Quantitative Funds May Be Turning Health Care Into a Hedge Against Chip Stocks
If you do not understand the moves in AI and chip stocks, you may no longer qualify as a “competent” U.S. health care investor. Drug-development pipelines and clinical trials may no longer be the biggest forces driving health care stocks. To keep up with the market, every trader in the sector increasingly has to become something of an AI expert because, for large pharmaceutical companies and health insurers, the most important market catalyst is the momentum of the artificial-intelligence boom. Quantitative funds may be helping drive a change in health care’s investment logic. For years, health care and semiconductor stocks had only a loose relationship in the U.S. market. They sometimes moved in the same direction, but the connection was not strong. That has changed sharply in recent months, according to FactSet data. The VanEck Semiconductor ETF (SMH) and the SPDR Health Care Sector ETF (XLV) have begun moving inversely. In other words, they are increasingly moving in opposite directions: When chip stocks are sold, health care stocks often attract buying. Over the past several weeks, after years of underperformance, health care investors have enjoyed a powerful rally as the market has grown more fearful about AI. The shift has come at a cost, however. When an entire sector is carried along by broad macro fund flows, it becomes much harder to evaluate individual stocks rationally through bottom-up fundamental research. “The biggest focus determining the trading logic within health care today is actually coming entirely from outside the sector,” said Asad Haider, Goldman Sachs’ head of U.S. health care equity research. “For investors focused on company fundamentals, this passive tug is certainly frustrating.” Under the market’s daily surface, algorithmic money is constantly moving. As the signals being monitored change, funds can quickly shift from one area to another. Whenever momentum indicators reverse, quantitative funds may exit decisively, pulling money from crowded areas such as technology and moving into previously neglected sectors such as health care. These reallocations have become more intense recently. They not only show that the market is becoming more wary of the AI boom, but also reflect concerns about how sustainable the sector’s rapid growth can be. They may also offer an early indication of the chain reaction the market could face if an AI bubble were eventually to burst completely. The chip-stock “perfect hedge” During the sharp volatility from late June to late July, as concern mounted over whether the AI bull market could continue, health care stocks outperformed semiconductor stocks by more than 30 percentage points. That was a stark reversal from the previous four years, when SMH surged more than 300%, while XLV’s cumulative gain was only about 25%. The rapidly widening performance gap may help explain why investors are treating health care stocks as a defensive hedge. About a decade ago, chip and pharmaceutical stocks were viewed as having similar growth profiles. In that pre-AI boom era, the two sectors’ forward price-to-earnings ratios both remained in a reasonable range of 15 to 16 times. Today, health care stocks have a pronounced valuation advantage. FactSet data shows that although SMH has been highly volatile, its forward P/E ratio has remained elevated at 22 to 30 times in recent months, while XLV’s P/E ratio has hovered around 18 times. Semiconductor growth is clearly much faster, helped by strong AI-driven demand for chips. But the central question hanging over the market’s recent unease remains: How long can that high growth last? What makes health care a solid defensive shield? Analysts say the key difference is that semiconductors are highly cyclical, while health care has natural noncyclical defensive characteristics. Regardless of the macroeconomic environment or the progress of AI infrastructure plans, patients continue to have an inelastic need for medicines and medical services. That allows the earnings and cash flow of related companies to remain relatively stable even during an economic slowdown. When the broader stock market has effectively become a one-way bet on AI, a sector that can operate independently of the macroeconomic cycle naturally becomes an attractive refuge for capital. Political uncertainty surrounding health care has also eased more quickly recently, providing additional support. Market fears over major drug-price cuts under the Trump administration have cooled, while payment rates announced by the federal Medicare program were higher than previously expected. Consistent with that backdrop, large industry leaders including Eli Lilly, Johnson & Johnson, UnitedHealth Group and AbbVie have continued to produce steady and predictable earnings growth. Regardless of how health care’s own long-term growth prospects evolve—which ultimately remains the fundamental driver of long-term stock performance—the sector’s actual performance over the next one to two years will depend heavily on what stage the AI trading boom reaches. The 2022 U.S. bear market offers one possible guide to what may happen next. Under the combined pressure of high inflation and aggressive Federal Reserve rate increases, high-valuation technology stocks were hit hard, while health care outperformed semiconductors by more than 30 percentage points. At present, the operating conditions of individual health care companies vary widely, but the market is increasingly applying the same macro logic to the sector as a whole. Bristol Myers Squibb and Johnson & Johnson illustrate the risk of doing so: Both stocks gained more than 40% over the past 12 months, yet their fundamentals moved in completely opposite directions. Johnson & Johnson continued to deliver steady earnings growth, while Bristol Myers Squibb faced an expected decline in performance because of the expiration of key patents. For investors, however, selecting the strongest companies may still be necessary. Haider of Goldman Sachs emphasized that, regardless of how the AI trade evolves, the most resilient investment approach remains to concentrate on companies capable of generating organic revenue growth rather than blindly buying securities that merely appear cheap. As health care’s own fundamentals gradually stabilize and improve, the sector’s inherent strengths may be sufficient on their own to support an allocation case. If the AI-led trade does collapse, that rationale could become even more compelling.
Drug-development pipelines and clinical trials may no longer be the biggest forces driving health care stocks. To keep up with the market, every trader in the sector increasingly has to become something of an AI expert because, for large pharmaceutical companies and health insurers, the most important market catalyst is the momentum of the artificial-intelligence boom.
Quantitative funds may be helping drive a change in health care’s investment logic. For years, health care and semiconductor stocks had only a loose relationship in the U.S. market. They sometimes moved in the same direction, but the connection was not strong.
That has changed sharply in recent months, according to FactSet data. The VanEck Semiconductor ETF (SMH) and the SPDR Health Care Sector ETF (XLV) have begun moving inversely. In other words, they are increasingly moving in opposite directions: When chip stocks are sold, health care stocks often attract buying.
Over the past several weeks, after years of underperformance, health care investors have enjoyed a powerful rally as the market has grown more fearful about AI. The shift has come at a cost, however. When an entire sector is carried along by broad macro fund flows, it becomes much harder to evaluate individual stocks rationally through bottom-up fundamental research.
“The biggest focus determining the trading logic within health care today is actually coming entirely from outside the sector,” said Asad Haider, Goldman Sachs’ head of U.S. health care equity research. “For investors focused on company fundamentals, this passive tug is certainly frustrating.”
Under the market’s daily surface, algorithmic money is constantly moving. As the signals being monitored change, funds can quickly shift from one area to another. Whenever momentum indicators reverse, quantitative funds may exit decisively, pulling money from crowded areas such as technology and moving into previously neglected sectors such as health care.
These reallocations have become more intense recently. They not only show that the market is becoming more wary of the AI boom, but also reflect concerns about how sustainable the sector’s rapid growth can be. They may also offer an early indication of the chain reaction the market could face if an AI bubble were eventually to burst completely.
The chip-stock “perfect hedge”
During the sharp volatility from late June to late July, as concern mounted over whether the AI bull market could continue, health care stocks outperformed semiconductor stocks by more than 30 percentage points. That was a stark reversal from the previous four years, when SMH surged more than 300%, while XLV’s cumulative gain was only about 25%.
The rapidly widening performance gap may help explain why investors are treating health care stocks as a defensive hedge.
About a decade ago, chip and pharmaceutical stocks were viewed as having similar growth profiles. In that pre-AI boom era, the two sectors’ forward price-to-earnings ratios both remained in a reasonable range of 15 to 16 times. Today, health care stocks have a pronounced valuation advantage.
FactSet data shows that although SMH has been highly volatile, its forward P/E ratio has remained elevated at 22 to 30 times in recent months, while XLV’s P/E ratio has hovered around 18 times. Semiconductor growth is clearly much faster, helped by strong AI-driven demand for chips. But the central question hanging over the market’s recent unease remains: How long can that high growth last?
What makes health care a solid defensive shield?
Analysts say the key difference is that semiconductors are highly cyclical, while health care has natural noncyclical defensive characteristics. Regardless of the macroeconomic environment or the progress of AI infrastructure plans, patients continue to have an inelastic need for medicines and medical services. That allows the earnings and cash flow of related companies to remain relatively stable even during an economic slowdown.
When the broader stock market has effectively become a one-way bet on AI, a sector that can operate independently of the macroeconomic cycle naturally becomes an attractive refuge for capital.
Political uncertainty surrounding health care has also eased more quickly recently, providing additional support. Market fears over major drug-price cuts under the Trump administration have cooled, while payment rates announced by the federal Medicare program were higher than previously expected. Consistent with that backdrop, large industry leaders including Eli Lilly, Johnson & Johnson, UnitedHealth Group and AbbVie have continued to produce steady and predictable earnings growth.
Regardless of how health care’s own long-term growth prospects evolve—which ultimately remains the fundamental driver of long-term stock performance—the sector’s actual performance over the next one to two years will depend heavily on what stage the AI trading boom reaches.
The 2022 U.S. bear market offers one possible guide to what may happen next. Under the combined pressure of high inflation and aggressive Federal Reserve rate increases, high-valuation technology stocks were hit hard, while health care outperformed semiconductors by more than 30 percentage points.
At present, the operating conditions of individual health care companies vary widely, but the market is increasingly applying the same macro logic to the sector as a whole. Bristol Myers Squibb and Johnson & Johnson illustrate the risk of doing so: Both stocks gained more than 40% over the past 12 months, yet their fundamentals moved in completely opposite directions. Johnson & Johnson continued to deliver steady earnings growth, while Bristol Myers Squibb faced an expected decline in performance because of the expiration of key patents.
For investors, however, selecting the strongest companies may still be necessary. Haider of Goldman Sachs emphasized that, regardless of how the AI trade evolves, the most resilient investment approach remains to concentrate on companies capable of generating organic revenue growth rather than blindly buying securities that merely appear cheap.
As health care’s own fundamentals gradually stabilize and improve, the sector’s inherent strengths may be sufficient on their own to support an allocation case. If the AI-led trade does collapse, that rationale could become even more compelling.