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Highlights We reiterate our longstanding overweight on healthcare equities for the next 12 months and possibly beyond. The macro environment, as well as underlying demand factors, will continue to drive the sector’s outperformance. Within healthcare equities, we favor biotechnology and healthcare technology over pharmaceuticals. Healthcare corporate bonds, however, are not especially attractive, and therefore warrant no more than a neutral position. Feature Chart 1Healthcare Has Outperformed Over The Past Decade... Over the past decade, global health care stocks have been clear outperformers, alongside information technology and consumer discretionary stocks, rising by almost 50% relative to the broad market (Chart 1). Not only have they benefited from increased demand from an aging population in developed economies and a growing middle class in emerging markets, they have also provided a downside cushion during recessions and bear markets, given their defensive, non- cyclical nature. The COVID-19 pandemic leads us to reiterate our longstanding overweight position on global healthcare equities over the next 12 months and possibly beyond. Favorable tailwinds will continue to drive healthcare outperformance. It is likely that government spending on healthcare will increase over the coming years. Innovative solutions in healthcare technology (healthtech), as well as increased overall research and development (R&D), the shift to value-based healthcare delivery, the focus on preventive medicine, and a low risk of substantial regulatory change and reform (at least in the US, assuming former Vice President Biden is elected president this November) should continue to support the sector’s outperformance. In this Special Report, we analyze whether our long-term overweight position on healthcare equities remains valid. In a later section, we also review healthcare-related investments in bonds and private equity. Why We Like Healthcare BCA Research’s Global Asset Allocation (GAA) service has been positive on global healthcare stocks for over five years. The main reason is that we see demand for healthcare services continuing to rise, as life expectancy increases, populations age – people over 65 will comprise 25% of the developed world’s population by 2040, up from 15% in 2020 – and the middle class in emerging economies becomes richer (Charts 2&3). As people live longer, healthcare spending should rise since, after the age of 65 (retirement), it tends to squeeze out discretionary spending (Chart 4). Chart 2...As The Global Population Grew Older... Chart 3...And Richer       Healthcare spending everywhere represents a large proportion of GDP, but the percentage varies considerably between countries. In the US for example, healthcare spending comprises 16.9% of GDP, higher than in other advanced economies, where it averages 9.9%, and substantially higher than in emerging economies (average 6.5% of GDP) (Chart 5). It is likely that these figures will increase over the next few years. Chart 4Healthcare Expenditure Dominates Late-Life Spending Chart 5Spending On Healthcare Will Rise   A strong case can be made for serious outbreaks of infectious diseases becoming more common, and therefore governments will have to increase their readiness. The number of countries experiencing a significant outbreak has almost doubled over the past decade, after being on a declining trend during the prior 15 years (Chart 6). The World Health Organization (WHO) warns that, while pandemics are rare, highly disruptive regional and local outbreaks are becoming more frequent and causing more economic damage.1 The non-cyclical nature of healthcare demand makes the industry less vulnerable to economic downturns. In times of below-trend growth, investors rush into defensive-growth stocks. Over the past two recessions, the drawdown of healthcare equities was, respectively, 20% and 27% less than the broad market. Chart 6Number Of Countries Experiencing Serious Outbreak Of Infectious Disease Chart 7The Defensive Side Of Healthcare   However, the sector is not totally cyclically insensitive, given its capital intensity and reliance on debt. In the US, healthcare sector debt amounts to almost $500 billion (Chart 7). This also leaves it vulnerable to rising interest rates. Nevertheless, the current macro outlook should keep a lid on interest rates for some time. The healthcare industry has lagged in digitalization (Chart 8). This offers wide-ranging opportunities for the sector, particularly in healthtech, biotechnology, and pharmaceuticals. Innovative solutions in robotics, artificial intelligence (AI), and genomics will drive the industry in the years to come. Digitalization will accelerate productivity and improve profitability. Chart 8The Healthcare Sector Is Way Behind In Digitalization Lastly, valuations for healthcare equities in most countries remain attractive, close to their long-run averages. The only exceptions are the UK and Japan, which are two standard deviations above the historical mean relative to their respective markets (Chart 9). The Future Of Healthcare Every crisis provides insights into what went wrong, what needs to be changed, and what areas should be explored. The COVID-19 pandemic is no exception. The pandemic has highlighted supply-chain fragilities, particularly a shortage of some healthcare equipment and drugs, the production of which is outsourced. In the US, for example, according to the Food and Drug Administration (FDA), over 70% of facilities producing essential medicines for the US are located abroad (Chart 10). Chart 9Valuations Remain Reasonable Chart 10Supply Chain Fragilities   Some argue that reshoring healthcare production is essential. Joe Biden, favored to be the next US president, has highlighted this in his plan to rebuild US supply chains.2 This could, however, lead to higher healthcare costs. This would either require increased government spending to subsidize medical expenses, or lead to fewer people being able to afford adequate healthcare. This effect would be pronounced in economies where a large percentage of the population is uninsured, around 10% in the US, and much more so in some emerging economies where healthcare quality is poor. This might be less of a risk for pharmaceutical and biotechnology companies, where the largest cost of bringing a new drug to market is R&D and marketing, rather than manufacturing. In the first months of the outbreak, resources such as ventilators, hospital and ICU beds, and basic personal protective equipment (PPE) quickly became scarce. Inventories of such items and overall hospital capacity will need to increase. This will entail massive investments to boost the public healthcare infrastructure and increase the number of healthcare workers. Chart 11COVID-19 Unveiled Poor Health Standards... The pandemic also underlined weaknesses in social and health standards. The excessive number of deaths from COVID-19 in nursing homes in some developed economies emphasizes the need for investment in this area. For example in Quebec, Canada, a staggering 80% of the province’s deaths occurred in nursing homes and senior residences (both public and private), illustrating the mismanagement and lack of funding (Chart 11). Most notably, care homes run for profit (approximately 70% of the total in the US) have seen almost four times as many COVID-19 infections as those not. The quality ratings of for-profit nursing homes, as measured by the Centers for Medicare and Medicaid Services (CMS), are much lower on average than those of non-profit or government-run facilities (Chart 12). This could imply the mass nationalization of nursing homes. However, this is unlikely. A better option would be to impose higher standards on privately run homes, reducing the sector to a smaller number of high-quality providers. Chart 12...In Most For-Profit Nursing Homes Chart 13The Evolution Of Genome Sequencing Is Illustrated In The Price More positively, there remains a large gap to be filled by a new era of technology-driven, integrated, and online healthcare. Investments in biotechnology – particularly related to genetic information – are also likely to increase, as DNA sequencing becomes cheaper (Chart 13). The way patients interact with physicians will also change. The American Medical Association (AMA) surveyed more than 1000 physicians on the use of digital tools in their practices. Reliance on digital tools for monitoring and clinical support has increased significantly over the past three years. The largest jump however was in the number of practices using telemedicine and virtual visits (Chart 14). Chart 14The Transition To A Digital-Driven Healthcare Model “Contact tracing” is a term that has been widely used during the coronavirus outbreak. The ability to track those infected and monitor their interactions to limit the spread of the virus is seen as a crucial step to mitigate further contagion. This would help not only to eradicate the virus, but might be developed into a long-lasting technology. Similar to how security screening equipment was developed after 9/11, there should be investment opportunities in the medical-screening segment. Breaking Down Healthcare Equities It is important to note that not all healthcare equities are equal: Different regions and industries have performed differently. In this report, we distinguish between the industry groups and subgroups, based on the GICS Level 2 and Level 3 classifications. We also look at the nine largest regions in the MSCI indexes to see if certain regions provide more favorable opportunities. Healthcare equities are broken down into two industry groups, which in turn break down into six industries: Healthcare equipment & services Healthcare equipment & supplies Healthcare providers & services Healthcare technology Pharmaceuticals, biotechnology & life sciences Pharmaceuticals Biotechnology Life sciences tools & services In Table 1, we drill down the constituent weights of the MSCI healthcare indexes. This allows us not only to analyze the size of the sector and its parts, but also to gain multiple insights. For example, a bet on Swiss healthcare stocks is essentially a bet on pharmaceuticals, given the greater-than-80% weighting of that industry. Exposure to the overall Danish equity index is by default a play on healthcare stocks, since they comprise almost 60% of the index. Table 1Global Healthcare Weights Chart 15Healthcare Has Outperformed Broad Indices Globally... As noted earlier, global healthcare stocks have outperformed the broad index by almost 50% over the past decade. This is true across all regions. However, several distinctions can be made. US, Swiss, and Danish healthcare equities have outperformed the global healthcare benchmark over the past decade, but their counterparts in the euro area, UK, and Japan have lagged (Chart 15). On a risk-adjusted basis, Danish healthcare equities have been the best performer with a Sharpe-ratio of 0.84 and an annualized return of 18% since 2000 (Table 2).   Table 2...However Not All Healthcare Stocks Are Alike Investment Opportunities Chart 16Within Healthcare Equities, Favor Biotechnology and Healthcare Technology... Viewing healthcare as a set of separate segments, rather than as a single industry, highlights pockets of opportunity.  A selective approach might be preferable for asset allocators in the coming years. As discussed in The Future Of Healthcare section, the sector is likely to shift to a model that relies more on technology, is data-driven, and harnesses the power of digitization, robotics, and AI. The patient will be at the center of the new healthcare model.  We divide our overview of investment opportunities into three categories: equities, corporate bonds, and private investments. Equities: Based on our view of the future of healthcare and the structure of the GICS equity classifications, we favor biotechnology and healthcare technology, and would have only a benchmark allocation to pharmaceuticals. There are insights to be drawn from the fundamentals, historical performance, and valuation metrics. Historically, pharmaceutical equities stand out as the worst performers within the sector. Over the past decade, they have underperformed the global healthcare benchmark by 20%, whereas biotechnology and healthcare technology stocks have outperformed by 59% and 127%, respectively (Chart 16). The outperformance of biotechnology has predominantly been earnings-driven, whereas pharmaceuticals’ and healthcare technology stock prices appear to be detached from earnings (Chart 17). It is worth nothing that despite the fact that valuations for those industries appear expensive relative to the broad market, we remain positive on their outlook. As we drill deeper into Level 3 industries, the small number of constituents within the index makes relying on valuations challenging (Chart 18). Chart 17..Despite A Detachment From Earnings... Chart 18...And Elevated Valuations   Chart 19No Attractive Opportunities Within Healthcare Corporate Bonds Corporate Bonds: Within the corporate bond universe, we favor those that qualify for central banks’ purchase programs: Investment-grade bonds and the highest tranche of high-yield. BCA Research’s US fixed-income strategists have an overweight recommendation on US healthcare corporate bonds, though their recommendations are based on a six-to-12 month investment horizon rather than the longer perspective that we are taking in this report.3 Both healthcare and pharmaceuticals bonds, similar to their equity counterparts, trade defensively, outperforming the broad corporate index when spreads widen and underperforming as they tighten (Chart 19). This applies to both investment-grade and high-yield bonds. The credit risk measure favored by our US bond strategists is the duration-times-spread (DTS) ratio. This measure confirms the sector’s defensive nature: A value below 1 implies credit risk lower than the market. However, the recent uptick in the DTS ratio of healthcare investment-grade bonds shows the sector has become riskier and as such may trade more cyclically in the short term. Nevertheless, the macro environment should remain favorable. Pricing power is still strong, with medical care services rising by almost 6.0%, and drug prices rising by 1.4% on a year-over-year basis, outpacing overall consumer prices (Chart 20). Neither segment within the investment-grade space offers an attractive spread advantage over the broad index. However, the risk outlook for healthcare remains better than that for pharmaceuticals, particularly related to political risk (as discussed later in the Risks section). Private Investments: Venture-capital investments in healthtech reached a quarterly record high of $8.2 billion in Q1 2020. The recent pandemic is likely only to push this trend higher. Moreover, large private-equity investments in recent years have been targeted at biopharma.4 According to Bain & Company, global biopharma private-equity deals where value was disclosed, reached $40.7 billion in 2019, up from $16.5 billion the prior year.5  The number of biotech firms going public is also trending up, despite slipping to 48 in 2019 from 58 in 2018 (Chart 21). To date (as of early June), 21 out of 43 US IPOs this year are healthcare-related. Chart 20Pricing Power Remains Favorable Chart 21More Biotech IPOs Are Coming To Market   Additionally, M&A activity has been increasing, particularly within the biotechnology segment, although the economic shutdown has slowed the deal flow recently. The number of M&A deals peaked in March 2020, when the average premium is 45% (Chart 22). The long-term rising trend is likely to persist. Over the next year, firms with drugs or vaccines related to COVID-19 would be clear targets for acquisitions and should outperform. Over the long term, we also expect to see some industry consolidation. Risks We see the following as the biggest risks to our overall positive outlook for healthcare investments: Quicker-Than-Expected Economic Growth Rebound: As we highlighted, the healthcare sector is defensive – outperforming the broad market during recessions and economic slowdowns. However, if growth rebounds more quickly, driven by further fiscal and monetary stimulus, the upside for healthcare performance could be challenged. Political Risk: Joe Biden might swing to the left in the run-up to the US presidential election to bring on board supporters of Elizabeth Warren and Bernie Sanders. Nevertheless, we see that particular risk for healthcare as relatively small (Chart 23). Biden’s approach is to restore and expand Obamacare (the Affordable Care Act, or ACA), shifting some of the burden of healthcare spending from individuals to the government. Overall, this should be positive for healthcare spending, particularly for insurers and healthcare providers. However, pharmaceutical companies may face headwinds if the administration imposes price caps on drug prices. Chart 22Secondary Market Activity Is Also Strong Chart 23Political Risk Has Waned As Biden's Chances Of Election Have Increased Chart 24Reliance On Inorganic Growth Might Prove Unsustainable Lack Of Innovation: Over the past two decades, the healthcare sector has shifted to relying on inorganic growth, driven by takeovers, rather than on research and development. Capital expenditure as a percentage of sales by both pharmaceutical and biotechnology firms fell sharply in the 2000s and has stagnated around 2% and 4%, respectively since (Chart 24). Only A Few Make It: While more IPOs in the healthcare sector is a sign of improving innovation, it is worth noting that only a few newly listed companies are successful. Over the past decade, only 3% of the 349 biotech IPOs had positive earnings at the time of their IPO. This nevertheless is a consequence of the nature of the industry: Companies tend to list while they await a big breakthrough in product development or regulatory approval. Conclusion We continue to recommend investors hold an above-benchmark allocation to healthcare-related investments on a long-term basis. Aging populations, the need to improve the quality of global healthcare, a likely increase in government spending, the shift to digitalized healthcare, and demand which is non-cyclical all support this stance. Healthcare equities in general, and particularly biotechnology and healthcare technology, should perform well over the coming years. For investors with global mandates, allocations to US, Swiss, and Danish healthcare equities should outperform those in the euro area, Japan, and the UK. Corporate bonds do not offer any advantage over the broad corporate US bond index. Political risks for the US healthcare sector should be limited even if the Democrats win the White House. However, the risk is highest for pharmaceuticals, in the event where the government imposes price caps.   Amr Hanafy Senior Analyst amrh@bcaresearch.com   Footnotes 1  "World Economic Forum, Outbreak Readiness and Business Impact, Protecting Lives and Livelihoods across the Global Economy," January 2019. 2  For more info please see Joe Biden https://joebiden.com/supplychains/ 3  Please see US Bond Strategy, "Assessing Healthcare & Pharma Bonds In A Pandemic," dated June 9, 2020.available at usbs.bcaresarch.com. 4  Biotech refers to manufactured products that rely on using living systems and organisms. The biopharma industry is backed by biotechnology, the science, which allows products to be manufactured biologically. 5  Bain & Company, Global Healthcare Private Equity and Corporate M&A Report 2020.

The deeper we dig in the concentration of SPX returns the more worried we become. The top five stocks in the SPX (AAPL, MSFT, AMZN, GOOGL & FB) have added $4.82tn to the S&P 500 market cap since 2015, whereas the bottom 495 stocks have added $3.82tn. In percent return terms, these five tech titans’ market capitalization has gone up roughly four fold or 288% over the past 5 ½ years from $1.67tn to $6.49tn. In marked contrast, the S&P 495 market cap has gone nowhere rising a mere 23% (increasing from 16.57tn to $20.39tn) during the same time frame (top panel). If investors have not been in these tech titans, then they have not really participated in the SPX’s run up. The measly return since 2015 in the Value Arithmetic index and negative return in the Value Line Geometric index gauging the mean and median US stock, respectively, corroborate our analysis (not shown). Clearly, such a steep divergence is unsustainable and the longer these handful of stocks defy gravity the steeper their eventual fall will be (second panel). Bottom Line: We remain cautious on the near-term prospects of the S&P 500, until the election uncertainty lifts in November.   ​​​​​​​

Highlights For financials and energy to produce a sustained rally, there must be no relapse in global growth during the autumn and winter of 2020/21. However, with the coronavirus still in play and the usual flu and virus season yet to come, a key hurdle to overcome will be the physical reopening of schools and childcare facilities this September. Hence, for the time being, remain overweight healthcare and technology versus financials and energy. This implies underweight European stocks versus US stocks, and overweight Germany, France, Netherlands and Switzerland within Europe. Play good news in Europe by remaining long EUR, CHF, and SEK versus USD, and long US T-bonds and Spanish Bonos versus German Bunds and French OATs. Fractal trade: Short silver. Feature Chart Of The WeekDenmark's OMX Is At An All-Time High, While The FTSE 100 Is Languishing. Why? Once upon a time, the stock market existed as a barometer of the economy. Or at least, a good representation of the size and composition of profits in the host economy. But that time is long gone. Today, a tiny handful of companies are driving the performance of supposedly broad indexes such as the FTSE 100 and the S&P 500. Indeed, we should more accurately call the FTSE 100 the FTSE ‘10’ ignoring the other 90. And we should call the S&P 500 the S&P ‘5’ ignoring the other 495. Meaning that stock markets are no longer stock ‘markets’. Yet many analysts still try and explain the stock market’s performance through traditional top-down macro drivers such as GDP growth, profit margins across the host economy, and so on. The trouble is that when the stock market is dominated by a tiny handful of companies, this 20th century approach is doomed to fail. Today, we must take a more granular approach based on the type of companies that are dominating each stock market. Sector Concentration Is Driving Stock Markets The handful of companies that dominate each stock market tend to be the leaders in their global sector. This means that each stock market is defined by a sector concentration, which has often evolved by chance, based on where companies chose to start up and list. This sector concentration usually has little or no connection with the host economy. For example, Denmark’s OMX index is dominated by Novo Nordisk, a global biotech company. The FTSE 100 is heavily weighted to the oil majors Royal Dutch and BP as well as global bank HSBC, which have only a limited exposure to the UK economy. On the other side of the Atlantic, Apple, Microsoft, Amazon, Google and Facebook are massively over-represented in the S&P 500 compared with their contribution to the US economy. A crucial defining feature of a stock market turns out to be its exposure to healthcare and technology – whose profits are in major structural uptrends – versus the exposure to financials and energy – whose profits are in major structural downtrends (Charts 2 - 5). Chart I-2Healthcare Profits Are In A Structural Uptrend Chart I-3Technology Profits Are In A Structural Uptrend Chart I-4Financial Profits Are In A Structural Downtrend Chart I-5Energy Profits Are In A Structural Downtrend The stock market capitalisation in healthcare and technology stands at 52 percent for Denmark and 40 percent for the US, compared with just 20 percent for Europe and 12 percent for the UK. The flip side is that the stock market capitalisation in financials and energy stands at just 8 percent for Denmark and 11 percent for the US, compared with 21 percent for Europe and 30 percent for the UK. This explains, for example, why Denmark’s OMX is hitting all-time highs while the FTSE 100 is languishing (Chart of the Week). That said, the price of the growing stream of healthcare and technology profits can still fall if it is at an unjustifiably high level. And the price of the shrinking stream of financial and energy profits can still rise if it is at an unjustifiably low level. Hence, the key question is: what determines the prices of these two groups of sectors, one whose profits are in a major uptrend, the other whose profits are in a major downtrend? Healthcare And Tech Performance Hinges On The Bond Yield The price of a rapidly growing profit stream is weighted to the values of the large distant cashflows, making it highly sensitive to the discount rate applied to those distant cashflows. Whereas the price of a rapidly shrinking profit stream is weighted to the values of the large immediate cashflows, making it much more sensitive to the near-term evolution of the economy (Box I-1). Box I-1Bond Yield Sensitivity Versus Economic Sensitivity The upshot is that for stocks and sectors whose profits are in a major uptrend, the key driver of the price is the direction of the bond yield. Whereas for stocks and sectors whose profits are in a major downtrend, the key driver is the near-term direction of the world economy (Chart I-6 and Chart I-7). Chart I-6Exposure To Healthcare And Technology Determines Bond Yield Sensitivity Chart I-7Exposure To Financials And Energy Determines Economic Sensitivity Pulling all of this together, the rally in healthcare and technology stocks is extremely vulnerable to a sustained rise in the bond yield. But a sustained rise in the bond yield seems highly unlikely without a breakthrough vaccine or treatment for COVID-19. While the coronavirus is still in play, the long-term hollowing out and scarring in the jobs market will only become apparent in the coming months once furlough schemes and temporary relief programs end. This will force all central banks to remain ultra-dovish and where possible, become more dovish. Meanwhile, for financials and energy to produce a sustained rally, there must be no relapse in global growth during the autumn and winter of 2020/21. However, with the coronavirus still in play and the usual flu and virus season yet to come, a key hurdle to overcome will be the physical reopening of schools and childcare facilities this September. Hence, for the time being, remain overweight healthcare and technology versus financials and energy. This translates to underweight Europe versus the US. And overweight Germany, France, Netherlands and Switzerland within Europe. How To Play Good News In Europe Things have been going right in Europe. First, unlike in the US, the COVID-19 outbreak is subsiding, at least for now. New infections have been steadily declining through the warm summer months (Chart I-8). Chart I-8New Infections Declining In Europe, Rising In The US Second, the ECB has injected ample liquidity into the banking system which, combined with ultra-low interest rates, has permitted a strong expansion in bank lending. Though somewhat disappointingly, the bank lending surveys tell us that the loans are being used for emergency working capital requirements rather than investment. Third, the EU has approved a €750 billion Recovery Fund, over half of which will take the form of grants to the sectors and regions most stricken by the coronavirus crisis. Given that the fund will be financed by jointly issued EU bonds, this amounts to a fiscal transfer to the areas that need the most help. Hence, even if the amount of the stimulus may be smaller than in other parts of the word, it comprises a huge symbolic step towards greater unity in the EU and euro area. Still, despite this trifecta of good news, European stock markets have not outperformed (Chart I-9). This just emphasises that stock market relative performance has little connection with domestic economics and politics. To reiterate, stock market relative performance is almost always the result of the sector concentration of a handful of dominant stocks. Chart I-9Despite Good News In Europe, European Equities Are Not Outperforming Begging the question: how to play the continuation of good news in Europe? The answer is through the currency and fixed income markets, which have a much stronger connection with domestic economics and politics (Chart I-10 and Chart I-11). Chart I-10Play Good News In Europe Via European Currencies... Chart I-11...And Sovereign Yield Spread Tightening Remain long a basket of EUR, CHF, and SEK versus the USD. Our favourite cross out of these three is long CHF/USD given the haven character of the CHF in periods of market stress. To play bond yield convergence between the US and Europe and between core and periphery Europe, remain long US 30-year T-bonds and Spanish 30-year Bonos versus German 30-year bunds and French 30-year OATs.   Dhaval Joshi Chief European Investment Strategist dhaval@bcaresearch.com Fractal Trading System* The spectacular rally in silver is fractally fragile, and at a point which has signalled several trend reversals through the past five years. Accordingly, this week’s recommended trade is short silver, with the profit target and symmetrical stop-loss set at 12.5 percent. In other trades, long GBP/RUB achieved its profit target. Against this, short Germany versus UK and long bitcoin cash versus ethereum reached their stop-losses. Long nickel versus copper reached the end of its holding period in partial loss. The rolling 12-month win ratio now stands at 59 percent. When the fractal dimension approaches the lower limit after an investment has been in an established trend it is a potential trigger for a liquidity-triggered trend reversal. Therefore, open a countertrend position. The profit target is a one-third reversal of the preceding 13-week move. Apply a symmetrical stop-loss. Close the position at the profit target or stop-loss. Otherwise close the position after 13 weeks. * For more details please see the European Investment Strategy Special Report “Fractals, Liquidity & A Trading Model,” dated  December 11, 2014, available at eis.bcaresearch.com. 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