2023-03-24 15:49:54 ET
Summary
- The US market is highly speculative right now, as it's bid up to levels comparable to before stresses in the banking system had been revealed by SVB Financial.
- PPH, which follows a broad basket of the pharmaceutical industry, fell as much as the general market.
- Healthcare is a pretty first order refuge from market forces, so its relative decline doesn't make much sense.
- Regulatory changes that are becoming more important in the value picture as they come closer to being in effect are something to worry about, as well as the general state of the market.
- Moreover, the 0.5% expense ratio seems a little high for such a simple theme. Still, large-cap pharma is an easy sector to overweight where credit issues are evident.
The VanEck Pharmaceutical ETF ( PPH ) is the instrument that we look at when trying to get a read on the performance of the large-cap pharmaceutical industry. It holds 25 stocks, including stocks originally from foreign markets, and it is more or less value-weighted. It's mainly composed of the larger cap pharma exposures, which cuts out the need to consider the peculiar economics of smaller pharma firms. We've been focused on regulatory issues that are being faced by the industry, and continue to worry that large-cap pharma is being particularly targeted and is already slated for some cash flow hits as regulations come into effect. But in the current market that is looking way too optimistic in the US despite banking concerns, the similar fall in PPH to the rest of the market seems indiscriminate, as healthcare is one of the first places you go for defensive positions in the equity markets. There is a case for PPH, but the general risks to an equity market that will be sensitive to more banking concerns might trump that.
Pharma is Insular
Pharmaceutical companies are self-financing, and demand in their market doesn't really depend on financing conditions. As a necessity, they are also not dependent on economic conditions. They were only hit during COVID-19 due to the specific nature of the pandemic and its effects on healthcare delivery, where diagnosis and treatment rates suffered because everyone was more worried about COVID-19. Relative to the rest of the market since just before the onset of the pandemic, PPH has managed to hold value, and even grow. Of course, so has the S&P 500 ( SPY ), but it has given up more gains from its peaks than PPH. In past crises, healthcare spending grew throughout .
Somehow, the SPY is managing to be bid up to levels from before the SVB Financial ( SIVB ) blowup, which is a landmark event because it was the first moment where obvious stresses on the financial system became visible after the rate-hiking regime. With the centrality of banking for credit transmission in an economy so used to readily-available credit, difficult economic conditions are virtually assured going forward. PPH has fallen to a similar degree to the SPY relative to pre-SVB levels, meaning that markets haven't decided to overweight pharma and biopharma in their trading and positioning, which seems odd - both are down about 2.3% from 6th of March.
As said, PPH is exposed to large-cap pharma. The fundamental downside with the companies' prospects, in addition to regulatory risks focused on the largest blockbusters, is that some of the larger PPH allocations are exposed to the COVID-19 vaccine, where COVID-19 therapies across the board are seeing major declines in sales.
Top Holdings (etfdb.com)
The other issue is that the expense ratios are rather high at 0.5% considering how simple the ETF's theme actually is. But still, it is a first-order consideration that pharma should be resilient to a recession.
Bottom Line
Overweighting large-cap pharma over the medium term is pretty easy to do, since in our opinion the markets will be hit by tightening credit standards, and there are still more fault lines that could cause non-linearities in how the rate-hiking regime is transmitted. Specifically, we are worried about commercial real estate , whose loans are sitting in balances of many regional banks. PPH's portfolio companies should be resilient to those factors, although we do expect continued erosion of COVID-19 related revenues, but those should be generally offset by restored diagnosis rates.
Relative lack of strength in PPH compared to SPY seems like a market mistake. However, the stock prices of PPH companies are likely to still be levered to further hits in confidence to the banking system and the availability of credit. Also, the 0.5% expense ratio is a little too high for such a simple theme, so investors may find ETFs in the iShares umbrella perhaps which effectively covers the same exposures.
For further details see:
PPH Fell As Much As The Market Despite Resilience