Health care stocks could shine in 2025

After two years of weak performance relative to the broader market and, particularly, its growth peers, health care is off to a strong start in 2025. Within the S&P 500, the Health Care sector is up 2.59% this year as of April 30, versus losses of 11.24% for Information Technology and 14.08% for Consumer Discretionary and a 4.92% decline for the S&P 500 as a whole.  

Valuations in health care are currently near all-time lows compared to the broader market.  This undervaluation presents a unique opportunity for investors to capitalize on the potential for substantial gains as these stocks rebound. Historically, health care stocks have demonstrated resilience during market downturns, and their current low valuations suggest that they may be primed for a strong recovery. Mergers and acquisitions, while slow, are also showing signs of life.

Another factor contributing to the optimistic outlook for health care stocks is their historical performance during inflationary periods. Typically, health care stocks underperform when inflation is high due to increased costs and pricing pressures. However, inflation has, ever so slowly, begun to decline again and optimism around rate cuts has resurfaced, giving life back to health care stocks. This shift in economic conditions will likely enhance the attractiveness of health care investments, as lower inflation and interest rates create a more favorable environment for growth and profitability.

Policy concerns have also weighed heavily on health care stocks, but these worries are largely overblown or priced-in, in our view. While there has been policy uncertainty regarding health care, the fundamental strengths of the sector remain intact. The potential for deregulation and favorable policy changes under the current administration could further bolster the performance of health care stocks. Additionally, the sector's defensive nature ensures that it remains a vital part of the economy, regardless of political shifts.

Innovation within health care, particularly in biotech, is likely to be another key driver of future outperformance. Rapid advancements in biotechnology, coupled with the integration of artificial intelligence (AI), are revolutionizing the industry. As the initial euphoria surrounding AI begins to settle, investors will likely seek new areas of secular growth, with biotech standing out as a prime candidate. The combination of cutting-edge research, innovative treatments and AI-driven solutions positions biotech companies to potentially deliver substantial value and growth in the coming years.

Given today’s uncertain economic situation, biotech investors might benefit by considering companies with:

• Existing products that are showing progress and growing in use
• Access to easy capital (partnerships) or the ability to self-fund
• FDA approval process already underway, with minimal additional resources needed from the FDA given the personnel changes

We think that investing in health care stocks may be an excellent way to navigate the current environment. Within this otherwise defensive sector, biotechnology may allow strong performance to continue once growth returns, though we recommend sticking with quality names given current uncertainty.