Market and sector review
Global equity markets delivered positive returns in August, led by the energy, materials and technology sectors. Energy and materials were buoyed by higher commodity prices, in particular oil, gold and copper. Meanwhile, a rally in software stocks coupled with NVIDIA’s strong second quarter (Q2) results allayed some fears about AI infrastructure spending and reignited interest in technology.
Healthcare also outperformed the broader market. Within the sector, healthcare technology, biotechnology, life sciences tools and services, and healthcare equipment were the strongest performing subsectors. Healthcare services, managed healthcare and healthcare supplies had a more challenging month.
Slowing momentum in the real US economy, combined with persistent inflationary pressures, presented a conundrum for policymakers, with the two forces pulling the Federal Reserve (Fed) in opposite directions. Payroll growth has stalled: July showed a loss of 23,000 jobs. The headline overstates the deterioration, however, given the labour force is shrinking as immigration curbs bite. The breakeven rate of payroll growth has therefore fallen sharply and the market is now closer to a ‘low-hiring, low-firing’ equilibrium than to genuine demand weakness which would be disinflationary.
Growth also decelerated but remains robust, with solid consumer spending and artificial intelligence (AI)-driven equipment investment offsetting falling government outlays and a widening trade drag. Inflation, meanwhile, is proving sticky. The combination of resilient economic growth, a steady labour market from a demand perspective and stubborn inflation meant that bond yields, especially long-dated ones (those maturing further into the future), moved higher in August. The announcement that the Treasury was doubling its buybacks of long-dated bonds provided only a brief respite, with yields falling on the day. That said, at the Jackson Hole meeting on 28 August, Fed Chair Kevin Warsh underlined his commitment to bringing inflation down and suggested interest rates may need to rise in the coming months. For now, equity and bond markets will remain hostage to the Fed's next move: will it hold rates steady and hope a slowing economy is enough to bring inflation down or will it raise rates to curb inflation and risk pushing the economy close to recession?
We were encouraged to see healthcare stocks outperform in August despite the higher-yield environment and we believe three factors contributed to the sector's positive relative performance. First, a continuation of the rotation away from AI-driven sectors, especially in the early part of the month; second, a Q2 earnings season that was generally strong for healthcare companies; and third, excitement generated by the announcement that a personalised cancer ‘vaccine’, intismeran autogene, developed by Moderna and Merck & Co*, delivered encouraging Phase 3 (i.e. late-stage clinical trial) results in combination with Keytruda in the adjuvant melanoma indication – patients whose melanoma has been removed surgically and who then initiate therapy to reduce the risk of recurrence. The news added over $80bn in market capitalisation between the two companies involved. It also had a favourable halo effect not just on biopharma companies but also those that benefit indirectly such as life sciences tools and services.
Company performance
The Company’s net asset value (NAV) rose by 3.0% in August, behind its benchmark, the MSCI All Country World Net Total Return Health Care Index, which was up 3.6% for the month (both figures in sterling terms).
Positive contributors relative to the benchmark in August were Innovent Biologics, Insmed and Hansa Biopharma.
For Insmed, strong sales of recently launched Brinsupri, for a respiratory condition, re-established investors' confidence in the launch and the drug’s long-term potential. Insmed's management also raised peak-sales expectations for Brinsupri.
Similarly, Innovent Biologics delivered a robust set of Q2 earnings but also disclosed mid-term guidance that was above consensus and, if delivered, would see the company's revenue roughly double by 2030.
There was no thesis-changing news concerning Hansa Biopharma, with the stock continuing to grind higher as investors begin to better understand the commercial opportunity for its main asset, Idefirix (a desensitisation therapy that enables kidney transplantation in highly sensitised patients), ahead of a possible US approval later in the year.
Negative contributors were CVS Health, Merck & Co and Apotex Health.
CVS Health sold off despite solid Q2 results as expectations were high and management highlighted possible headwinds to its pharmacy benefit management segment. The latter primarily related to a new business model and changes to the so-called 340B programme which enables qualifying facilities to buy outpatient drugs at steep discounts. The stock was also caught in the weakness of managed healthcare stocks which had meaningfully rerated in the previous months.
As noted above, Merck & Co rallied when it and Moderna disclosed that a Phase 3 trial had achieved its two goals in a specific group of patients: they went longer without their cancer returning and longer without it spreading to distant parts of the body. Though hailed as a ‘cancer vaccine’, intismeran is not a vaccine in the traditional sense, as it does not stop an individual developing melanoma in the first place. Rather, it is a personalised neoantigen (an abnormal protein found in cancer cells) therapy that is administered with Keytruda – a drug that prevents cancer cells from evading the body's immune system response – and should amplify Keytruda's effect. Despite the promising potential of this new way to treat cancer recurrence, we would caution that no detailed data has been released yet on the magnitude of the benefit of adding intismeran to Keytruda. Additionally, we would want to see whether similar results are borne out in cancer types that are less immunogenic than melanoma.
Finally, Apotex Health reported its first set of results as a public company. These were generally positive, but the outlook for the full fiscal year left some investors underwhelmed. Additionally, the company, based in Canada, was caught in the crossfire of an escalating trade dispute between the US and Canada.
Activity
We initiated new positions in Danaher and Stevanato Group during August.
A selloff following Q2 results gave us the opportunity to initiate a position in Danaher, one of the largest life sciences tools and services companies. With improving end markets and incoming management focused on execution, we see upside to revenue and earnings estimates, while the valuation is undemanding relative to peers.
Similarly, in our view Stevanato Group, a manufacturer of primary packaging for the biopharma industry, had a compelling risk/reward profile. Not only are the company's end markets improving, but we believe the market underprices its ability to deliver operating leverage on accelerating top-line momentum.
The positions were funded, in part, by an exit from Merck KGaA.
Outlook
We were pleased to see the healthcare sector perform well in August, both in absolute terms and relative to the broader market. In our view, this improvement rests on four factors. First, the Q2 results season itself was generally supportive, with healthcare companies broadly meeting or exceeding expectations. Second, the sector's fundamentals remain robust, underpinned by resilient demand, consolidation and healthy balance sheets. Third, the market rotation away from AI-driven sectors redirected investor attention towards areas of the market that had been overlooked. Finally, and perhaps most encouragingly, innovation is once again being rewarded.
Should healthcare companies continue to deliver earnings upgrades in the quarters ahead, we believe the sector is well positioned for a sustained period of outperformance. The combination of improving earnings momentum and undemanding valuations has historically provided fertile ground for a positive rerating.
