Healthcare Stocks Show Early Recovery Signs Amid Valuation Discounts

Analysts at Evercore ISI have noted that the U.S. healthcare sector is exhibiting early signs of recovery. This sector has been trading at a significant discount relative to the S&P 500 index, reaching a 30-year high in valuation discount. Since hitting a historical peak on September 3, 2024, healthcare stocks have been in a continuous downward trend, underperforming both in absolute terms and relative to the S&P 500. This trend has persisted despite the broader market rally that pushed multiple indices to new highs post-holiday.

However, the situation began to change in August, as healthcare stocks started to reverse their previous weakness. The chief equity and quantitative strategist at Evercore ISI highlighted that this recovery is driven by a historical valuation gap and an economic environment characterized by GDP growth slowing to 1.5% or lower, while inflation remains at 3% or higher. This macroeconomic backdrop has historically favored the healthcare sector's outperformance.

From a quantitative perspective, stocks that offer both valuation appeal and high market sentiment have proven to generate excess returns, even in the current environment of extremely high market multiples. The strategist emphasized the importance of focusing on stocks with strong upward revisions in earnings expectations to avoid value traps that may arise from stocks appearing cheap due to absolute or relative valuation metrics.

Currently, the healthcare sector offers attractive investment opportunities with a market price-to-earnings ratio of 25.5, compared to the overall market. However, the strategist cautioned that the period from August to October typically experiences seasonal headwinds. Despite this, the potential recovery in healthcare stocks is seen as a significant component of the most rapid bear market rally in history, suggesting a larger bull market that could extend into 2026.

The dual effect of valuation discounts and improving sentiment provides a strong rationale for investors to include healthcare stocks in their portfolios, given the current economic conditions. Evercore ISI has recommended several healthcare stocks that offer both valuation and sentiment appeal, including Cencora, Baymarin Pharmaceuticals, Cigna, Cardinal Health, Humana, Incyte, LHC Group, Pfizer, Quest Diagnostics, Teladoc Health, Tenet Healthcare, Universal Health Services, and Viatris.