By: Robert Szeles, CFA

The year 2023 was a year of few certainties.  Commencing with a mini banking crisis and concluding with the impressive resurgence of the technology driven magnificent seven, the markets remained challenging but constructive throughout the year.  Contrary to market participant projections, a recession failed to materialize, leading to a fed funds rate peak of 5.50%.  As a result, investors navigating this environment redirected surplus funds into money markets, which reached a record level of $6.3 trillion.  Late in the year, a new conflict erupted in an oil-rich region, causing additional geopolitical ripples.  Despite the turmoil, US oil prices concluded the year 10% below their initial mark.

The healthcare sector in 2023 dominated headlines in the weight-loss category, as semaglutide, a member of the glucagon-like peptide-1 (GLP-1) receptor agonists class was brought to market.  Bypassing the scientific intricacies, the drug's market presence under the labels Ozempic and Mounjaro most know what I am talking about because these drugs became a ubiquitous topic across the family dinner table and at the water cooler in the office.

It wasn’t just talk, the overwhelming demand for the new drugs surpassed Novo Nordisk’s own expectations, leading to the delay of its European launch due to a shortage of raw material supply.  Even with the delay, Eli Lilly and Novo Nordisk experienced a surge in stock prices, boasting returns of over +50% in 2023.

Robust study results showcased not only significant weight loss but also an incredible 20% reduction in the risk of cardiovascular events among participants, expanding the addressable market and forcing investors to rethink other investments linked to heart-related surgeries and the consumption of sweets and sugary drinks.  The potential ripple effect, caused companies with robust financials to underperform the market, exemplified by a 7.5% decline in the stock of beverage and snack giant Coca-Cola, while heart valve behemoth, Edwards Life Sciences, experienced a modest 2.5% increase.  This particulate healthcare breakthrough will be watched throughout 2024 for any early indication of changes in consumer behavior.

As we approach 2024, the impending election cycle takes center stage, with drug pricing poised to dominate headlines as politicians embark on the campaign trail.  The escalating concern over the swift rise in drug costs resonates across both sides of the political spectrum, setting the stage for an inevitable push for new regulations and laws.  Despite the pharmaceutical industry investing a substantial $372 million in lobbying efforts in 2022, President Joe Biden's Inflation Reduction Act was passed and exerts pricing pressure.  Notably, the government's Medicare health program is set to directly negotiate prices for some of the most successful drugs, commencing in 2026.

This regulatory landscape has contributed to a pullback in valuations below historical averages for major pharmaceuticals that are not exposed to the GLP-1 market discussed earlier.  We are focused on Johnson and Johnson and Merck, two companies that anticipate the impact of impending pricing schemes.  However, a comprehensive analysis of their pipelines and scheduled study results reveals several catalysts on the horizon that could lead to a reevaluation of these companies' multiples, potentially returning them to historical levels.

Anticipating continued volatility in large pharmaceutical companies due to headline risks, we maintain our belief that high-quality pharmaceutical firms with robust pipelines will emerge as outperformers.  Navigating through the election cycle, we expect market dynamics to favor companies with a strategic focus on innovation, positioning them for sustained success amidst evolving regulatory landscapes and industry challenges. 

One thing is for certain, we will continue to see regulatory changes and pricing pressure within the healthcare industry in 2024.