As the calendar turns to a new year, investors face a challenging set of circumstances. Inflation is trending lower but well above what is comfortable for the Federal Reserve or the economy. Growth is also trending lower, although there continues to be resilience in key categories like employment and consumer spending.
This is certainly a positive as it's enabled the economy to continue growing at a healthy nominal clip, but it's a negative for financial assets as it means the Fed will be more hawkish for longer.
Amid these circumstances, investors should prioritize value, resilience in earnings, and companies that benefit from longer-term rates moving lower due to inflation rolling over and increased recession risk.
While it is remarkable that the economy and specifically employment have managed to remain so resilient, it's also contributing to increased recession risk as the Fed keeps hiking and intends to keep them elevated for all of 2023. Pharmaceutical stocks are likely to outperform if this comes to fruition as their earnings and revenues are insensitive to economic factors.
In fact, they are already outperforming despite Wall Street's broad downturn heading into the year's end, demonstrated by the VanEck Pharmaceutical ETF (NASDAQ: PPH) being up nearly 1% year-to-date.
Lower economic growth will also lead to downward pressure for longer-term rates. This will also benefit pharmaceutical companies that have massive balance sheets and lead to higher dividends and higher rates of share repurchases. Further, demand for these stocks will rise especially as their dividend streams will become more attractive in a falling rate environment.
Lower inflation is another meaningful catalyst for the sector as these companies' consistent cash flows in future years become more valuable. But, unlike most other stocks which are likely to feel a sting due to lower rates of economic growth, there will be no earnings deterioration when it comes to pharmaceutical stocks.
In fact, they also came out of the midterm elections a big winner. The divided government that will reign in DC over the next 2 years means that the chances of any significant legislation that would target drug pricing is close to zero. Additionally, the moderate factions of both parties were strengthened, while extremists on both sides, who tend to see pharmaceutical companies as adversaries, were disappointed.
All in all, the pharmaceutical sector seems primed for big gains in 2023.