In the search for sustainable long-term investing trends, casting your lot with the health care sector seems like a no-brainer. The U.S. population is aging and living longer, new medicines are in big demand, and managed care increasingly plays a vital role in the national economy.
Small wonder then that the S&P Health Care sector, which comprises 13 percent of the S&P 1500 index, has outperformed the index both year-to-date and during the prior two years. The S&P 1500, which includes the S&P 500, the S&P MidCap 400 and the S&P SmallCap 600 indexes, covers about 90% of the U.S. equity market.
According to investment research provider S&P Capital IQ, nine of the 10 sub-industries within the health care sector have outperformed the broader market this year, led by the scorching-hot biotechnology group, which was up nearly 58 percent as of September 13. That follows gains of 40 percent and 20 percent during the past two years.
Managed care is another stellar health care sub-industry, with year-to-date gains of 42 percent. The lone laggard among sub-industries this year has been health care equipment, which has registered a not-too-shabby 17 percent gain.
Naturally, exchange-traded funds tied to health care have handsomely rewarded investors of late. S&P Capital IQ looked at roughly two dozen U.S.-traded ETFs within that universe, and evaluated their underlying holdings based on its rating system that incorporates proprietary performance analytics, risk considerations and cost factors. After it crunched the numbers, S&P Capital IQ has put overweight rankings on just four of them: the Health Care Select Sector SPDR ETF (XLV); iShares Global Healthcare ETF (IXJ); iShares US Healthcare ETF (IYH) and the Vanguard Health Care ETF (VHT).
Valuation Concerns Balanced With Growth Catalysts
Investors’ love affair with health care stocks has boosted the sector’s overall valuation. According to S&P Capital IQ equity analyst Jeffrey Loo, the health care sector over the past several years had traded at 13 to 14 times forward earnings. It’s now trading at about 15 times next year’s estimates versus 14 times for the broader market.
“From that point of view, you could argue that it’s maybe getting a little frothy,” he says.
Indeed, all four ETFs that scored overweight rankings from S&P Capital IQ have hit 52-week highs during the past few days after the equity market was juiced by the Federal Reserve’s surprise decision to leave its quantitative easing program intact. And all of the funds are currently up in the 30 percent range since bouncing off of their 52-week lows, which for all four funds came on November 15.
Nonetheless, Loo believes that changes in health care stemming from the Affordable Care Act could be a growth catalyst for the sector. The government expects health care reform to add 25 million new people to the insurance rolls. “The associated revenue and potential profit coming with those 25 million people could be a big driver for health care,” Loo says.