Health Care Sector Surges: Not Just For Playing Defense?

The health care sector is no longer just a corner of the stock market for investors to play defense.

This category has chalked up the best performance in the S&P 500 index (SPX) year to date, climbing 9.2% through May 22 (versus a 3.3% gain for the S&P 500). Plus, it’s been the most actively purchased sector by the 10 largest hedge funds, according to S&P Capital IQ.

Traditionally, investors flock to the health care sector during times of broader-market uncertainty. It’s no surprise, perhaps, that people need medical care in good times and bad. But the current surge in health care stocks looks to be driven by good, old-fashioned, faster-growth fundamentals, not necessarily because investors are hunkering down, industry analysts say. After all, the SPX and other broad stock indexes continue their grind in record-high territory—no sign of feeling under the weather yet.

Are Earnings The Antidote?

The health care sector could remain underpinned if industry-projected earnings deliver.

"We are expecting health care to show an 11.5% gain in earnings this year versus a 0.6% projected increase for the market as a whole," says Sam Stovall, chief equity strategist at S&P Capital IQ. "This is likely to continue into 2016 as well, as earnings in the health care sector are expected to rise 12.7%.”

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"It is an ever-changing industry and the technology within that industry is changing very quickly,” says JJ Kinahan, chief strategist at TD Ameritrade. “The health care industry is in flux, which is providing potential opportunity.”

The so-called smart money or institutional players have been flocking to this sector. The 10 largest hedge funds logged net buys in health care stocks totaling $4.8 billion in Q1 2015, according to research from S&P Capital IQ. It was the most popular sector among this group in that time period.

Spring and fall are also seasonally positive for health care, stock history shows.

"Dating back to 1990, the S&P 500 index has risen only 1.6% on an annualized basis during the May–October period, relatively weak compared to other six-month periods. However, the health care sector has risen 5.2%, the strongest of the ten sectors, and outperformed the broader market 65% of the time," according to an S&P Capital IQ research note.

Break It Down

Within the health care sector are several industries, some more volatile than others. These include biotechnology, health care equipment and supplies, health care providers, and more. "Health care is a very broad sector. There are the insurance providers, and their business models are changing. Or are you talking about drug makers, biotechs, or the more traditional Band-Aid companies?" asks Kinahan.

For example, "biotech represents close to 20% of the sector now. This category has been seeing stellar growth because of the introduction of new drugs," notes Stovall.

For investors, it’s important to take the time to define what you truly want to invest in, and to consider valuation, long-term trends, and other factors, Kinahan says. A research tool is available for TD Ameritrade clients on tdameritrade.com that breaks down the sector and its industry components (see figure 1). "Understand what the components of the sector are, and then you have to make a decision. Do you want to take a position in an individual stock or an exchange-traded fund, for instance, or none at all?" Kinahan says.

"There are reasons for optimism in the price advances in health care, and the ride might not be over yet," concludes Stovall.

This piece was originally posted here by Kira Brecht on May 27, 2015.

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