In early June, the consumer price index (aka: “inflation”) reached the highest level in 40 years. In response, the Federal Reserve has started the process (and will likely accelerate soon) of raising interest rates. The capital markets are re-pricing all manner of financial instruments—stocks bonds, derivatives, etc.—in response to inflation as well as over supply chain disruptions, a resurgent COVID-19, lockdowns in China and war in Europe. A recent University of Michigan survey of consumer sentiment showed deepening pessimism over the U.S. economy.
And the #1 question: Are we headed into a recession?
Wall Street Weighs In
A recession is most simply defined as a period of two or more consecutive quarters of economic decline, or decreased growth rate of gross domestic product (GDP). This downtrend slows production, employment, spending, and household income.
Of course, consistent with the old saying “If you laid all the economists in the world end-to-end, they still wouldn’t reach a conclusion,” the current range of economic predictions is all over the place. Wall Street mega-banker Morgan Stanley estimates that the odds of a recession are 30% over the coming year. Morgan Stanley’s chief U.S. economist Ellen Zentner was quoted as saying, “accelerating inflation has been a common precursor to recessions.”
JP Morgan Chase, the largest bank in the U.S., trotted out its economist Bruce Kasman, who pegged the probability of a recession at 35%, saying, “The risks are skewed decisively to the upside on inflation and to the downside on growth.”
Swiss bank Credit Suisse, led by Jeremy Schwartz, describes the U.S. economy as on “the edge of a recession,” although his analyst team notes “buffers” that should be able to shield the U.S. economy from “spiraling into a broader downturn.”
In the meantime, Citigroup economists, led by global chief economist Nathan Sheets, calculate the odds of global recession are around 50%, stating, “we see recession probabilities as appreciable and rising.”
How Could a Recession Affect Medical Technology Sales?
Wall Street’s analysts are dusting off their old models and checking back at previous recessions to advise clients and investors. Specifically, Wall Street’s analytical corps has looked at the 2008-2009 financial crisis for guidance. In general, they are not expecting an imminent crisis, but do warn that medical device manufacturers are not immune from effects of a possible recession.
Again, taking a page from the 2008-2009 recession, Needham & Company’s analysts noted that while capital equipment sales declined for around 12 months, procedure growth was actually more negatively affected and fell for several years after.
There have been two major American recessions in the past 20 years. While the Great Recession lasted from December 2007 through June 2009 and was the worst U.S. economic downturn since 1937, the 2020 COVID-19 recession was unique in both its severity and brevity—lasting just 3 months: February, March, and April 2020. For this reason, analysts expect that any near-term economic downturn will look more like the 2008-2009 recession.
Larry Biegelsen and fellow analysts at Wells Fargo note an overall 280 basis points (bps) medtech sector deceleration in organic growth, from 7.4% in 2008 to 4.6% in 2009. In 2010, organic growth bounced back to 5.9%. Cardiovascular markets were the least impacted and the most resilient medtech end market during the financial crisis.
Wells Fargo analysts also emphasize that medtech in general outperformed the S&P 500 across all of the past four U.S. recessions—Abbott Laboratories, Baxter International Inc, Becton Dickinson and Co, and Johnson & Johnson in particular.
Biegelsen and colleagues do also point out that ortho markets including hips, knees, spine, and trauma were already experiencing a multi-year deceleration trend in 2008.
Analysts Mike Matson and David Saxon of Needham & Company also analyzed the med tech sector performance data of the last two recessions in the United States. Based on the data, they also feel that the med tech sector is fairly insulated from the risk of recession—yet the risk remains.
Matson and Saxon wrote to clients that they do not expect a repeat of the Great Recession of 2008-2009 in term of the downturn’s severity. As far as how particular companies may be affected, Needham’s analysts cite type of payer mix (Medicare v. private pay), types of procedure (non-elective or elective), and type of product (single-use, implantable, or capital equipment) as critical factors.
Matson and Saxon say the capital equipment category is the most vulnerable to economic downturns, particularly for replacement (and therefore deferable purchase) durable equipment (i.e., hospital beds) Companies with more capital equipment exposure, more deferrable or elective procedures, higher private payer mix or out-of-pocket procedures are more likely to see the most detrimental effects in the case of a recession, they predict.
Matson and Saxon also highlight the differences between 2008 and now, such as the fact that out-of-pocket burdens on patients have increased with the rise in use of high-deductible insurance plans. Average deductibles have also increased 6% from 2013-2020, growing from 3.3% of average household income in 2010 to 4.7% in 2020. This means families may be more likely to defer elective procedures. Alternately, however, the analysts note that the Affordable Care Act (ACA) of 2010 has altered the market since that recession, decreasing the uninsured population from 16.6% of the non-elderly in 2013 to 10.5% in 2015. The ACA protection of health insurance in the event of job loss could mitigate impacts on procedural growth.
Investment firm BlackRock also points out that recent performance in healthcare sectors was driven by COVID-19 beneficiaries such as Pfizer and Johnson & Johnson, both of whom benefited from FDA approval of COVID-19 vaccines and antibody treatments. The medical devices companies responsible for COVID-19 diagnostic and testing kits also saw significant returns, the firm noted. BlackRock, though, said in its Global Healthcare Outlook 2022 that it remains cautious regarding investment in COVID-19 beneficiaries as more highly effective treatments for the virus are available.
Other investment firms like Hartford Funds present more positive outlooks for the 2022 healthcare sector, due to ongoing innovation in biopharma, medical technology, and healthcare services, such as breakthroughs in disease treatment, new drug research, and immunology. These experts also note that the COVID-19 pandemic has made consumers become less dependent on hospitals and more likely to utilize less expensive healthcare delivery options such as home health or telehealth.
Looking Forward
According to analysts at William Blair and RBC Capital Markets, medical device companies and small medtech businesses will most likely limit spending in the second half of 2022, amidst rising inflation, staffing shortages, and fears of recession. Both companies state that trends like hospital staffing shortages, supply chain constraints, inflation and hospital staffing shortages have been affecting the medical device company market since the second half of last year. Such factors have already limited post-pandemic economic recovery. A potential recession added into the mix has the medtech industry on watch.
Matson and Saxon say that medtech stock prices are probably not reflecting recession rates currently, but that while large-cap medtech stocks were trading at a next 12 months price/earnings ratio (NTM P/E) of ~21x as of 6/22/22, medtech stocks might fall to a low-teens NTM P/E in a severe recession, or to high-teens NTM P/E in the case of a less extreme recession.
Stay tuned, for sure.
