Health care is historically resistant to economic downturns, but the sector could be more vulnerable in the future.
Investors looking to position themselves defensively often turn to market segments that are perceived as less economically sensitive. Health care is a sector that is often thought of as recession-proof. But is that reputation deserved? I sat down with Alex Morozov, an equity analyst on Morningstar's health-care team, to find out.
Sonya Morris: Have you done any work to see how sensitive health-care stocks are to the changes in the overall economy?
Alex Morozov: Yes. I dug into some historical data to see if that has been true in the past. The data show that there has been no significant statistical relationship between growth in health-care spending and gross domestic product growth for the past 40 years, which was as far back as my data extended. Growth in health-care spending outpaced GDP growth over the vast majority of that time frame. In fact, the largest gaps between health-care spending and GDP growth occurred during recessionary periods, indicating that consumers spend money on health care even when the economy is bad.
SM: Is it possible that there is a lag between the beginning of a recession and a downturn in health-care spending? Maybe it takes some time for an economic downturn to affect health-care spending.
AM: To test for such a lag effect, I adjusted the time frame of my study by looking at spending one year into a recession. That adjustment had little effect on the result. Health-care spending and economic growth remained uncorrelated.
SM: What do you think has contributed to the sector's resilience?
AM: Intuitively, health care should be less sensitive to economic cycles. It's one of the most basic needs that humans have, so demand for health-care services is very inelastic. It should be less economically sensitive.
I also think there have been industry forces that have contributed to its strength during bad economic times. For example, out-of-pocket expenditures as a percentage of total health-care spending have declined steadily since 1965, when Medicare and Medicaid were signed into law. Government and private health insurers have been picking up more of the tab. Consequently, health-care spending is less dependent on the consumer, and the sector is less exposed to consumer cycles as a result.
SM: How long can that continue? With rising costs, it seems like both government and private insurers won't always be able to pick up the tab.
AM: That's a definite risk. So far, the system has relied on the deep pockets of the government and private insurers, but those pockets aren't infinitely deep.
Also, a number of factors could cause out- of-pocket expenditures to increase. For example, employers have reduced coverage and pushed more health-care costs onto employees. Furthermore, the percentage of uninsured individuals has been rising, particularly among the middle class. Plus, if unemployment rises, out-of-work individuals could contribute to the increase in the uninsured. These consumers are often forced to pick up health-care costs on their own, and they may be more likely to cut back on health-care spending during lean times.
One of the contributing factors to the sector's past resilience is the decline in out-of-pocket expenditures. If that trend reverses, the sector could become more vulnerable to economic forces.
SM: If health-care spending has outstripped economic growth for the past several decades, does that mean health care has in turn grown considerably over time?
AM: That's right. In real terms, spending on health care exceeded economic growth by about 3% per year on average. As a result, health care increased from 5% of the economy in 1960 to 16% in 2006. That's the highest level of any developed country.
SM: How long can health care maintain that pace of growth?
AM: Such growth has to slow at some point, although it's anyone's guess when that will happen. Economic, industry, and political factors come into play here, and it's difficult to make a prediction as to when health-care spending will slow.
SM: Do you think health care will continue to be recession-proof?
AM: Well, my research isn't a forecast. Even though the sector has proved relatively insensitive to economic downturns in the past, there's no guarantee that it will continue to behave that way in the future. The system also faces some serious risks, including the few we discussed above.