Healthcare Sector Outlook–Tailwinds from Innovation

THE HEALTHCARE SECTOR has been a standout performer in U.S. equity markets for most of the current cycle. While regulatory concerns were weighing on the sector in the lead up to the Presidential election, we continue to see tailwinds from innovation over the longer-term. In particular, we highlight three areas that should support key parts of the healthcare market, via lower costs, improved drug discovery and higher-quality treatment. These are the three Ds of devices, DNA and data.

Robots, miniaturization and wearables driving devices
Medical robot usage is set to soar over the coming years, with the International Federation of Robotics expecting a total of 7,800 medical service robots to be sold between 2015 and 2018. This compares with 1,224 in 2014.

Most of these devices, 80% of the 2014 total, will be used in therapy and surgical procedures, allowing practitioners to perform with greater accuracy, yielding fewer mistakes, lowering the risk of infection and reducing the rate of common complications such as excessive blood loss and internal bruising. A study carried of the Journal of Patient Safety estimated the annual number of preventable hospital deaths at between 210,000 and 440,000, making them the third-leading cause of mortality in the U.S. behind heart disease and cancer.¹ This hints at the significant cost savings to be reaped from safer robot-assisted procedures.

A leading example is Intuitive Surgical's da Vinci system, which is widely used to deliver minimally invasive cardiac and gynecological operations. The device consists of a computer console, four connected robotic arms and an HD screen to view the operating theater. These controls allow the doctor to apply surgical instruments, such as forceps and retractors, through much smaller openings and with far more flexible and precise movements than an unassisted human hand, while limiting the need for assistants. In 2014, some 570,000 surgical procedures were performed worldwide using the system, up 9% from the prior year, and this number was estimated to have increased by another 8% –11% in 2015 (see Exhibit 1).

Medical robot productivity is expected to increase further with the application of artificial intelligence. Sensors and chips mounted on the operating equipment would be able to relay more real-time information back to the surgeon, further reducing the risk of errors or complications. The life sciences division of one Silicon Valley technology giant is, for example, working with a major healthcare conglomerate to develop a surgical robot that would augment the user's visual field. A blood vessel or unusual tumor edge that might be difficult to see could, for example, be highlighted on the console screen during the procedure, meaning that the surgeon need not look away to consult pre-operative images.

Meanwhile two trends that are familiar in the world of consumer electronic devices — miniaturization and wearable technology — are also expected to be major sources of growth for the medical device industry. A leading S&P500 equipment manufacturer is currently supplying its wearable exoskeleton to a Defense Department-funded research study, with commercialization expected in the near term. These are devices that can substitute for wheelchairs, but allow greater independence and mobility, for patients suffering from spinal injuries or diseases that impair movement such as arthritis or osteoporosis. A leading industry research firm forecasts exponential growth in the exoskeleton market from $16.5 million in 2014 to $2.1 billion in 2021 — a doubling every year.

The growth of miniature medical devices is also in its early stages. As a seminal example, in 2014 the Food and Drug Administration (FDA) approved an implantable device used by caregivers to remotely measure the blood pressure and heart rate of patients at risk of heart failure — the first approval of this type of implantable instrument.

Over time, commercialization of these technological advances, from surgical robots to wearables and implants, should remain a long-term tailwind — not only for device manufacturers but also for health facilities and insurance providers, who should stand to benefit from shorter hospital stays and lower payouts.

DNA sequencing has big implications for drug discovery
As is by now well-known, the cost of genomic sequencing has collapsed over recent years. But perhaps less widely appreciated has been the surge in sequencing activity over the same period. In the six years since the end of the financial crisis, the sequencing cost for a human-sized genome has fallen by 97% — from $47,000 at the end of 2009 to $1,245 at the end of 2015. And over the same period, the number of sequencing projects catalogued by the National Center for Biotechnology Information, an agency of the National Institutes of Health, has risen almost six-fold, from 54 million to 317 million (see Exhibit 2). However, with just 228,000 human genomes estimated to have been sequenced globally in 2014, overwhelmingly in laboratories as part of scientific research projects rather than in hospitals, we have yet to see the full economic impact on the healthcare sector and others, which McKinsey estimates could be worth $700 billion to $1.6 trillion annually by 2025.

The biggest implications will be for drug discovery, particularly in areas such as cancer treatment, where genetic variation plays a major role. A lower cost of sequencing should allow research scientists to produce larger sets of data on genetic mutation that can then be matched against observable diseases to develop targeted treatments. This represents a far more efficient approach to drug development than the traditional trial-and-error testing widely practiced now, and a much firmer basis for diagnosis than simply identifying which part of the body is affected and how far the disease has spread. The dominant manufacturer of the technology, a publicly-listed $20 billion San Diego-based biotech firm, is currently working with the U.K. National Health Service on a large-scale project to sequence 100,000 genomes by the end of 2017. However, at $10 million for the flagship system and $250,000 for a much smaller and lower-capacity desktop product, the prices of its sequencing machines remain prohibitively high for widespread commercial use in research laboratories and hospitals. This on top of the added costs of power and data storage, as well as the technical challenge of establishing firm links between genetic information and clinical conditions. The routine application of whole human genomic sequencing and the associated advances in targeted drug therapies are therefore still at an early stage.

But the falling cost of genomic sequencing for all organisms (plants as well as humans) also offers growth opportunities for companies in the broader life sciences category, particularly those in agriculture and energy. Designing more advanced genetically-modified crops, for example, will further improve yield as the supply-demand balance for agricultural commodities tightens. In emerging economies, where growth needs are higher and the cultural aversion to genetically-modified crops is lower, the land area dedicated to GM crops overtook that of developed economies in 2012 and reached 96.2 million hectares in 2014. Similarly, in energy, a better understanding of crop genomes based on more affordable sequencing will support the development of more efficient biofuels. The life sciences industry should therefore benefit from this intersection of innovation and demographics as more genomic information is gathered, and as the world's population grows, urbanizes and commands higher incomes.

Medical researchers and providers gaining insights from data explosion
Finally, we expect the explosive growth in electronic health information to be a further tailwind for health providers and drug developers, as well as for data analytics software firms. Researcher access to clinical data is expanding dramatically as the rise of mobile health applications and dedicated fitness trackers creates a growing pool of personal medical information. According to the FDA (citing industry estimates), roughly 50% of the more than 3.4 billion global smartphone and tablet users by 2018 will have downloaded mobile health applications, up from around 500 million in 2015. And the rise of mobile health platforms will further support the efforts of medical researchers in aggregating this information for laboratory studies and clinical trials on a range of conditions such as Parkinson's disease, asthma and diabetes.

A recent example is the twin health and research platform launched by a leading Silicon Valley smartphone maker in 2014 and 2015. These tools dramatically speed up and simplify the research process — allowing labs to gather a wider range of participants in a shorter period of time, and enabling patients to grant their consent with a few phone taps rather than long forms or in-person visits. The hospital systems at Duke and Stanford universities recently announced the launch of medical trials in chronic disease and diabetes using one of these new mobile health platforms. Meanwhile the growing number of physicians using electronic health records (see Exhibit 3), which can directly access this stored mobile data, will also benefit from better diagnoses and lower costs through more efficient patient care at the point of service.

Data analytics software developers also stand to gain from the explosion in personal health information. One artificial intelligence platform in use at a leading New York cancer treatment center, for example, is able to combine insights from a wide range of information sources to help doctors make diagnoses and recommend treatments. This includes both patient data stored across individual electronic health records and unstructured data in medical journals, news articles and research reports. Separately, the life sciences division of one Silicon Valley internet giant is partnering with a listed biotechnology firm to analyze the biological and environmental drivers of multiple sclerosis. The two companies are looking to personal health trackers as a potential data source, alongside proprietary information gathered from sensors and analytics software — both of which are expected to support the drug development process.

Political rhetoric may well cause further near-term anxiety around the prospects for market returns in the healthcare sector, but we therefore see innovation as a key structural tailwind for longer-term growth (see Table 1).