Big pharmaceutical stocks have routinely lagged those of the biotech sector and, so far this year, are underperforming the broader health-care sector by a margin of more than 7%. But a recent report by investment advisors Guggenheim Partners suggests a stronger outlook for big pharma. Citing fading headwinds along with innovation and boosted new-drug sales, Guggenheim’s Seamus Fernandez names Merck & Co. Inc. (MRK), Allergan PLC (AGN) and AstraZeneca (AZN) as three of his favorites, while also giving Eli Lilly & Co. (LLY) and Novo Nordisk (NVO) a buy rating, according to Barron’s.

“Now is the time for investors to take a fresh look at global pharmaceutical stocks as headwinds abate and the group enters its strongest new product cycle since the late 1990s,” writes Fernandez. Most of his favorites are already outperforming the S&P 500 index’s 5.1% year-to-date (YTD) performance. Despite a recent pullback, these stocks have also recouped some of their losses. (For more, see also: 3 Charts That Suggest Pharma Stocks Are a Buy in 2018.)

5 Big Pharma Stocks Poised to Lead

 Stock  YTD Performance
 Eli Lilly  + 31.5%
 Merck  + 26.6%
 Allergan  + 14.9%
 AstraZeneca  + 12.6%
 Novo Nordisk  - 19.2%

Source: CNN Money, as of 4 p.m. EST 10/16

Equipped to Face Price Pressure

Five main reasons supporting Fernandez’s bullish sentiment for big drug stocks include: an expectation of generic drug competition falling to a historic low point over the next several years; price increases being replaced by volume and mix as the primary drivers of earnings growth; sustainable emerging-market growth; improvements in innovation; and, greater risk-sharing benefits resulting from new partnerships among drug companies.

The fundamental strength of big pharma comes after almost a decade of deal-making, restructuring, and rebuilding within the drug industry. Drug companies are now better equipped to face increases in pricing pressure. They have also experienced less pushback from insurance companies when it comes to making payments for “differentiated new drug classes in areas of high unmet need,” such as for cancer or gene therapy, according to Barron’s.

What’s Driving Drug Stocks

  • Innovation
  • New drugs
  • Restructured and rebuilt drug companies
  • Less generic-drug competition
  • Sustainable emerging-market growth

Source: Barron’s

Few Roadblocks Ahead

While there appears to be no major roadblocks ahead that could hinder big pharma’s recent strength, the Trump administration’s plan to reduce drug prices could limit the pricing power of drug companies. But so far, the new policies have been much subtler than investors originally feared. (For more, see also: The Risks And Rewards Of Pharma Stocks.)

Given their currently low valuations relative to the broader market, pharma stocks will have to move higher and faster than the rest of the market before investors begin to really worry. But they might also want to keep an eye on the sales performance of newly introduced drugs.

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