Schwab Sector Views: How Should Investors Look at Health Care Now?

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

The health care sector has had a reversal of fortune—the worst-performing sector of 2016, it has been one of the leading gainers in 2017, posting the second-highest gains year to date. But as we cautioned when we upgraded the group in January, there will be a lot of action in the health care arena this year. That action really kicked into gear this month, when the legislative framework for the “repeal and replace” of the Affordable Care Act (ACA) was released. So, what now?  Does it change our view, or what investors should consider?

It’s important to remember that we’re still at the early stages of the debate over the replacement legislation, and that changes to the initial bill are highly likely. And, at this point, there is still no assurance that Republicans can garner enough votes to put something on the president’s desk.

However, at first blush, the replacement legislation doesn’t appear likely to have a large impact on our view of the health care sector. There is an effort to get the system to a more market-based situation, which we believe would ultimately be a positive one for the sector. We’re not going to spend a lot of time detailing the initial specific proposal, as it is likely to change in the coming weeks, but judging by the initial reaction of investors, they don’t believe it will be a large game-changer from the investment side—at least for now.

That’s not to say there won’t be some industries that are perceived as likely to do better than others under the new proposal. For example, the hospital group saw some pressure following the release of the plan, as there appeared to be increased fears that fewer people would be insured, which would potentially increase the burden on hospitals—an idea backed up by the report from the non-partisan Congressional Budget Office. .

Also, there is the elephant in the room—the pharmaceutical industry, which is the largest single industry in the S&P 500® health care sector. It wasn’t really addressed in the new legislation. There was a tweet from President Donald Trump on the morning of the release stating he was “working on a new system where there will be competition in the Drug Industry.” We don’t know what that means at this point, and some drug stocks dropped, but we think that reaction is overdone. To us, price controls seem highly unlikely to occur given the Republican makeup of Congress. Additionally, Trump seems to appreciate the innovation in the drug industry—in his recent speech before Congress, he mentioned Megan Crowley, a college student who has a rare condition called Pompe disease and continues to beat the odds, aided greatly by a drug treatment that costs close to $300k per year, according to the drug company Sanofi SA. To continue that innovation, companies need to be able to have the potential to profit, and we believe the president recognizes that. So while we don’t know what changes may be coming, we believe they won’t be as potentially damaging as some investors appear to believe.

While we’re keeping track of the legislation closely, we also want investors to focus on the bigger picture and not get too caught up in the political weeds. One of the reasons we added the health care sector to our outperform list was to add a bit of defensiveness to the mix after the great run the overall market had at the beginning of the year. In a market where valuations have become concerning to some, the health care sector appears to offer some value, with the group’s forward price-to-earnings ratio at only 90% of its historical level, according to Ned Davis Research (NDR). Additionally, with the Federal Reserve hiking rates again just recently, we believe it’s important to note that the health care sector has outperformed the S&P 500 on average during rate-hiking periods going back to 1970 (BCA Research), although just because it’s happened in the past doesn’t necessarily mean it will occur in the future.

On the growth side, we believe there is some potential for increased growth in the health care sector. Consumer confidence has risen since the election, which we believe could help many people decide to stop putting off elective medical procedures. And with an aging population, demand for both mandatory and discretionary medical care is likely to increase, in our view.

Rising confidence could spur increase in medical procedures

Rising confidence could spur increase in medical procedures

Source: FactSet, Conference Board. As of 3/14/2017.

As could an aging population

 As could an aging population

Source: FactSet, World Bank. As of Mar. 14, 2017.

And there is already some evidence that growth in earnings had been occurring in the sector. According to Cornerstone Research, the health care sector had the greatest number of stocks with double-digit earnings growth during the past five years. Finally, with the Federal Reserve again hiking rates, and other central banks sitting on their hands, the potential for a continuing strengthening dollar exists, which could add a tailwind to more domestically oriented companies. This could help the health care sector, which has the second-highest share of sales attributable to the U.S., at close to 80% (Cornerstone Research).

A stronger dollar could help the more domestically-oriented sector 

A stronger dollar could help the more domestically-oriented sector

Source: FactSet, Intercontinental Exchange. As of 3/14/2017.

As we noted when we boosted the rating to the sector, it is likely to be a bumpy ride at times, but we urge investors to be patient. At this point, the potential legislative changes don’t appear to be game-changers, and the outlook for the sector continues to look good to us. We will be continuing to follow the legislative process, however, and will make changes if needed, but for now we are sticking with our outperform view.  

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 03/14/2017

Consumer discretionary

Marketperform

07/17/2014

12%

7.06%

Consumer staples

Marketperform

05/07/2015

9%

6.47%

Energy

Marketperform

11/20/2014

7%

-8.37%

Financials

Outperform

05/07/2015

15%

6.60%

Health care

Outperform

01/26/2017

14%

9.89%

Industrials

Marketperform

01/29/2015

10%

4.22%

Information technology

Outperform

04/29/2010

22%

11.31%

Materials

Marketperform

01/31/2013

3%

4.37%

Real estate

Underperform

01/26/2017

3%

-0.60%

Telecom

Underperform

09/12/2013

2%

-2.87%

Utilities

Underperform

05/23/2013

3%

5.09%

S&P 500®  Index (Large Cap)

 

 

 

6.14%

Source: Schwab Center for Financial Research and Standard and Poor's as of 02/28/17.

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor's 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views' outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it's time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks. 

Next Steps

Talk to Us
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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