Eagle Asset Management | Growth Investment Team

Healthcare system’s response could drive equity markets


As investors are painfully aware, global economic activity came to an abrupt halt during the COVID-19 pandemic and subsequent government-imposed lockdowns. U.S. fiscal and monetary policymakers acted swiftly and took bold measures to minimize the impact of the economic shutdown. These unprecedented policy actions have thus far proven to be a tremendous success in mitigating sustained economic damage.

For the rest of 2020, we believe the biggest influence on equity markets will be the healthcare system’s response to the COVID-19 crisis. Timing and success of various vaccines and therapeutics will affect equity markets over the near to intermediate term. With the reopening of the economy, we will very likely see a second wave of occurrence; however, the healthcare system is better equipped than before, and with better treatment options we believe a second wave would just be a bump in the road.

Recent data indicates that April marked the trough in economic activity. Since bottoming in late March, the market has largely discounted the dismal outlook for corporate earnings in 2020 and has shifted its focus to the prospects for growth in 2021 — albeit from depressed levels. However, it can be expected that costs of $3 trillion (and counting) in spending will have some unforeseen negative economic consequences in the future.

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Contrary to most academics’ dire predictions, we have seen no dark side (so far) from the massive government spending.

We will closely be watching for signs of any inflationary pressures that could lead to higher interest rates as well as an abrupt shift in the Federal Reserve’s current extraordinarily dovish posture. We do worry the trillions in government spending ultimately will result in a weaker U.S. dollar and inflation. Contrary to most academics’ dire predictions, we have seen no dark side (so far) from the massive government spending. This is something we will monitor, as once the spending spigot is turned on, it is difficult to turn off.

The U.S. presidential election will undoubtedly serve as a major focus for investors in the second half of 2020. Current polls favoring Democrats suggest the election could have negative implications for the markets through higher corporate tax rates and increased regulation. We don’t necessarily think a Biden victory would be a big negative for markets; however, a Democratic sweep of both houses of Congress would instill fears of higher corporate and individual taxes and a higher capital gains tax rate. A lot can still happen between now and November. We caution against leaning too heavily on polls, which were proven unreliable in the last presidential election.

Regardless of the exact shape of the recovery, the outcome of the election, and the risk of a second wave of COVID-19, we believe the key point for investors to recognize is that things are getting better. The pandemic caught the world flat-footed on a variety of fronts, but we have since made tremendous progress in a short period. We expect this trend to continue. Our portfolio consists of both cyclical companies that are well-positioned to benefit from the reopening of the global economy and companies that are seeing an acceleration in their secular growth rates due to the response to COVID-19.

Given the significant changes already taking place in the U.S. healthcare system, are the stresses you foresaw taking place as anticipated and how do you think the sector will evolve going forward? How does this impact your portfolio positioning and are there any new opportunities going forward?

The U.S. healthcare industry is divided into three main segments:

  1. Providers — The physicians, dentists, nurses, technicians, chiropractors, acupuncturists, and other healthcare professionals who provide care to patients. They also include the facilities where care is provided, such as hospitals, outpatient clinics, imaging centers, and private offices.
  2. Payers — The insurance companies (managed care organizations) and government agencies (Veterans Administration, Medicare, and Medicaid) that manage patient co-pays and deductibles, and also reimburse hospitals, clinics, physicians, and other healthcare professionals for the care they provide to patients.
  3. Patients — The people who seek care from providers in a variety of settings, including emergency rooms, physicians’ offices, outpatient surgical centers, and imaging centers.

The COVID-19 pandemic, and the subsequent restrictions and shutdowns that were imposed on the healthcare industry, affected each of these segments very differently.

First, the providers were hit the hardest because most healthcare professionals not directly involved in the care of patients with COVID-19 were prohibited from providing care to any patients except for emergencies. For many physicians and dentists in private practice, case volumes dropped by as much as 90%. This was economically devastating for them. Hospitals were among the hardest hit. According to consulting firm Kaufman Hall, the median operating EBITDA margin for U.S. hospitals dropped from 6.5% in February to -19% in April. The American Hospital Association estimates hospitals will be negatively impacted by $36 billion in the four months between March and June 2020.

Payers were actually beneficiaries of the shutdown of the economy, especially the healthcare economy. This may be seem a bit odd, but given “shelter-in-place” orders for patients and doctors alike, there was a dramatic drop in the number of claims that managed care organizations needed to pay providers. As a result, they generated excess profits. Many managed care plans decided to take these excess profits and reinvest them into the communities they serve.

Patients, meanwhile, were forced to cancel and reschedule office visits and defer elective procedures.

The magnitude of the changes to the healthcare system was greater than we had expected. The nearly complete shutdown of the healthcare industry (18% of U.S. GDP) was unprecedented. Initially, many thought that the shutdown would be short-lived. However, as the incidence and death rates rose, the wait for the curves to flatten and ultimately decline took longer than anyone expected.

While we did not make many changes to our portfolio, we were blessed to have certain companies benefit from the pandemic, especially the trend to telemedicine. In addition, a point-of-care diagnostic test maker benefited from COVID-19 as it developed specific assays for the rapid detection of SARS-CoV-2.

The road to recovery in the U.S. healthcare industry is underway. It is our opinion that it will take at least a year to bring healthcare companies and players back to pre-COVID levels, both in terms of revenues and profitability.

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