A broadly overlooked pharmaceutical sector has recently staged a powerful comeback from its lows.

Since late June, the medical sector has shown strength. Over the past month, the broader biopharmaceutical sector has risen more than 20%, with the innovative drug segment surging over 30%, reversing a prolonged period of deep correction.

What factors ignited this rapid rally? Is this move a temporary bounce or a sustainable trend reversal? With technology valuations seemingly stretched, can healthcare take over as a structural investment theme for the second half of the year? Amidst rising sector divergence, how should investors seek opportunities?

To address these questions, financial reporters interviewed several fund managers, including Cai Qiang from the Southern Pharmaceutical Innovation Equity Fund, Chen Ximing from the Boshi Healthcare Balanced Fund, Ma Yiwen from the Kechuang Innovation Drug ETF of Guotai Fund, Zhou Sicong from the Ping An Pharmaceutical Select Fund, Pi Jinsong from the Chuangjin Hexin Healthcare Equity Fund, and Tang Chen from the Luoan Selective Value Fund.

These fund managers attribute the recent surge to a confluence of valuation recovery, positive policy developments, and improving industry dynamics. While a full-scale reversal still requires earnings to materialize, they believe innovative drugs and their related supply chains currently offer high cost-performance for allocation.

Confluence of Multiple Positive Factors

Financial Reporter: Recently, the pharmaceutical sector has performed strongly, especially the innovative drug sector which has surged over 20% in the past month. What are the main drivers?

Cai Qiang: The recent strength in the pharmaceutical sector is primarily due to three factors. First, there was a significant drawdown in May and June, with the A-share medical sector falling nearly 15% and the Hong Kong-listed medical sector dropping nearly 25%, making many companies attractive. Second, fundamental expectations are improving. Chinese innovative drug out-licensing is accelerating, with potential total transaction value reaching approximately $99.7-110 billion in the first half of 2026, already 70% of the full-year 2025 total. Domestic medical insurance policies are also shifting towards a new phase that balances cost control with encouraging high-level innovation. Third, regarding capital flows, funds were heavily concentrated in AI technology earlier this year, but since late June, this concentration has begun to loosen, with market style shifting towards balanced allocation. The medical sector, with good future growth prospects and a position near the bottom, is likely to attract capital.

Chen Ximing: An important reason is that the industry remains very active. In the first half of the year, Chinese innovative drug companies completed 81 out-licensing deals with a total transaction value of about $110 billion, representing 80% of the full-year 2025 total. Another reason is the prior sector correction, which created a gap between the price and value of many companies. Therefore, after the AI-driven "liquidity drain" eased, the sector experienced a rebound.

Ma Yiwen: The recent strength in the innovative drug sector is a result of multiple factors coinciding. First, there has been a systemic breakthrough in policy. The 2026 edition of the National Essential Drugs List is expected to include innovative drugs on a large scale for the first time. The 12th round of bulk procurement continues to "free up space" by saving medical insurance funds for innovative drug payments, which could effectively support market expansion. Second, fundamental recovery is better than expected. The CXO sector is highly prosperous, with oral peptide formulations surpassing expectations, and CRO firms benefiting from the overseas financing recovery, potentially leading to upward revisions in full-year guidance for leading companies. Technically, the short-term intraday negative correlation between innovative drugs and the tech index remains high, and the recent weakness in the tech sector has provided liquidity for healthcare.

Pi Jinsong: The main reason is the strong fundamentals of innovative drugs, with rapid earnings growth, continuous clinical progress for listed companies' new drugs, and significant data readouts at academic conferences like ASCO/ESMO. Some clinical studies have the potential to change existing treatment standards, and domestic innovative drugs are accelerating their integration into the global industry chain. In the first half of the year, innovative drug stock prices significantly diverged from fundamentals, so the recent rise is a correction of the prior oversold conditions. Additionally, funds flowing out of the high-positioned tech sector are seeking growth assets, and innovative drugs are one of the few areas with good earnings and a strong investment thesis.

Zhou Sicong: The correction in innovative drugs starting from September 2025 lasted for nine months, fully digesting the previous valuation premium, and the sector's valuation fell back to relatively low levels. Meanwhile, the recent convergence of multiple positive factors at the policy and industry level, combined with high tech valuations, is leading more funds to rotate from high to low positions.

Tang Chen: The recent rise in the innovative drug sector is essentially a valuation recovery. The K-shaped market divergence intensified in May and June, leading to a liquidity crunch and overselling in the sector, deviating significantly from its intrinsic value. Therefore, conditions for a valuation recovery were already present. The innovative drug sector shows an upward trend in both policy and industry fundamentals, making the valuation recovery reasonable. Furthermore, the recognition of the improving cycle in CXO and life science service upstream sectors has become a catalyst for this recovery.

Short-term Medical Sector Remains a Recovery Rally

Financial Reporter: Is this medical sector rally an oversold bounce or a trend reversal? What signals are needed to confirm a reversal?

Ma Yiwen: We believe the current trend is more likely a bottoming process after an oversold bounce rather than an immediate reversal. The recent rise is mainly a valuation recovery from previous pessimistic expectations. Sustained momentum requires catalysts like major clinical data, milestone payments for drugs, and overseas sales revenue sharing. Key observation points are the Q3 ESMO conference and the realization of BD milestone payments and revenue sharing in the coming years.

Cai Qiang: I think it's too simplistic to define the entire medical sector uniformly, as it contains many sub-sectors like innovative drugs, CXO, medical devices, traditional Chinese medicine, and medical commerce, with significant divergence. Therefore, a full-scale reversal in the sector is not yet clear, requiring careful selection of sub-sectors and individual stocks. In the short term, the overall medical sector is still in a recovery rally. Current market pricing remains within the framework of existing BD and data. A full reversal would require seeing the realization of overseas commercial profits from leading innovative drug companies, which might peak around 2028-2029.

Tang Chen: It's a reasonable judgment to view the recent rise as an oversold bounce. The apparent valuations of CXO and life science service upstream sectors have entered a reasonable range. Further upward movement requires earnings verification. The overall innovative drug sector has also entered a period of earnings and clinical data verification. Future growth requires seeing the continuous progress of "deepened BD," including successful global Phase 3 trials for licensed projects, overseas regulatory filings, and overseas sales ramp-up. Of course, domestic sales ramp-up after approved products enter medical insurance is also a crucial driver.

Pi Jinsong: It is likely a reversal. The medical sector has been adjusting continuously since Q3 last year without significant fundamental negatives. The main reason was the market style favoring extreme growth, with popular sectors absorbing liquidity from the entire market. To determine if it's a reversal, we need to watch: first, if the market style returns to balance. The mid-year report showed medical holdings in the top 10 public fund positions were only 3.95%, a historical low. Second, the 2025 out-licensing wave drove a broad sector rally. As out-licensing becomes normal, the market will focus more on the quality of these deals, as well as companies' operations and clinical progress. We expect high-quality companies to reverse first.

Zhou Sicong: Short-term movements are more driven by capital flows and market sentiment, which are unpredictable. However, from a long-term perspective, the industry trend for innovative drugs is clear, with significant upside potential, making it a direction we are bullish on for the long term.

Current Valuations Offer High Cost-Performance for Allocation

Financial Reporter: What is the current valuation level and growth potential of the medical sector? Does it offer value for allocation?

Tang Chen: The current valuation levels and institutional holdings in the medical sector are at historical lows. Domestically, the sector will maintain a growth rate higher than GDP, and combined with expanding overseas demand, the industry's growth rate over the next five years could significantly increase, opening up further growth space. After several years of clearing, the industry is at a relatively low point in the cycle. Innovative drugs are in the early stages of volume growth. The domestic medical insurance surplus rate is high, the diagnosis and treatment rate has room for recovery, and overseas certainty is gradually being verified. Overall, the sector has allocation value.

Cai Qiang: The current PE for the Shenwan Pharmaceutical and Biological Index is about 32 times, at the 42nd percentile of the past decade. The PB is only 2.5 times, at about the 11th percentile. This indicates that the sector's asset valuation is still low, offering high cost-performance for allocation. After the rapid rise, valuations of innovative drugs and their supply chains have been repaired. Subsequent digestion of valuations will depend on clinical data, BD upfront payments, and commercial performance. Therefore, stock selection is crucial, and chasing broad rallies should be avoided. For other sectors like medical devices, medical services, and traditional Chinese medicine, the fundamental turning point has not yet arrived, and valuations remain low. Their fundamentals need continuous monitoring.

Zhou Sicong: Previously, the innovative drug sector experienced a typical mismatch: industry fundamentals were advancing while stock prices were retreating. Normal profit-taking has washed out weak holders, creating a highly cost-effective "golden pit" for long-term capital. Looking ahead, as the previously out-licensed pipelines enter the phase of international multi-center clinical data readouts, these key "milestone" developments will replace the initial "upfront payments" as the core catalyst driving the next round of valuation expansion for the industry.

Ma Yiwen: The current sector valuation is in a reasonable range near its historical median, offering some cost-performance for allocation.

Pi Jinsong: The current sector valuation is relatively low. For innovative drugs, market capitalization is viewed in terms of peak sales potential, while in the short term, it depends on the realization of sales and clinical data. Currently, most companies' market caps only reflect their domestic business potential, with little or no value assigned to overseas opportunities. Domestic companies generally have extensive pipelines, so there is still room for market cap growth. The sector has allocation value, but stock selection is necessary. From 2025 to 2032, multinational pharmaceutical companies face $370 billion in sales patent expiries, creating significant opportunities for domestic innovative drug out-licensing partnerships. Domestic companies have many promising molecules in areas like ADC, small nucleic acids, and TCE, and partnerships with multinationals could bring substantial long-term value. From a policy perspective, this year's government work report listed biopharmaceuticals as a pillar strategic emerging industry for the first time. The domestic sales proportion of innovative drugs is low, indicating significant room for growth, making domestic growth for innovative drugs highly certain.

Poised to Become One of the H2 Market Themes

Financial Reporter: Going forward, can the medical sector become one of the main market themes? Which sub-sectors are you most bullish on?

Pi Jinsong: The medical sector is expected to become one of the main market themes. There are structural opportunities within the sector, primarily focused on innovation. We are bullish on innovative drugs and CRO. The innovative drug industry is in an upward cycle, moving from a pure R&D investment phase to a phase of realizing commercial value both domestically and internationally. The out-licensing trend for Chinese innovative drugs has just begun. High earnings growth, out-licensing deals, and clinical progress enhance company value. Domestic-oriented CRO benefits from increased R&D investment in domestic innovative drugs, with safety evaluations and clinical orders recovering rapidly. Export-oriented CRO is deeply integrated into the global innovation industry chain, undertaking commercial production of blockbuster drugs.

Cai Qiang: The medical sector is likely to become one of the structural themes for the second half of the year, but it will more likely rotate with themes like tech and high-end manufacturing rather than being the sole focus. Currently, the medical sector is driven by out-licensing expectations rather than realized overseas commercial scale-up, and the overall earnings flexibility of the sector is limited, insufficient to support a rapid valuation jump. The current main theme in healthcare is "innovation + internationalization," not a broad medical sector rally. Three directions are worth noting. First, innovative drugs with global competitiveness: those with differentiated clinical data, clear overseas partners, and a clear path to global registration and commercialization. Among these, ADC, bispecific antibodies, autoimmune, and metabolism areas have strong clinical value logic. Second, the improving CXO/CDMO cycle: driven by the BD wave, upstream of the innovative drug supply chain is seeing a broad recovery in orders. New molecular entities, peptides, ADC, bispecific/multi-specific antibodies, and oligonucleotide chains offer more structural opportunities. Third, innovative medical devices and internationalization: fundamentals for companies in this area are improving, but market attention is low, and the sector remains at a low level.

Chen Ximing: The rally in innovative drugs is likely to continue. First, the fundamental landscape is relatively prosperous. Second, the US biotech index is performing very strongly, and US innovative drug stocks are also absorbing some funds flowing out of the AI sector. We are also bullish on CXO, as it is the "picks-and-shovels" provider for innovative drugs. Historically, when innovative drugs perform well, CXO usually does not miss out.

Ma Yiwen: In the context of increased volatility in growth sectors like AI and the market's search for earnings certainty, the innovative drug sector is expected to attract some capital. However, the start of a sustained sector rally still requires the realization of the major clinical data and commercial milestones mentioned earlier. From a fundamental perspective, the CXO sector offers relatively higher earnings certainty. Some innovative drug companies have achieved a transition from loss to profit through BD or drug sales, allowing their valuations to potentially shift from PS to PE, providing stronger earnings support.

Tang Chen: The medical sector has not seen an index-level rally in the past five years. An index rally requires a confluence of industry logic and market cycle. I prefer to capture alpha opportunities within the sector. As industry fundamentals continue to play out and expected investment returns improve, the medical sector may gradually gain market recognition. I am bullish on innovative drugs and their related supply chains. Recovery rallies in other sub-sectors emerging from the bottom of their cycle are also worth watching.

Zhou Sicong: In 2026, the innovative drug rally has moved from a phase of pure BD transaction recovery to a verification cycle driven by both policy support and product realization. This strengthens the long-term growth thesis. High-quality innovative drug companies, especially those with deep prior adjustments and strong fundamentals, are likely to see a window for valuation recovery, potentially becoming a key direction for mainstream capital allocation.

Be Aware of Risks Like Liquidity and Clinical Data Disappointments

Financial Reporter: What is your main operational strategy for the medical sector? What risk factors should be noted?

Ma Yiwen: A prudent operational approach like "buying on dips and building positions in batches" could be taken for investing in the current medical sector. The focus should be on the industry's growth logic and valuation cost-performance, rather than chasing short-term rebounds. In terms of market rhythm, the innovative drug sector faces certain risk factors in the second half of the year. First, the risk of key clinical trial data missing expectations, which could dampen market sentiment. Second, geopolitical and policy disturbances, such as the US BIOSECURE Act, which could repeatedly impact the sector. Third, pricing pressure from overseas pharmaceutical companies, as proposals to lower drug prices in the US could suppress earnings expectations for innovative drug out-licensing. Finally, there is a difference in the driving logic of the market. The domestic market is driven by out-licensing, unlike the US biotech rally driven by M&A logic. Investors need to be aware of the different pricing power dynamics.

Cai Qiang: For allocation in the medical sector, the first step is to grasp the main theme. The medical sector has many sub-sectors with significant internal divergence. For example, innovative drugs and CXO have shown significant outperformance this year, so choosing the right theme is crucial. Second, it is important to select individual stocks carefully. Just picking the right theme is not enough; investors need to screen for stocks with clear competitive advantages, as performance can vary greatly even within the same sub-sector. Risks to watch in the medical sector include overseas clinical data outcomes, international trade conflicts, the potential return of funds to the tech sector, and the global macroeconomic environment.

Chen Ximing: In terms of risks, some risks for innovative drugs are actually macroeconomic. It is difficult to predict whether the Federal Reserve will raise interest rates in the near term. In the current high-interest-rate environment, we believe rates are more likely to fall than rise, so this risk might not be too significant, but it remains a short-term risk to watch.

Tang Chen: Over the past two years, the opportunities captured were mainly in value revaluation. Going forward, the focus will be on earnings realization, with the core being "commercialization." Clinical data, overseas partnership progress, and sales performance are the most critical risk factors.

Pi Jinsong: Currently and for the foreseeable future, the operational strategy should focus on innovative drugs. The sector has entered a resonance phase driven by both commercialization and clinical data. Domestic innovative drugs are growing rapidly overall, combined with the continuous volume ramp-up of new products, extending the earnings cycle. Furthermore, starting from 2026, several domestic innovative drugs will begin sales in Europe and the US, bringing significant profit elasticity. Many potential domestic innovative drugs are in key clinical stages, and positive data is likely to catalyze stock prices. In terms of risks, attention should be paid to the impact of geopolitical risks on investor sentiment towards innovative drugs, as well as the risk of clinical data for new drugs falling short of expectations.