Sick as a Dog

Good morning, everybody. This is Michael Cembalest with the August 2025 podcast. For the last couple of months, I’ve been working on a healthcare piece. Something that I thought I was never going to do because the sector is very broad and very complicated. But, I decided that it was important to do, given all the conflicting things going on.

And so, we've written a deep dive piece on the healthcare sector, its cheapness issues about and also issues about battles over publicly funded healthcare research and its implications for the sector. I'm going to go through a little bit of it here. But the broader piece goes through the details. And if you are interested in the healthcare sector, take a look.

So let’s dive into it. And the first couple of charts really explain the reason why I felt I had to look at this. For most of my career, and I joined J.P. Morgan in 1987, so I started the clock pretty close to that date, and from 1989 until 2019, I remembered healthcare as having this incredible run.

And you can see here in this first chart from 1989 to 2019, healthcare generated, almost like the identical term returns as the tech sector and with a lot less volatility. And so it was it was really seen as, as a parallel growth investment theme for most of my life. And then ever since 2019, technology, the tech sector has been barreling ahead and healthcare has more or less completely stagnated.

This is one of the biggest before and after shifts that I’ve ever seen at the sector level. And just to look at a couple of the pieces, large cap pharma P/E is right now on a forward basis are around 14. That sounds a little distressed, but when you think about the fact that Lilly is a third of the pharma index and trades at a multiple of 24, it kind of tells you what's going on.

The rest of the sector, Merck, Pfizer, Bristol-Myers and the other stalwarts are trading at that forward multiples of just 8 to 9 times earnings. Biotech trades at one of the largest valuation discounts in the entire market. 80% of biotech IPOs since 2018 have imploded. I'll define what imploded means later. Managed care returns have completely collapsed.

And then the life sciences companies may be hurt by cuts to the NIH and CDC and other scientific research organizations, a trend which we can already see based on the sharply reduced pace of NIH grants this year. So this healthcare piece looks at a lot of different pieces, not everything in the sector, because there’s too many widgets.

But we look at valuations and earnings. Both absolute and relative to the tech sector. We looked at prescription proposals to cut prescription drug prices in the U.S., closing the large gap versus other OECD countries. Issues around the patent, closed patent thickets and drug companies, war chests, pending tariffs on the pharmaceutical sector, which still haven't been announced.

Competition from China. A section, this is unavoidable, a section on the pace of drug approvals at the FDA, the bizarre things going on there, and the impact of RFK Jr.’s leadership. But Health and Human Services, we look at the managed care sector, whose returns, as I mentioned, have imploded, and headwinds coming from the Big Beautiful Bill and things like that.

We take another quick look at GLPs, more evidence of cardiovascular benefits and possible dementia benefits, but some obstacles on the path to greater adoption. We take a quick look at the healthcare services sector. We have some charts in here on biotech IPOs and just how miserable that space has been the last few years, and closed with some comments on new potential drug discoveries on the horizon.

As I mentioned, the section on the political battles over publicly funded science research and then some peer reviewed evidence on longevity drugs in mice. There’s some kind of shyster guru types out there talking a lot about longevity treatments. I'm going to focus instead on the actual peer reviewed science on the subject, so those are the topics. I'm going to talk about a few of them briefly in this podcast.

As I mentioned, you know, the piece gets into the details, if you’re interested, on valuations, right. This this chart reminds me of the one where Homer Simpson keeps falling down a hill, and then he hits a tree, and then he hits a bus. And then he hits the highway. And then he keeps falling.

So from 1976 to the end of last year, the healthcare P/Es relative to the market have just continuing, have just continued to stumble. Healthcare used to trade at 1.8 times the P/E of the market. Now it trades at just 0.65 or so. So a 30% discount to the market. And then we have this dashboard that we like to look at to see how industries are priced, where we plot return on equity on one axis and then price to book on another axis.

And it’s a way of seeing what sectors are key, expensive and fairly priced. And you can see from this chart that we put together, with the exception of medical devices, almost all of the healthcare industries, whether it’s biotech, pharma, healthcare providers or managed care, are trading at steep discounts to the overall market of all the other sectors and things like that, and industries. And then this is the killer. This looks at healthcare PE ratios versus the market since 1992. And again, with the exception of medical devices, the rest of the healthcare sector P/Es are trading at either close to the lows or at the lows of the valuations that they've seen over the last 35 years or so.

So this is this is a unique time for value investors to look at the space when things are this cheap. Sometimes all you need is a little bit of a catalyst. And combined with low valuations and there can be some interesting opportunities. But we have to look at that more closely. The again, another cut on just how much things have changed.

We have charts here. For the S&P 500 healthcare industries, their annualized returns for the period up until 2019, and then their annualized returns from 2019 until July of this year. And, without exception, every single industry has seen a sharp decline in its annualized returns. The same thing is true in the mid-cap space. In case anybody was wondering.

Obviously, there’s a lot of companies in the healthcare space that are not large cap. When we ran the analysis for mid-cap and small cap, we got the same thing. Massive performance gaps between for the pre 2019 period and the post 2019 period. Now you know there’s dispersion in every sector right. So medical devices is a good example.

And the returns on the sector kind of mask some very attractive large returns of a few companies and then some very negative returns or other. So you know, for stock pickers there are always opportunities here to outperform benchmarks and things like that. But as a whole, a lot of these sectors have struggled. And I thought this was it was also important to put this in the context of how technology has done.

So over the last few years. if you look at annualized earnings growth, the leaders have been obviously software, semiconductors and tech hardware and most of the healthcare sector earnings growth has been much lower, in particular, pharma and biotech, which have barely kept up with things like telecom equipment within the tech sector. So there’s a real have and have not picture here when you’re looking at recent earnings growth.

So it’s not just valuations. It’s also earnings growth where technology and healthcare have begun to separate. One of the big drivers of the concerns that people have is proposals to lower drug prices in the U.S. And there’s lots of different ways of measuring just how high U.S drug prices are versus other countries. And I love looking at these reports from Health and Human Services.

They’re pretty agnostic about this and do it a lot of different ways. And you can see here they do it for all drugs, brand names, generics different country weights but just biologics, just biosimilars, before and after rebate adjustments and things like that. It’s a pretty consistent story here. And even when you’re netting out all the, of the, of the rebates and things like that, U.S drug prices are in the neighborhood of two times higher than other OECD countries, and much higher when you’re looking at certain brand name drugs.

So that’s been the lot of focus of proposed legislation. We also have a giant table in here that looks at this by country. And it’s a pretty consistent story here, whether we're looking at the U.S. or Canada, France, Germany, Italy, Japan, you know, and the U.K. But it’s really the brand name retail drugs where some of the multiples are just much higher in terms of U.S. prices versus overseas prices.

So until this year, most of the drug price proposals that were getting thrown around in policy circles and in legislative circles would have certainly taken a bite out of growth expectations. But they were up for the stocks, but they would only have reduced drug prices by anywhere from 0 to 3%. And some of them would have said, let’s add more drugs to the CMS Medicare, Medicaid negotiations.

Let's, make negotiated drug prices also available to commercial purchasers, require manufacturers to play to pay inflation rebates for sales in the commercial market. They were kind of tinkering on the margin. And I think over the last year or so, what's really spooked people is the discussion of a most favored nation policy that the Trump administration has mentioned to set drug prices for Medicaid and Medicare based on drug prices outside the U.S. In other words, you wouldn't be able to have a higher price than in some of these other most favored nations or some multiple of those prices.

And if that approach were adopted, drug prices could fall by 5 or 10%. And the people who look at this more closely, say that large cap pharma earnings could decline by 9 or 10%, you know, over the next few years if that happened. Some people are a little bit less concerned about this because they say that the drug price U.S. to other country multiples are not quite as high for the drugs that are covered by government channels when compared to the commercial ones.

And if this kind of policy were done at the agency level rather than through legislation, it would be challenged in court, just like the tariffs happen. Right. And it also might be limited in scope. So I think the truth is somewhere in between. I think the Trump administration is going to push harder on drug prices than them in previous administrations.

But I think a blanket most favored nation policy affecting the entire market is unlikely. That said, there are at least six bipartisan bills, designed to lower drug prices that are kind of floating around the Senate right now. And, you know, there are two things that unite people in the Senate. One is the need to ring fence China and have anti-China legislation, and the other one is to lower drug prices.

And so that’s reflected in the multiple for the sector. The other thing that’s floating around is the tariff issue and the tariff issue on pharmaceuticals is something, it’s important to understand what the driving factor is behind this for a variety of reasons. And based on all the publicly available information, the U.S. pharmaceutical sector, large cap pharma has really kind of contorted itself into a pretzel as it relates to the domicile of its profits and the domicile of its cells.

And so this is based on data from testimony from Brad Setser, who I know at the Council on Foreign Relations and, U.S. drug companies report massive amounts of domestic revenue and almost no domestic profit. And, on a smaller amount of foreign revenue and a pretty large amount of foreign profit. And what that translates into is, is a lot of tax paid offshore and very little tax or much less tax paid onshore, particularly when you strip out the annual payments that drug companies are making from the 2017, accumulated earnings tax.

That was part of that bill. So, but to be clear, it while this while citing drug company manufacturing for, for tax purposes offshore it’s something that a lot of sectors do. It got a lot of worse under Trump administration number one. And we know that because we can look at the pharma trade deficit, which over the course of around 15 years was, I don't know, 30, 40 billion.

And then with the passage of the TCJA tax bill in 2017 the pharma deficit exploded, implying that a lot more production was moved offshore. Why did this happen? That tax bill set a 10.5% minimum tax on global intangible income, a tax rate that was much lower than the tax rates those companies would have based on onshore.

And so for all the obvious reasons, the former deficit exploded. And so it’s kind of weird to see the Trump people trying to solve this problem through tariffs, when they could simply instead have adopted a higher minimum tax on global intangible income in the recent tax bill, which would have been a lot cleaner way to do it, you know, anyway, that said, we're waiting for the outcome of the section 232, tariff investigations.

And, they, you know, the former secretary will face the other the same decision other sectors face, which is do they pass those price increases on to consumers or do they eat to in terms of lower margins? Neither one, neither one is a great selling point for the sector right now. And then to make matters more interesting, you have the patent cliff.

Now, there’s always a patent live in in the large cap pharma sector, which refers to when patents expire. And, but there happens to be, some fairly large patents that that expire over the next five, ten years, and with anywhere from 15 to $30 billion of revenue annually associated with those drugs. For the companies that we show here, whether it’s Merck or IBD or Novo or JNJ or Lilly.

So, you know, there are there are there are legitimate questions people are asking about how those revenue streams are going to be replenished. I would argue that by the time a large cap pharma company is trading at a multiple of eight times earnings, you’re being compensated for that kind of risk. But that’s an issue. And then the a lot of those same companies have very large war chests of cash and cash equivalents that they have built up for purposes of replenishing those revenue streams.

Obviously, some of those, they're going to be doing their own internal R&D, but they've earmarked a lot of capital for acquisitions. And so I, I do think that, that, you know, by the time you can buy some of these companies at eight times earnings, it’s interesting when you think about the, the magnitude of acquisitions that they might be able to make to replenish them.

In the piece, we also walk through what's called a patent thicket. And, I don't want to get into too much detail, but I do think it’s important because it’s another regulatory risk that’s kind of floating out there. Most lay people think of patents as, you know, your file, your patent, you have your patent, the patent expires.

Generics come in, but it in reality, whether it’s for biologics or small molecule drugs, companies file patents and then after they get them and after the drug is being commercially sold, they file for more patents. And the patent can be on things other than just the active ingredient. They can be on formulation, method of use, and a variety of creative ways that companies have figured out to file for new patents.

And so essentially the generics and things like that can't really compete on scale with these drugs until they go off all the patents, not whether they go off the initial patents. And there have been some ideas floated over the last couple of administrations in both parties to change the nature of these patent thickets so as not to represent some kind of abuse of the whole patent system.

We have a chart in here. For example, these are the four highest selling small molecule drugs in the U.S. for HIV, stroke, cancer and myeloma. And once you take into account the patents that were filed after FDA approval, the companies have dramatically pushed out the period of patent protection. And that that could change. Okay, so I mentioned that there was no way to avoid this.

So, and I'm not going to mention everything that we've written. So sometimes I, I write more pointed things than I say, on these podcasts. But that has to do with what's going on at the FDA and RFK Jr and Health and Human Services, the biotech. And why does this matter for investors? The biotech sectors R&D, as a share of its market capitalization has grown a lot faster than the rest of the market.

And we have a chart in here that shows that, accumulated R&D, the market cap of biotech relative to the S&P, this number has gone up from, from almost no premium in 2015 to 25% premium. That there’s a lot of money in drug development that’s at risk to changes in how the FDA functions. And so far it’s early yet.

But so far, the pace of drug approvals has declined. When you look back over the last few years, the Trump administration says they're going to speed things up. They're going to simplify things. They're going to use AI to fix the approval process, whatever that is. They say, you know, whatever they're saying, I'll believe it when I see it.

Instead, investors who are focused on FDA issues have to have had to deal with all a lot of noise and uncertainty. Okay, so reports of unorthodox and unexplained interventions by the head of the FDA and his deputies and the drug approval processes. And there’s a few examples we discussed in the piece. The massive departure of senior FDA officials with decades of experience, at the center for Drug Evaluation and Research, the Center for Biologics Evaluation Research, the Office of New Drugs and Gene Therapy, 19% DOGE cuts to the FDA workforce.

They have brought back. We’ll see how long it lasts. They've brought back the head of one of these agencies. We’ll see what happens. RFK Jr. fired all 17 members of the CDC Advisory Committee on Immunization Practices. And then in a step that really kind of spooked a lot of people in the healthcare research industry, RFK announced last week that, BARDA will terminate all 22 contracts it has with university researchers and private companies to develop new uses for mRNA technology and some fairly tepid people who are normally very balanced in what they say, had some very sharp commentary. You know, Michael Osterholm at the center for Infectious Disease Research at the University of Minnesota, this may be the most dangerous public policy public health judgment that he's seen in 50 years. Its basis will pay huge price. Rick Bright, who ran BARDA during Trump's first term. It’s irresponsible. We're taking our country's in 2025 back to 1940, Jerome Adams, who was the surgeon general under Trump's first term, said something like, a lot of people are going to die from this.

I'm just sharing with you the reactions to this. And so there are a lot of questions about RFK leadership that are weighing on multiples in multiple places within the healthcare space. And understandably. And then in the piece, I also have a section with some personal reflections on what's going on with RFK, what he said over time, and the MMR vaccine paces of vaccination in the United States, and the risk around active and inactivated vaccine.

So you can take a look at that. Another train wreck to hit the healthcare sector, as if they didn't need anymore. is the collapse in managed care returns. Managed care is basically, it’s in the large cap space, five large healthcare insurance companies, including United Healthcare Molina and companies like that. And the sector returns have imploded since the middle of 2024 or down by roughly half.

Right. These are some pretty catastrophic returns. The this decline doesn't appear to be based on lower earnings, at least so far. So when you look at trailing EPS trends for the sector, you'd be confused. Like what's going on? Why is this happening? But when you look at forward earnings projections that pick up some of the guidance comments, that’s where you can see, why the market's so concerned.

And one example is the impact of the Big Beautiful Bill on this sector. In July, Centene, one of the five large cap names, cut its guidance from $7.25 a share to $1.75 a share, driven by lower market growth in in most of the states where they operate, particularly as it relates to its ACA exchange business. One way to visualize what's going on here is a chart showing the projected increase in the number of people uninsured by cause and, KFF.

You know, which used to be called the Kaiser Foundation, which is now just call KFF. They're the ones that do the work on this, and they're estimating 16 million people by 2034, as a result of spending cuts to Medicaid, which is of around 14%, and then some changes in tax credits for the, for the ACA.

So their four categories are people of people losing their insurance: Changes to ACA proposed rules, the expiration of the ACA enhanced premium tax credits, the ACA changes in the reconciliation bill and then the Medicaid cuts. And so for companies in the managed care space that insure a lot of these people, their earnings guidance is being slashed.

So that’s what's going on there. Okay. I said it we're not going to cover everything. Let me just cover a few more things. I know people have things to do. So for GLPs there’s good news and bad news. The good news is there’s more evidence that these things are effective in in addressing conditions unrelated to weight loss.

And there was a study of 1.7 million diabetes patients, people that were recently diagnosed with diabetes. And what they examined was their dementia risk based on which diabetes treatment they got. And, because a lot of these people were older and the rate at which people developed diabetes, I'm sorry, the rate at which people developed dementia, I hope I'm not getting it.

It was 2% for people treated with insulin and half that rate for people being treated with glucose. And so and the strongest impact was seen on vascular dementia. And there may be a connection there because of semaglutide’s association with reduced vascular inflammation. So that’s good news. Second, continued good news on GLP impacts on cardiovascular events. And this is from about a little over a year ago.

We have a chart here showing all of the of the different outcomes, on a controlled trial versus a placebo of cardiovascular things, whether it’s drugs or heart attacks, anginas, hospitalizations and things like that. Around a 20% decline, from semaglutide on some of these outcomes. So that’s good. The bad news is that a couple of recent studies, one directly from Lilly and another one from a paper in the Journal of Merck Medicine, are showing very high discontinuation rates, of people taking these drugs and then some limited effectiveness as it relates to weight loss. And so Lilly's stock, got clocked last week by around 15% after they announced their oral GLP results. And so just to simplify this whole thing, the injected version of the semaglutide has a given level of, of weight loss and then discontinuation from adverse events. And I think everybody always knew that the pill version might not be as good as the injected version, but the pill version was kind of critical to the outlook for Lilly and some of the other stocks, because there’s a broader universe of people that would be willing to take the pill than to inject themselves.

But the weight loss numbers from the Lilly study that they announced last week was only like 8 to 12% over 18 months. And so, you know, that’s a modest amount of weight loss and lower than the injectable version, particularly when almost a third of all the participants had to deal with nausea, vomiting, diarrhea, constipation and things like that.

So, that was not a great outcome in terms of those phase three trials. One of the things we’ll have to watch is CMS, you know, which is the center that that oversees Medicaid and Medicare is talking about, you know, what's going to happen, talking about a trial program to cover these drugs, which currently, for the most part, they don't do.

And if they if it’s approved, this experiment would start in April of next year, for Medicaid and in January 27th for Medicare. And, it would cost 35 to $50 billion. Which used to be a lot of money, but in the context of the Trump deficits is just another drop in the bucket. And so, we’ll see.

That would be a welcome boost for the sector if Medicare and Medicaid covered these drugs. But, you know, it’s early stage and these those experiments, this this kind of treatment experiment is still being debated. Let’s see, on biotech IPOs, I’ve mentioned that they've been harder to find than a needle in a haystack. I think this table that we have in the piece should be taught in every high school stats class so that people understand the difference between mean and median.

So let me give you an example. In 2022, there were 22 biotech IPOs. The average return on those 22 IPOs was 13%. The median return was -68%. In other words, you know, you have a population that skewed to a few winners and a lot of big losers. And similarly in 2023 or here's another one, how about 2019, 47 biotech IPOs average return 41%.

Positive median return 86% negative. So in other words, most of the IPOs implode and go to zero. And then there’s a handful of winners. And so this is a tough space for investors. Since 2018, half of all IPOs in the biotech space have lost 80% plus of their value and only 20% of positive returns. So that is tough.

And we did some analysis using three different biotech IPO universes, one from biopharma, one from Bloomberg and one from our capital markets colleagues. They got the same results, with each universe, which you can see in the piece. Okay, so wrapping up, there are some interesting drug discoveries on the horizon, right, these things are kind of technical.

I'm just learning about them. But bispecific antibodies to revolutionize cancer care. New treatments for neuro psychic conditions, antibody products that may slow progression of Alzheimer's, certain new gene editing formats unrelated to CRISPR, and then longevity, which we which I'll talk about very briefly and which we cover in the appendix. There’s also a lot of work to be done on cancers, most of which are still not curable.

Debilitating autoimmune diseases, cardiovascular disease, lots of genetic diseases and high mortality rates. So there’s still a lot of people to cure in the healthcare space. The problem is the country, the United States is running out of money to do it. And there’s two ways of looking at this. You can either look at total national health expenditures to GDP or personal consumption health expenditures to GDP.

Those numbers were consistently rising during that heyday of healthcare performance and were consistently rising, as you can see here, from 1976 to around 2010. Ever since then, these expenditure levels have more or less flatlined, with the exception of the bump during Covid. So, you know, the country may have reached a peak of what it can afford to spend as a share of GDP on healthcare stuff, which means that new treatments and new ideas are substitution effects for existing drugs rather than being additive.

And when you look at life expectancy versus annual health expenditures per capita, it’s another reason to be concerned that the U.S. isn't really getting as much of a return on its money when compared to other countries, which have higher life span, life expectancy, and lower health expenditures. And for those of you that follow the on the market have seen this chart before.

What does the federal government spend money on? And you look at this ratio of entitlement spending dwarfing non-defense discretionary spending, where the latter is really key to future productivity growth and jobs and national security. I think there’s an there’s an informal national referendum going on to narrow this gap rather than to increase it. And if that’s the case, there are going to be limitations on how much the country can afford to be spending on healthcare and expansions of entitlement spending related to Medicaid, Medicare.

Okay. So, the sector is trading at some of the lowest valuations in many years. There’s probably an M&A wave coming. Low prices solve a lot of problems. But, you know, if the country is serious about reforming drug pricing through some kind of most favored nation approach, it may take some time for the sector to demonstrate that it deserves higher multiples.

And it’s getting today. I think the sector is definitely worth a look for long term value investors, that have patience. So. Last couple of things, we have an appendix on the battles over publicly funded U.S. scientific research. And I have to admit, I was kind of spooked when I saw there’s this American Association for the Advancement of Science, and they were talking about projected cuts, anywhere from 27 to 60% of the budgets of the NIH, the National Science Foundation and NASA.

But the political process is complicated. The White House can't unilaterally decide how much those agencies get funded. Right? Appropriations belong to Congress. So as a general principle, Congress decides the amount of funding for these entities. And while the White House might submit something called a rescissions package, which is to claw back money from the NIH, I think it’s very unlikely to pass both chambers.

And in the short term, Congress is likely to pass a continuing resolution which maintains funding at levels roughly similar to prior years. Government shutdown may happen first, but a continuing resolution would not slash the budgets of these organizations. Then, if an appropriations bill ever gets passed and it’s unclear that one will be, it can't be passed via reconciliation, which is the way that so many bills been passed over the last couple that over the last ten years, a regular appropriations bill is going to require 60 votes in the Senate.

And gutting the NIH and the National Science Foundation is likely to be a nonstarter for the for the Democratic votes needed to pass an appropriations bill. And as a sign that the Senate views the NIH issue very differently from the president, the Appropriations Committee, which the GOP runs, approved a budget for HHS, that had flat year on year funding by a vote of like 26 to 3.

So even there’s a there’s a lot of distance between the White House and the GOP in the Senate on these kinds of issues. That said, we're already seeing the negative impact of the Trump policies on the NIH, and we have a chart here showing the decline in new and competitive renewal grant funding, compared to prior years. And this is already hurting, the sector.

And it does raise some questions about whether or not the U.S. will be able to maintain the leadership position it has in science and technology innovation. Right now, the United States is at the top. And compared to all other countries, even all the European countries. But we’ll see whether or not that changes. And last, I, I’ve been at some conferences with longevity gurus.

I typically step out during those parts of the presentation because I’ve had my share of wackos. I am interested in peer reviewed studies about certain drugs. There have been a couple that we discuss in the second appendix. One of them looks at the life expectancy of mice that are taking certain longevity drugs. Let’s feel like in a botched this traumatic to oh, gosh, traumatic to I'm going to give up and rapamycin.

And then the second one was I spoke to some scientists just last week that are working on these TERT activators that slow down some of the cellular aging. And so both of those studies actually showed reasonably decent results to either stall or reverse aging processes in mice. That said, mice are very different from people. And there have been a lot of failed trial going from preclinical to phase three because the animal models didn't work, which is another topic that we discussed.

And I’d say anyway, take a look. Thank you for listening to this long healthcare rant. It’s probably the last time I'm going to talk about this sector, because this was very aggravating to do. And we will be back to you in early September looking at labor markets and other signs of a potential economic slowdown. Thank you very much.