Sectors

Pharmaceutical stocks have broken from their correlation with biotech stocks, and we expected this divergence to be sustained. Pharmaceutical profits remain one of the few bright spots within the corporate sector. Drug demand continues to boom, as measured by consumer spending data. Inventories have moved higher at both the wholesale and manufacturing level, but this appears to reflect demand-driven stocking of product, given ongoing strong pricing power gains. In a deflationary world, the ability to significantly lift selling prices warrants a premium valuation. Yet the S&P pharmaceuticals index still trades at a large discount to its historic average relative valuation. If domestic economic disappointment mounts, as we expect, it will provide another catalyst for a relative performance re-rating. Stay overweight the S&P pharmaceuticals index. Importantly, it will be important to differentiate pharma from biotech, please see the next Insight.