Under ordinary circumstances, the pharma industry would look like a bad place to park your money right now.
The government is working to suppress drug prices through a recently signed law , and the industry is staring at a patent cliff worth more than $200 billion later this decade, as blockbuster drugs face competition from generics.
Yet these aren't ordinary times, and those dark clouds gathering over pharma look relatively mild if you consider the storm threatening the rest of the economy.
With inflation running hot and the Federal Reserve's aggressive monetary tightening making traditionally safe assets like government bonds difficult to own, drug companies are looking remarkably resilient. And while the NYSE Arca Pharmaceutical Index has outperformed the broader stock market this year, falling 9.6% compared with 22.5% for the S&P 500, it continues to trade at a discount, fetching 13.4 times forward earnings, versus 15.4 for the S&P 500. Since Tuesday's close, just before the 75-basis-point increase by the Fed on Wednesday, the pharma index is down just 0.7%, compared with a 4.2% decline for the S&P 500.
One reason investors are willing to stomach the aforementioned threats to the industry is that much of the pain is expected in the second half of the decade, giving the industry ample time to mount a defensive strategy.
When it comes to prescription drugs, Medicare will start n egotiating prices for only 10 drugs in 2026, with the list growing each year afterward. That number will increase and eventually eat up a chunk of industry profits. It could also lead commercial insurance companies to toughen their negotiating stance, a significant threat that isn't yet priced in.
But a deep dive by a Jefferies team led by analyst Akash Tewari shows that the bite, for now, might not be as bad as first thought. In all, Jefferies sees the bill's impact on revenues growing incrementally every year to a total of about $38 billion by 2032. That could translate to a $100 billion reduction in the industry's market cap this decade out of about $3 trillion in total valuation, or about 3%, the team members said. They added that the impact could be larger if negotiation is extended beyond Medicare or if prices are negotiated more aggressively than expected.
The drug-patent cliff is a more sizable threat. Many of the top-selling blockbusters, such as Merck's Keytruda, Bristol-Myers Squibb's Revlimid, and Johnson & Johnson's Stelara, are likely to face generic competition after 2025. But drug companies will unleash all their weapons—from legal efforts to protect patents to clinical repurposing of their drugs—to slow down that competition and extend their runway.
Beyond that, industry chiefs have made it abundantly clear they aren't holding back on mergers and acquisitions as a way to grow inorganically, with Pfizer having already done some significant acquisitions such as the agreement to purchase Biohaven for $11.6 billion this year, and Merck reportedly holding talks with Seagen Inc.
For now, the drug industry and much of the broader healthcare sector—with the exception of biotech, where rising interest-rate costs are a bigger problem—represents a haven because of the relatively inelastic nature of consumer demand for its products. During a recession, people will postpone such things as travel and dining before they cut back on their medical care.
For investors who think the economy is bound to get a lot worse before it gets better, drug companies continue to offer safety despite the threats hanging over them in the longer term.