Coming into the year I was a raging bull on biotechnology and healthcare, as they made up the vast majority of my portfolio. The valuations were attractive and were not dependent on the economy being strong. It was hard for me to see how one could lose much. The group has since become one of the best performers and I have been recently reducing positions.
I believe that healthcare is now trading close to fair value, which is still better than the majority of the market. When looking at the shares on most metrics the group still seems to trade cheap. My main concern is that one day the US will need to undergo austerity measures as the deficit balloons to unsustainable levels and that healthcare will bear a large part of the brunt.
One of the first austerity measures that European countries underwent was to cut the cost of healthcare and pharmaceuticals. The US pays a huge premium for drugs and healthcare when compared to other countries because it does not bargain on price. Many drugs cost nearly double in the US than they do in the EU.
I don’t believe drug companies are getting paid too much because it is so difficult to find new drugs. Recently, R&D spending has resulted in fewer drugs and has had poor returns. If one cannot make money on the drugs that work than R&D makes even less sense. That said, the reality is that the US is paying the development costs for the rest of the World and it can no longer afford to do so.
In my valuations, I put a 10% discount on all healthcare shares based on the risk that the US government will one day go after healthcare costs. That is the reason I view the group as fairly valued even though the numbers still seem to work. I am not bearish at these levels but I no longer see the reason for such a large overweight position.
Why I Am Reducing Healthcare Redux
Healthcare is getting clobbered today as the debt ceiling agreement is going after healthcare costs. This round of austerity was brought on by the Tea Party but when the day comes that the market forces the US into austerity I believe it will be far worse. Here is a post I wrote in April on the subject.