Wednesday, October 14th, 2015

A Long Shot

Most investors know that the US pharma sector has been in a spin ever since Hillary Clinton tweeted about “price-gouging” on September 21st. This was part of the publicity for her healthcare plan which includes (1) regulating the percentage of revenues pharmaceutical companies must spend on research and development, (2) instituting a cap on the cost of many out-of-pocket drugs for chronic and serious health conditions, and (3) allocating additional funding to put more generic versions of drugs on the market. The New York Times quotes an estimate of the savings as approaching $100bn a year. This sounds aggressive given that the 12 largest pharma companies in the world have annual global EBITDA of $153bn, according to Bloomberg Intelligence. Whatever the number, the plan is meant to generate material savings for the US government, which by definition must be material to the global healthcare sector.

In our US equity model, the sector has gone from a recommended overweight of +70% in August to an underweight of -21% as of last week. This is the sort of move which gets systematic investment processes a bad name, because it looks like an over-reaction. However we find that there are two other occasions in the last 20 years when the US Healthcare went from a very big overweight to a big underweight almost in a straight line. Between September 1998 and August 1999 the sector went from +80% to -64%. In February 2009 it went from +90% to -46% in October 2009, followed by a partial rally and then -70% in October 2010. In both cases, it took over two years from the peak for the sector to regain an overweight rating.

We may not see a similar pattern this time round, but the earliest realistic date for ruling out Mrs Clinton’s chances of becoming President is May 2016, more likely November, and this assumes that she does not actually get elected. Fifteen months is a long time to ignore the possibility of an existential threat to the sector’s revenues. Even if investors don’t think she will be elected, they have to price the risk that she may be. By way of confirmation we see similar moves for the sector in our US High Yield model and in all our regional equity sector models: UK, Eurozone, Pan-Europe and Japan.

For every loser there is a winner. Some of the benefits may accrue to the US Technology sector, but there are almost as many stale bulls here as there were in Healthcare. What follows is a long-shot, but all our regional sector models record a significant reduction in the underweight attached to the Energy sector. In the US we have gone from -95% to -81% in four weeks. In Europe the move is even larger: -91% to -57%. In our view this is not about the price of crude; it is about the ability of large-cap integrated producers to survive at the current price levels. These companies will benefit when parts of the US shale oil industry gets shut down. Shell has recently confirmed that it will cut capex in order to maintain its dividend, which currently yields over 7%, and we expect the other global majors to make similar commitments during the upcoming results season.

Energy is not an obvious replacement for Healthcare, but as one of our clients put it last week, “Do you want to buy something which was priced for perfection and is no longer perfect, or something which has already blown-up and is being put back together?”

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