2022 was a challenging year for global equity markets as investors navigated an uncertain macroeconomic environment characterized by persistent inflation, rising interest rates, and geopolitical conflicts. The health care sector in aggregate outperformed during this volatile period as companies such as large-cap pharmaceuticals and managed-care organizations were relatively insulated from ongoing macroeconomic concerns compared to other segments of the market. Even with health care’s relative outperformance in 2022, we remain excited about the opportunities within the sector in 2023 and continue to see meaningful innovation, supportive valuations, and a benign political and regulatory backdrop. 

Biopharma

Given ongoing advances in our understanding of disease biology and our ability to modulate disease processes using biochemical tools, we continue to find a rich environment for innovation. We saw meaningful progress in 2022 in the realm of Alzheimer’s disease: We now have further evidence that plaque-removing antibodies have the potential to slow the progression of cognitive decline from this devastating disease. We also saw significant developments in metabolic diseases, where profound weight-loss efficacy should help create a multi-billion-dollar opportunity in the treatment of obesity as a new and important disease category. 

As we look to 2023, we anticipate continued developments in these areas as well as new modalities such as targeted protein degradation. This is a promising therapeutic approach that harnesses the body’s natural mechanisms to eliminate disease-causing proteins; it already has demonstrated clinical benefit in several cancers. Furthermore, we are evaluating companies that are focused on anti-inflammatory and psychiatric diseases, as well as those that are discovering drugs using new modalities such as messenger RNA, RNA interference, and gene therapy. 

Aside from these groundbreaking innovations, we expect the fundamental backdrop in 2023 to be supportive of the biopharma subsector. While the long-term implications of recent US drug reform legislation remain to be seen, we are encouraged that the law’s passage has lifted a long-standing overhang from the industry and alleviates investor concerns of a worst-case outcome. Additionally, we view the biopharma industry as well-positioned to navigate a potential recessionary environment, given the resilient earnings of large-cap pharmaceutical companies as well as business models that are more independent of economic cycles compared to models in other sectors. We are also optimistic that the worst of the biotech sell-off is behind us, and we are finding valuations to be attractive relative to history. Importantly, we expect an abundance of key clinical readouts in the year ahead. In our view, this creates an environment in which stock prices will be driven by fundamental catalysts, instead of the macroeconomic events and factor rotations that drove the market in the past two years.

Medical technology

Over the past few years, medical technology has been an area of the health care market that saw the most pronounced dichotomy between companies that benefited from COVID-19 pandemic tailwinds and those that experienced material disruptions to their business. Looking ahead to 2023, we expect differentiated pipelines to matter more as we move into this endemic COVID-19 phase. We are finding attractive opportunities in companies that came out of the pandemic stronger than when they entered, with larger installed bases and more cash on hand to reinvest in product pipelines. We also are interested in names where the market may be punitively valuing pandemic headwinds as structural impairments, as opposed to temporary disruptions that should abate as procedures continue to recover and pipelines contribute further. With potential acquirers carrying stronger balance sheets and attractive small- and mid-cap targets trading at better valuations, we now are seeing M&A activity within life sciences and increasingly in medical devices. We expect to see more consolidation in 2023. 

As for the macroeconomic environment, the medical technology industry has not been immune to broader pressures as input-cost inflation, supply-chain shortages, and currency headwinds weighed on profitability in 2022. That said, we are seeing companies take stronger action to navigate this environment around sourcing semiconductor chips, managing inflationary pressures, and gradually passing on pricing over the next few years. Encouragingly, we believe organic growth trends in medical technology are showing resilience relative to the broader market as demand for health care procedures, diagnostics, and the technology needed to develop life-saving therapeutics tend to be less sensitive to GDP growth due to underlying demand. 

We continue to have a positive outlook within medical technology. Innovation pipelines have never been stronger, with more attractive medical device categories poised to accelerate in the 2020s compared to the 2010s. These include advances in new diabetes devices, TAVR and mitral valve therapies, robotic surgery, bioproduction consumables, and genetic sequencing/diagnostics. In the coming years, we believe many firms will grow their addressable market through geographic expansion, new technologies, and the use of existing ones to treat new patient populations.

Health care services

Amid a challenging period for global equities, managed care companies were among the best performers in 2022 given their strong fundamentals, lower-than-expected cost trends, and defensive nature of their businesses. Despite the relative outperformance of this group, we expect the strength of these business models to shine in 2023 given the stability of the US health insurance market, particularly in the government-exposed Medicare segment, as well as tailwinds from a higher-interest-rate environment. We expect these companies will continue to see a linear increase in utilization as opposed to the once feared step-up in demand coming out of the pandemic. The risk that we are monitoring for this group is the potential for higher costs from a possibly more intense flu season than we saw during the pandemic, when masks and stay-at-home orders reduced the number of incidences. 

In terms of political risks, we expect the political landscape for health care services to remain benign in the year ahead. The results of the November US midterm elections highlighted that while abortion rights, health care spending, and prescription costs remain important issues for voters, politicians are increasingly focused on modifying the health care infrastructure as opposed to more drastic repeal and replacement of the Affordable Care Act. Furthermore, with Democrats maintaining a Senate majority and Republicans taking a House majority, we expect this backdrop of political gridlock to support a continuation of the status quo in policy outcomes. 

We continue to believe that health care services companies are well-positioned to help solve the societal challenge of rising health care costs, and that some will benefit from the ongoing transition from a fee-for-service to a fee-for-value care system. We are following with great interest the continuing evolution of health care and are finding attractive opportunities among companies providing patients with better outcomes at lower costs, including capitated physician groups, health care technology companies, and home health platforms. 

Closing thoughts

As we enter 2023, we remain excited about the opportunity set across the entire health care sector. In our view, groundbreaking innovation, supportive valuations, and business models that are positioned to show resilience through the cycle should ultimately benefit long-term investors in this sector.