The U.S. health care sector has underperformed the market by 21% since 2015 and is currently 14% undervalued based on our composite measure.¹ The sector has been weighed down by a cyclical upswing in global and U.S. growth, as well as concerns about health care reform—two factors that we believe have played out for now. From a cyclical standpoint, as global growth decelerates and the U.S. economy enters its late-cycle stage, health care’s defensive characteristics should help it outperform. It has historically been profitable to discount worries about health care reform, especially when valuation provides an attractive starting point, and we believe this time is not different. We review our bull case for the U.S. health care sector below.

Over the past 45 years, the U.S. health care sector has outperformed the broader market. Its earnings and total returns have outpaced the market by 2.9% and 0.9% per year, respectively, since 1973. It has also outperformed during five of the last six recessions, by 9% on average.² While most other sectors have occasionally underperformed for prolonged periods of time (e.g. energy in the 1990s and 2010s, tech in 1970s and 1980s), health care’s underperformance has tended to be short-lived and has often occurred early in the expansion after sharp outperformance during recessions. Unlike the broader market, the sector’s fundamental outperformance has not been based on margin expansion. In fact, margins have shrunk since the 1970s, from around a 10% net margin to 7.5% today.³ In contrast, the broader market’s net margins expanded from about 5.5% to 10% over that time period,  is proportionately benefiting from capital and labor outsourcing as well as lower interest costs. Despite this, health care’s return on equity (RoE) never dipped below that of the market.