, it’s still aggressively expanding its GLP-1 business.

That’s driving analysts’ forecasts of almost 6% sales growth annually for the sector from the end of this year though 2027, according to FactSet. Profit margins should remain stable because, even with tariff costs, other operating expenses probably won’t balloon. These large, profitable companies will continue to repurchase shares, pushing expected earnings-per-share growth to more than 10% annually. That growth can push the stocks higher.

Expect healthy returns from this sector.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com