Halfway'26 HealthCare Sector Outlook

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Although Health Care is traditionally a defensive sector that often lags in fast-rising markets, BROTHERS & Partners believes it is positioned to benefit from several key drivers: underappreciated political tailwinds, warming sentiment, and robust industry fundamentals.

Despite the year-to-date lag, our outlook is supported by the following factors:

- Historical Performance: The sector historically outperforms during US midterm election years alongside other defensive industries.

- Market Sentiment: While sentiment remains subdued following a significant US election-driven lag, we are observing a gradual shift toward more positive outlooks.

- Strong Fundamentals: Industry health remains favorable, characterized by strong M&A activity, significant R&D investment, and an accommodative drug-approval environment.

Within the sector, we currently favor:

- Small and mid-cap Therapeutics

- Biotech firms

- Large, innovative Biopharmaceuticals

The rationale for these specific selections is outlined in further detail herein.

Recent performance and outlook for the Healthcare sector.

• Recent Performance

Healthcare has lagged YTD as the closure of the Strait of Hormuz weighed on most sectors and industries, aside from Energy and Semiconductors. Growth-oriented Healthcare industries, such as Life Sciences and Medical Equipment, faced headwinds, while Health Insurers dealt with heightened regulatory scrutiny. Additionally, several large, innovation-challenged equities within the sector (such as Sanofi, Novo) dragged down broader sector performance.

• Future Outlook

While specific industries may continue to face idiosyncratic headwinds, we expect the sector—notably Biopharma, small/mid-cap Biotech, and Providers—to outperform moving forward. Healthcare’s YTD lag at the sector level has been driven by non-Pharma industries, while the large, innovative Biopharmaceuticals we favor are leading.

We expect the following trends ahead:

- Biopharma: Should continue benefiting from political and market-cycle tailwinds against a backdrop of overly dour sentiment and better-than-feared fundamentals.

- Small and Mid-Cap Biotech: Expected to resume outperformance as the clearest downstream beneficiaries of improving conditions for big Biopharma. They stand to benefit from recovering funding conditions, accelerating M&A activity, rising investor sentiment, and an accommodative US Food and Drug Administration (FDA).

- Healthcare Providers: Expected to benefit from stronger 2027 M&A rates and fading cost pressures.

Political Tailwinds Ahead & Headwinds in Rearview: US Midterm Outperformance

US midterm election years represent one of the most consistent periods of outperformance for the Health Care sector, particularly Biopharma. Historically, Health Care tends to underperform during US presidential election and inaugural years due to political rhetoric surrounding health care reform and cost-reduction measures.

However, in the lead-up to midterm elections, political focus shifts away from reform legislation and toward re-election campaigns, which significantly reduces policy uncertainty. Consequently, Health Care—alongside other defensive sectors—typically outperforms during this period.

Weak Sentiment, Strong Economic Fundamentals

As political headwinds have started subsiding, sentiment toward the pharma sector has improved. 

However, it remains below historical averages, suggesting there is still ample room for recovery before reaching optimism. 

One way of observing this is via valuations—namely price/earnings ratios—which presently reflect pharma trading at a discount.

Sustained Innovation Cycle, R&D & M&A Activity

Despite prevailing weak sentiment, economic fundamentals in these sectors remain robust. Notably, there has been a significant rebound in M&A activity and biotechnology funding, which serves as a positive tailwind for small and mid-cap firms. This upward trend is anticipated to persist as numerous large pharmaceutical companies approach major patent expirations by 2030. Consequently, we expect sustained investment in healthcare R&D and accelerated M&A activity as these organizations look to replace projected revenue losses.

The healthcare sector is currently in a strong innovation cycle, driven by elevated approvals and the FDA’s recent deregulatory push. This environment creates strong pricing power, making the sector—particularly Biopharma—ripe for outperformance.

Late-Cycle Winner(s)  

HealthCare tends to outperform during late-cycle environments, which is the phase of the market cycle we believe we are currently in. 

Today's market exhibits the typical definitions of a late-cycle environment, including narrow market breadth and elevated, ballooning equity supply.

Conclusion

At BROTHERS & Partners, we believe the healthcare sector’s recent weakness is increasingly disconnected from its underlying fundamentals. 

Despite selective industry pressures, the resolution of political and regulatory

uncertainties should allow investors to better appreciate resilient earnings, stable regulatory approvals, improving funding conditions, and increased M&A activity.

While we remain selective across broader healthcare exposure, we currently favor innovative Therapeutics, Pharma, and Biotech businesses where improving sentiment and strong fundamentals are best aligned

Best wishes for an enjoyable summer break to all!