“There's an opportunity to outperform in health care, but it's a bit more stock as opposed to industry specific going forward,” BNP Paribas Asset Management portfolio manager Jon Stephenson said in a telephone interview. “We're trying to find innovation that's now selling at a discount relative to where it has been trading at, and our relative industry-weight bets have become marginally smaller.”

The S&P 500 Health Care Index fell 1.6 percent at 10:05 a.m. in New York as heavyweight Johnson & Johnson crashed the most since February after a Reuters report that said the company knew for decades that asbestos was sometimes in its baby powder.

Only a handful of stocks in the group traded higher led by Regeneron Pharmaceuticals Inc. after Goldman Sachs upgraded shares to buy.

The Health Care Select Sector SPDR Fund, known by its ticker XLV, remains up more than 10 percent this year, while the S&P 500 Index erased gains.

Even with that outperformance, some groups like large-cap biotech remain near record low multiples, presenting an opportunity, Jefferies health-care specialist Jared Holz noted.

“They've gotten hit so hard, how much further down can they go?” he said by phone. “Especially against the backdrop with large-cap pharma names being up a minimum of 20 percent over less than six months, which is fairly unprecedented.”

Here's where some buy-side and sell-side observers are focused for the coming year:

Biopharmaceuticals

Mizuho ( Salim Syed):

• “Smid-caps are just much cheaper, and while you have to be selective, that's where a lot of the innovation is at,” he said.
• “For general investors, there needs to be some improvement on the macro front where drug pricing isn't as much of a risk.”

Jefferies ( Jared Holz):

• “There's much less upside in some of the large-cap pharma names” like Eli Lilly & Co. and Pfizer Inc., given the recent sector run-up made them more appropriately priced compared with the broader market.
• “Drug pricing debate has not ended; it will not end. It will be a subject that we talk about every year for the foreseeable future. But the noise level around one party and their ability to make wholesale changes very quickly is over,” he said, noting that it may take a couple of years for any plans to be implemented.

BNP Paribas Asset Management ( Jon Stephenson):

• “Right now the broad market needs 2019 guidance to be behind us before they can have any faith in applying a multiple on stocks. The guidance for companies that provide it will be key.”
• “People were expecting more M&A and it didn't happen this year due to elevated valuations. But with valuations in the smid-cap biotech market just trending down the last few months, it is more feasible but will likely be another couple months before kicking in as management teams and boards get accustomed to their stock prices.”

Smead Capital Management ( Bill Smead):

• “We're happy holders. We believe in letting our winners run,” Smead, whose firm owns Merck & Co. and Pfizer, said by telephone.
• Despite looking “pretty fully priced,” the stocks still trade at a discount to “glamour” staple stocks like Procter & Gamble Co. or Colgate-Palmolive Co.

Specialty and generic pharmaceuticals

Mizuho ( Irina Koffler):

• “A lot of these companies have to do M&A in spite of having to de-lever,” she said, noting potential deals for drugmakers in her coverage aren't going to be “anything too revolutionary.”
• Some of the focus to start the year will be on commentary for 2019 guidance and management teams' ability to meet or exceed expectations, she said.

RBC Capital Markets ( Randall Stanicky):

• “Aggressive re-positioning has set the group up for improved performance” in the second half of 2019, “with three years of generic down-cycle behind us.”
• A potential correction on improving fundamentals “should set the generic sector up well this year,” he wrote, noting “macro uncertainty is a swing factor and the generic sector is not a defensive response.”
• Specialty sector “needs to actively re-think strategic positioning” with an increase in “business development geared at better leveraging existing assets into more focused therapeutic platforms.”
• Key themes include difficulty for single-product players, given growing payer pressures, new class of buyers set to diversify generics, and renewed value in platforms with potential for private equity to play a role.

Medical devices and tools

Goldman Sachs ( Isaac Ro):

• Bullish outlook for innovation across the industry with a “more dovish U.S. regulatory backdrop still underappreciated,” though valuations remain elevated despite the recent market pullback.
• Continue to prefer names where a path to share upside “is tangible via new product cycles.”

William Blair ( Margaret Kaczor):

• Expect companies to “build out reimbursement groups and contracts that may improve and simplify patient access to technology.”
• Look for “M&A and IPO activity as growth remains scarce, players look to consolidate the market, and balance sheets remain cash rich,” though smaller deals are most likely.

Goldman Sachs ( Patrick Donnelly) on life-sciences tools:

• Maintains neutral view on sector as data suggest limited upside for 2019 amid “incremental headwinds from exchange rates and tariffs negatively impacting margins.”
• He views “the path to EPS upside as less compelling than in recent years and the magnitude of potential beats as less impressive in 2019.”

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