One of the best ways to keep your investment portfolio healthy this year and beyond may be to focus on health care. In 2018, as the S&P 500 stock index lost 4.4%, the health-care sector gained 6.5%. And that wasn’t a fluke—it’s because health-care companies have unique traits that allow them to thrive late in economic expansions. 

On the one hand, these companies are growing strongly, thanks to demand from an aging population and the introduction of many innovative new drugs, other treatments and medical devices. On the other hand, if the economy stumbles, consumers still resist cutting way back on medical care. A recent CNBC study found that over the past three decades, when the stock market dropped more than 10% in a six-month period, the S&P 500 lost an average of 14% but health-care stocks lost an average of just 5%.

Bottom Line Personal asked health-care stock fund managers Jason Kritzer, CFA, and Samantha Pandolfi how to find the most attractive growth prospects in health care that also offer downside protection…

Four Big Trends

We’re cautiously optimistic about the health-care sector this year. We’re emphasizing companies and industries that should remain strong in the face of various political, social and technological trends…and avoiding those that pose too much risk. For example, in 2018 we added to our drug stock holdings because valuations were compelling, but we cut our exposure to overvalued ­biotechnology stocks. Also, a slowdown in price increases for drugs is hurting drug distributors. And we’re avoiding hospital stocks, partly because of continued uncertainty over the fate of the Affordable Care Act (Obamacare), which has provided hospitals with extra money from insured ­patients. 

Here are four trends that are likely to propel health care in 2019 and ­beyond—and the stocks most likely to benefit from these trends…

1. Trend: Political gridlock in ­Washington, DC, which means little action on reducing drug prices. Pharmaceuticals have been under pressure since the 2016 presidential election, when both candidates promised to give the federal government’s Medicare Part D program the authority and tools to ­negotiate lower prescription drug ­prices. But Congress, which is conducting extensive hearings on prescription-drug pricing, is unlikely to pass legislation to authorize price controls. When that becomes clear to more people, drug stocks should rally.

Stock likely to benefit the most: ­Novartis (NVS). The Swiss pharmaceutical giant has remade itself in recent years. It has been divesting its consumer health-care businesses and plans to spin off its eye-care ­business so that it can focus on developing blockbuster drugs—and it has the wherewithal to do so. For example, sales of the new Novartis drug Kymriah, the first gene-therapy drug to be approved in the US, are expected to reach $350 million this year and $1 billion by 2023. Kymriah treats acute lymphoblastic leukemia, the most common form of childhood cancer. Novartis also has completed a deal with Tilray, the high-profile Canadian marijuana company, to distribute its medical marijuana products in dozens of countries. 

2. Trend: The booming business of health care for animals and pets. Globally, the animal health-care market is expected to grow nearly 6% a year and reach $64 billion by 2025. Rising standards of living in emerging markets mean a wider adoption of protein-based diets, driving greater demand for livestock vaccines and supplements. In the US, consumer spending on pet health care is driven by enormous innovations in medications and other treatments. Compared with makers of drugs for humans, pet-pharmaceutical companies have a much faster route to FDA approval, and once on the market, their products are largely paid for in cash without facing insurance reimbursement issues.

Stock likely to benefit the most: ­Zoetis (ZTS). Although it’s not a household name, Zoetis was a division of pharmaceutical ­giant Pfizer for more than 60 years until it was spun off in 2013. Since then, its stock performance has crushed the returns of the S&P 500. The company has become the largest pet-pharmaceutical firm in the world, selling more than 300 product lines ranging from livestock vaccines to new medications such as the recently launched Simparica, a chewable flea-and-tick drug for dogs. Zoetis is counting on recent acquisitions to fuel growth, including the veterinary technology firm Abaxis, which specializes in diagnostic instruments that let veterinarians analyze blood samples immediately and provide more cost-effective diagnoses and treatments. 

3. Trend: The big expansion of Medicare. This government-sponsored health-care program is projected to grow at an annual rate of 7.4% through 2026 as more than three million baby boomers hit age 65 each year. Medicare beneficiaries typically have a choice of several plans, but enrollment for years has been dominated by for-profit insurers that offer Medicare Advantage. These government-funded private health-care plans are a popular alternative to “original Medicare” because they often offer additional perks such as reimbursements for gym memberships, coverage for dentists and eye doctors and capped out-of-pocket expenditures at reasonable costs. In addition, Medicaid, the government-sponsored health coverage for low-income Americans provided through private insurers, is expected to grow 5.8% annually through 2026.

Stock likely to benefit the most: ­UnitedHealth Group (UNH) is the largest health insurer in the US, with about 50 million members—20% more than its nearest competitor, Anthem. A big piece of the company’s business is focused on Medicare Advantage and Medicaid. Analysts expect UnitedHealth earnings to grow 15% annually over the next five years, thanks in part to its highly profitable but lesser known divisions. Its OptumRx division manages pharmacy benefits for health plans and processes more than one billion prescriptions per year. Its Optum division is a leader in data-analytics consulting, analyzing patient health-care data and claims to find ways to reduce costs and improve patient treatment. 

4. Trend: Innovations in medical ­equipment. Many investors ­assume that medical breakthroughs are focused on new drugs. But some of the most exciting and profitable areas of health care are in high-margin, patent-protected devices inserted in the body to treat disease and manage pain. The medical-device industry is getting a boost from the two-year suspension of the federal excise tax on medical devices sold domestically, which began last year. Globally, the medical-device market is expected to grow 4.5% ­annually from 2018 to 2023. 

Stock likely to benefit the most: Boston Scientific (BSX) is a medical-equipment powerhouse with more than 13,000 products that offers very strong growth prospects. Its stents and balloon systems are among the best-selling devices used by doctors to deter or clear blood clots. Boston Scientific also is a major player in the field of pacemakers and has 30% of the market for equipment used to perform endoscopies. Strength in these niches and others generates strong cash flow that the company is using to ­acquire fast-growing businesses, mostly companies focused on interventional treatment, which involves implanting tiny devices in the body to diagnose and/or treat diseases. The company’s recent acquisition deals include BTG, which makes a tiny coil inserted into the lung’s airways to treat emphysema, and ­nVision Medical, which makes a scope that collects cells from fallopian tubes to provide early diagnosis of ovarian cancer. 

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