Key takeaways
As the third largest industry represented in the S&P 500 Index, healthcare stocks play an important role in the portfolios of many investors today.
Healthcare stocks generated strong 2024 performance through August, though returns modestly lagged those of the broader market.
There’s a significant disparity between “winners” and “losers” among healthcare stocks, which creates opportunities and risks investors should consider.
Healthcare stocks represented in the S&P 500 have had a mixed year but demonstrated strength in July and August. For 2024’s first eight months, the healthcare sector of the S&P 500 is up 16.31%, modestly underperforming the 19.53% return of the broad S&P 500 index.1
“Healthcare stock performance year-to-date is reasonable,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “The market has broadened out, and strong performance extended beyond the technology-oriented stocks that previously dominated the market.” Technology stocks retreated in August and early September.
Yet wide stock performance dispersion is a healthcare sector characteristic. “If you look closer, there’s a significant differentiation of performance between winners and losers within the industry,” says Haworth. For example, Eli Lilly & Co. stock enjoyed dominating performance dating back to 2022, as the popularity of its drugs aimed at treating diabetes and obesity proved extremely profitable. By contrast, Pfizer’s stock soared beginning in late 2020 and through 2021 on the strength of its leadership role in delivering COVID-19 vaccines. However, the company’s stock has struggled more recently as it awaits its next big breakthrough.
This varied performance even within the pharmaceutical category of the healthcare sector demonstrates that it is far from a monolith. It’s common to see wide gaps between winning and losing stocks. That sets healthcare apart from one of the largest sectors in the S&P 500, information technology. “When some major technology stocks benefit, it seems to lift up the rest of the sector,” says Haworth. “The environment is different for healthcare stocks.”
Another prominent category within the sector, biotech, experiences similar performance variation, according to Haworth. “Even though we’re seeing good returns as a whole, most of that is generated from a few, very solid performing stocks.”
The healthcare industry is one of the economy’s most prominent. “It’s at the core of our daily lives,” says Haworth. “Health is important to our quality of life. Companies that provide healthcare products and services are also vital to our national economy.”
Over the past 50 years, healthcare has become a more notable component of the U.S. economy. Significant expenditure growth occurred between 1960 and 2005. The growth in expenditures as a percent of the nation’s economy (measured by Gross Domestic Product or GDP) moderated since 2005, except for a spike in costs in 2020, the year that COVID-19 emerged. Costs, as a share of the economy, are projected to moderate into 2025, but grow again by the end of the decade.2 The rise in healthcare spending is attributable at least in part to the aging of America’s population, as older Americans represent the largest users of healthcare services.
Investment opportunities in the healthcare sector vary. They range from pharmaceutical companies to medical technology firms to insurers and operators of healthcare facilities such as hospitals and senior care centers. “An understanding of the underlying opportunities in the sector and an active management approach can play an important role in achieving success with healthcare investments,” says Haworth.
The important role that healthcare stocks play in the broader market is evidenced by its positions within key stock indices. Healthcare represents the third largest sector in the large-cap S&P 500 Index, behind information technology and financials.1 It is the fifth-largest sector in the Russell MidCap Index (an index of about 800 stocks). Within the small-cap Russell 2000 Index, healthcare is the second largest sector, trailing only industrials.3
After experiencing a slowdown in first quarter earnings growth compared to a year earlier, S&P 500 healthcare sector earnings appeared to be on pace for a 3% increase for second quarter 2024 compared to 2023’s second quarter. The sector was the third largest contributor to S&P 500 earnings in 2024’s second quarter, trailing only the financial and technology sectors.1
“An understanding of the underlying opportunities in the sector and an active management approach can play an important role in achieving success with healthcare investments,” says Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management.
Haworth cites pharmaceutical companies as a prime example of how prospects can vary. Dating back to the end of 2022, Eli Lilly & Co., currently the largest stock in the S&P 500 Health Care sector, generated outstanding performance. Its stock price appreciation far outpaced the five other pharmaceutical stocks in the sector index.
“Investors can gain exposure to the healthcare sector by owning the S&P 500 through a passively managed index fund or ETF,” says Haworth. “Investors may also want to take a more selective approach, as the record demonstrates there can be varied performance within the healthcare sector.”
One potential constraining factor for the sector is the increasing emphasis placed on controlling healthcare costs. “The aging of our population indicates a strong demand for healthcare services, but there are constraints on what can be delivered,” says Haworth. He notes that since the COVID-19 crisis, elective surgeries have declined significantly. “This was a profitable business for providers, so the slowdown in elective procedures has a bottom-line impact,” says Haworth. “Now that facilities are open and able to conduct procedures, healthcare providers face staffing shortages that may limit the amount of activity they generate.”
To an extent, says Haworth, healthcare must be rationed due to cost constraints. For example, Medicare and other insurers set payment schedules, determining the amount that healthcare providers are reimbursed for various services and treatments. Under terms of the Inflation Reduction Act of 2022, Medicare has negotiated prices for 10 popular drugs paid for, in part, by the program. The new price structure doesn’t take effect until January 1, 2026. However, once it does, it could potentially limit revenues to pharmaceutical companies. Future plans include adding more drugs to the list of those subject to price negotiation for the benefit of Medicare participants.
Haworth notes that cost containment, in essence, occurs in other ways as well. “For example, as new drugs come to market, they can provide a more cost-effective means of treating a medical condition.” Haworth says when this occurs, it can be a boon for the company that developed and distributes the new drug, while taking away from the success of other companies that provided now outdated treatments. “While drug and medical technology advancements might appear to be beneficial in raising revenues and earnings for the entire industry,” says Haworth, “the difference between the winners and losers in these situations can be striking.”
Healthcare plays a critical role in our day-to-day lives. On that basis alone, publicly traded companies that address the demand for healthcare products and services offer intriguing investment potential. Advancements in life-changing drugs and medical devices can significantly enhance our quality of life. They also create potential to generate new revenue and profits for innovative companies that deliver those products.
Nevertheless, the disparate fortunes of healthcare companies, which can change significantly over time, create some challenges for investors. “There are clear opportunities in more active management of healthcare investments given the push-pull dynamic of demand relative to the winners-and-losers system in the pharmaceuticals field,” says Haworth. “For others, relying on a passive management approach, an S&P 500 Index fund or ETF, may be the best way to access the investment potential of the healthcare sector.”
As you explore such investment opportunities, be sure to discuss it with your financial professional. You’ll want to consider how healthcare investments can work within the context of your overall financial plan and investment strategy.
Healthcare represents one of the largest sectors of the major market indices. As of February 29, 2024, it was the third-largest sector in the large-cap S&P 500,2 and the second-largest industry sector in the small-cap Russell 2000 Index.3 With healthcare services representing more than 17% of the economy,1 investors can expect that healthcare should play an important role in their portfolios.
According to S&P Dow Jones Indices, the healthcare sector was expected to contribute approximately 11.1% of estimated corporate earnings generated by S&P 500 companies in 2024’s second quarter. Healthcare ranked behind only the financials and information technology sectors in terms of contributions to the S&P 500’s earnings. S&P’s estimates project healthcare stocks will generate earnings growth of 21.2% in 2024, outpacing earnings growth expectations for the broader S&P 500.2
Over the past 50 years, healthcare has become an increasingly visible component of the U.S. economy. Significant expenditure growth occurred between 1960 and 2005, growing from 5% in 1960 to 15% of the economy in 2005. Expenditure growth as a percent of the nation’s economy (using Gross Domestic Product or GDP) has moderated since, except for a spike in costs in 2020, the year that COVID-19 emerged. In 2024, healthcare spending is projected to represent 17.7% of the economy.1 The rise in healthcare spending is related in part to the aging of America’s population, as older Americans represent the largest users of healthcare services.
Investors focus on evolving dynamics in the stock market’s energy sector.
Technology stocks declined 2% from July to August, while the broader S&P 500 gained 2.6%.
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