Eye On The Market: "Sick as a Dog" Episode Summary

Podcast Information:

• Title: Eye On The Market
• Host: Michael Cembalest
• Episode Title: Sick as a Dog: the cheapness of US healthcare stocks, and the battle over publicly funded science research
• Release Date: August 12, 2025

Introduction to the Healthcare Sector Decline

Timestamp: [00:25]

Michael Cembalest opens the episode by addressing the significant downturn in the U.S. healthcare sector, a topic he previously perceived as too vast and complex to tackle. However, recognizing the critical and conflicting dynamics at play, he embarked on an in-depth analysis of healthcare's valuation issues and the ongoing battles over publicly funded research.

Historical Performance vs. Recent Stagnation

Timestamp: [02:30]

Cembalest reflects on his long career, noting that from 1989 to 2019, the healthcare sector mirrored the tech industry's robust growth, offering similar returns with less volatility. This period positioned healthcare as a reliable parallel growth investment. However, post-2019, a sharp divergence occurred: while tech continued its rapid ascent, healthcare entered a phase of stagnation and decline.

• Notable Quote:

  “From 1989 to 2019, healthcare generated almost the identical returns as the tech sector and with a lot less volatility.” — Michael Cembalest [02:45]

Valuation Discrepancies in the Healthcare Sector

Timestamp: [05:10]

The discussion delves into the current valuation metrics:

• Large Cap Pharma PE Ratios: Averaging around 14x forward earnings, which appears distressed. For instance, Lilly trades at a multiple of 24, while peers like Merck and Pfizer hover around 8-9x.

• Biotech Sector: Faces one of the largest valuation discounts in the market. Since 2018, 80% of biotech IPOs have "imploded," meaning they have significantly lost value post-IPO.

• Managed Care: Returns have dramatically decreased, reflecting investor concerns despite stable trailing earnings.

• Earnings Growth: Contrary to tech, which boasts strong annualized earnings growth, sectors like pharma and biotech have lagged, exacerbating the valuation gap.

• Notable Quote:

  “Healthcare used to trade at 1.8 times the PE of the market. Now it trades at just 65 or so. So a 30% discount to the market.” — Michael Cembalest [12:15]

Political and Regulatory Challenges

Drug Pricing Legislation

Timestamp: [16:40]

A central theme is the U.S. government's push to lower drug prices, which stands as a significant headwind for pharma companies:

• Current Proposals: Earlier proposals aimed for marginal reductions (0-3%). However, recent discussions around a "most favored nation" (MFN) policy could slash prices by 5-10%, potentially reducing large-cap pharma earnings by up to 10%.

• Industry Reaction: Mixed sentiments; some believe the MFN approach may be adopted piecemeal rather than as blanket legislation, potentially limiting its impact.

• Notable Quote:

  “If that approach were adopted, drug prices could fall by 5 or 10%, and large cap Pharma earnings could decline by 9 or 10%.” — Michael Cembalest [18:05]

Tariffs and Taxation Issues

Timestamp: [22:30]

Cembalest discusses the complexities surrounding pharmaceutical tariffs and tax strategies:

• Offshore Taxation: U.S. drug companies report high domestic revenues with minimal onshore profits due to substantial offshore tax payments. The 2017 Tax Cuts and Jobs Act (TCJA) exacerbated this by introducing a 10.5% minimum tax on global intangible income, leading to increased offshore operations.

• Tariff Implications: The Trump administration's consideration of tariffs aims to address trade deficits but may force companies to choose between passing costs to consumers or reducing margins, neither of which is favorable.

• Notable Quote:

  “The pharma deficit exploded, implying that a lot more production was being moved offshore.” — Michael Cembalest [24:50]

Patent Cliff and Thickets

Timestamp: [27:15]

The impending "patent cliff" poses a threat as major drugs lose patent protection, potentially reducing revenues by $15-30 billion annually for top companies. Concurrently, "patent thickets" complicate generic competition, as companies extend patent protections through various filings beyond the active ingredient.

• Strategic Responses: While current low valuations may compensate for these risks, companies rely heavily on cash reserves for acquisitions and internal R&D to offset revenue losses.

• Notable Quote:

  “Whether it's for biologics or small molecule drugs, companies file patents and then after they get them and after the drug is being commercially sold, they file for more patents.” — Michael Cembalest [29:40]

FDA Operations and Leadership Under Scrutiny

Timestamp: [33:00]

Michael criticizes the current administration's handling of the FDA and Health and Human Services (HHS), highlighting:

• Operational Decline: A 19% reduction in the FDA workforce and the departure of seasoned officials have slowed the drug approval process despite promises to expedite it using AI and other technologies.

• Leadership Controversies: RFK Jr.'s tenure has been contentious, marked by significant policy shifts like terminating contracts with researchers focused on mRNA technology, drawing sharp criticism from public health experts.

• Notable Quotes:

  “RFK Jr. fired all 17 members of the CDC's Advisory Committee on Immunization Practices.” — Michael Cembalest [35:20]

  “This may be the most dangerous public policy, public health judgment that he's seen in 50 years.” — Michael Osterholm [35:50]

Managed Care Sector's Collapse

Timestamp: [38:10]

The managed care segment, encompassing major insurers like UnitedHealthcare and Molina, has experienced a drastic decline in returns since mid-2024, plummeting by approximately 50%. This downturn isn't attributed to declining earnings but rather to bleak forward earnings projections influenced by:

• The "Big Beautiful Bill": Hemisphere reforms and spending cuts, especially in Medicaid, forecasted to leave 16 million people uninsured by 2034.

• Impact: Companies are forced to lower earnings guidance, reflecting reduced market growth and increased uncertainty.

• Notable Quote:

  “Managed care returns have imploded since the middle of 2024, down by roughly half.” — Michael Cembalest [38:35]

Emerging Trends and Future Prospects

Good and Bad News in GLP-1 Therapies

Timestamp: [40:45]

Cembalest examines the dual nature of GLP-1 therapies:

• Positive Developments: GLPs show promise beyond weight loss, including reducing dementia risk and improving cardiovascular outcomes.

• Challenges: Recent studies indicate high discontinuation rates due to adverse effects and limited weight loss efficacy, negatively impacting companies like Lilly.

• Notable Quote:

  “The weight loss numbers from the Lilly study... was only 8 to 12% over 18 months.” — Michael Cembalest [42:30]

Biotech IPO Landscape

Timestamp: [45:00]

The biotech IPO market has been turbulent, with a stark disparity between mean and median returns:

• Performance Metrics: From 2018 onwards, half of all biotech IPOs lost over 80% of their value, while only 20% yielded positive returns.

• Investor Caution: The high failure rate of biotech startups makes this sector particularly challenging for investors.

• Notable Quote:

  “Half of all IPOs in the biotech space have lost 80% plus of their value and only 20% have had positive returns.” — Michael Cembalest [47:15]

Innovations on the Horizon

Timestamp: [50:05]

Despite current challenges, there are promising advancements in healthcare:

• Bispecific Antibodies: Potential to revolutionize cancer treatment.

• Neuropsychic Treatments: New therapies targeting neurological conditions.

• Gene Editing Techniques: Innovations beyond CRISPR.

• Longevity Research: Peer-reviewed studies showing life expectancy improvements in animal models, though human applications remain uncertain.

• Notable Quote:

  “There’s still a lot of people to cure in the healthcare space.” — Michael Cembalest [52:20]

Economic Constraints and Healthcare Expenditures

Timestamp: [55:30]

Cembalest discusses the U.S.'s financial limitations in sustaining healthcare innovation:

• Spending Trends: National health expenditures as a percentage of GDP have plateaued since 2010, limiting funding for new treatments.

• Life Expectancy vs. Expenditure: The U.S. lags behind other OECD countries in life expectancy despite higher per capita health spending, indicating inefficiencies.

• Policy Implications: With entitlement spending overshadowing other critical areas like discretionary spending, future healthcare funding faces stringent constraints.

• Notable Quote:

  “The country may have reached a peak of what it can afford to spend as a share of GDP on healthcare.” — Michael Cembalest [58:45]

Publicly Funded Scientific Research Battles

Timestamp: [61:10]

An appendix delves into the threats facing publicly funded research:

• Budget Cuts: Potential reductions ranging from 27% to 60% for agencies like the NIH, NSF, and NASA.

• Legislative Hurdles: Despite administrative intentions, Congress holds the power of the purse, making significant cuts unlikely without bipartisan support.

• Current Trends: While past administrations have influenced funding levels, recent legislative actions suggest a resistance to dramatic budget slashes.

• Notable Quote:

  “Gutting the NIH and the National Science foundation is likely to be a non-starter for the Democratic votes needed to pass an appropriations bill.” — Michael Cembalest [63:40]

Longevity Research Insights

Timestamp: [66:00]

Cembalest briefly touches upon longevity research, emphasizing a focus on scientifically vetted studies over "guru" claims:

• Studies Highlighted: Research on rapamycin and TERT activators shows potential in slowing or reversing aging processes in mice, though human applicability remains unproven.

• Industry Skepticism: Acknowledges the high failure rate of translating animal model successes to human trials.

• Notable Quote:

  “There have been a lot of failed trials going from preclinical to phase three because the animal models didn't work.” — Michael Cembalest [69:20]

Conclusion and Investment Outlook

Timestamp: [72:00]

Cembalest concludes with a cautiously optimistic view for value investors:

• Low Valuations: The healthcare sector's current low P/E ratios present potential buying opportunities, especially if catalyzed by positive legislative or market developments.

• M&A Potential: Anticipates a wave of mergers and acquisitions as companies with robust cash reserves seek to navigate patent cliffs and bolster their pipelines.

• Long-Term Value: Despite short-term challenges, the sector remains ripe for long-term investors who can navigate the complexities and wait for favorable shifts.

• Notable Quote:

  “The sector is definitely worth a look for long term value investors that have patience.” — Michael Cembalest [74:50]

Final Thoughts

Michael Cembalest offers a comprehensive analysis of the U.S. healthcare sector's current challenges and future prospects. From valuation woes and regulatory hurdles to innovative breakthroughs and economic constraints, the episode underscores the intricate landscape investors must navigate. While the sector faces significant headwinds, particularly from political and economic forces, there's potential for resurgence driven by strategic acquisitions and eventual legislative reforms. For long-term investors with a keen eye on developments, the healthcare sector may present compelling opportunities amidst its current undervaluation.