Healthcare Investors Weigh Defensive Stocks Against Higher-Risk Growth Bets

Large-cap healthcare stocks such as Johnson & Johnson and CVS Health are often seen as defensive stocks to buy in a slowdown, while small- and mid-cap healthcare companies can offer higher risk and potential reward. The ongoing conflict in Iran is creating a risk that the economy could fall into a recession, with inflationary pressures from soaring energy and food prices stemming from the inability to transport crude oil, liquefied natural gas, and fertilizer through the Strait of Hormuz and from the growing geopolitical conflict itself.

In such conditions, investors often turn to healthcare stocks. Large-cap healthcare stocks such as big pharma company Johnson & Johnson and integrated healthcare company CVS Health, covering insurance, pharmacy, and healthcare delivery, are often seen as defensive stocks to buy in a slowdown. While consumers can hold back on discretionary purchases in a slowdown, healthcare is often a non-negotiable, and healthcare stocks tend to hold up relatively well in a recession, not least because their earnings do too.

They are "low beta" stocks; if the market moves in one direction, say a 1% move, low beta stocks will move in the same direction but by a factor less than one. CVS's current beta is 0.46, and Johnson & Johnson's beta is 0.33. These numbers indicate that CVS will only lose 4.6% if the market declines 10%, and Johnson & Johnson will lose 3.3%.

Depending on tolerance for risk, or the need to minimize drawdown or to generate income, buying such low-beta defensive stocks may make sense. However, there is another strategy that investors can follow, which could deliver positive returns even in a recession.

The strategy involves buying into a collection of small- and mid-cap healthcare companies whose growth drivers depend almost entirely on binary events, including clinical trial and test results and establishing product sales, that have little to do with the economy at large. While some may fail, some will not, and the upside potential in the ones that do can offset losses in the others.

One example is multi-cancer early detection test company Grail. If it can prove the efficacy of its Galleri test with follow-up data from its three-year trial with England's National Health Service, the stock will soar. The test failed in its primary endpoint of demonstrating a statistically meaningful reduction in stage 3 and stage 4 cancers, possibly because the trial was too short for cancers to develop in the control group. The test succeeded in detecting cancers in stage 3, but not meaningfully compared to the control group, and the follow-up data could show more cancers developing in the control group.

Another example is Viking Therapeutics and its lead GLP-1/GIP agonist, VK2735, which is in trials for obesity and diabetes in both subcutaneous and oral forms. VK2735 has excellent efficacy results across its trials, but some disappointing safety and tolerability in a phase 2 trial in obesity in oral form. There is reason to believe those results were due to an overly aggressive titration, and the company continues to advance VK2735 into phase 3 in subcutaneous and oral forms. In addition, Viking is testing oral formulation as a maintenance dose after an initial subcutaneous treatment in a separate study with results due in the third quarter of 2026.

These companies are examples of a high-risk, high-reward strategy, and it makes sense to build a broader portfolio of such companies to help diversify stock-specific risk, which is high in such companies.