Schwab Sector Views: What’s Ailing Health Care?

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.

Health care. It affects us all and we likely all have opinions about it, both positive and negative, and the arguments can at times get heated—as we’ve seen examples of as of late. While we join you in being interested and engaged in those issues, we’re not going to address them here!  Hopefully that will be a bit of relief.  We want to get past the emotional and philosophical disagreements and look at the investment story that’s developing in the sector.

In short, it’s been a tough year for the health care stocks, with the sector underperforming the S&P 500® index by around 700 basis points over the past year. That underperformance has continued in the last month. What has likely frustrated many investors is that this is an economic environment that should be favorable for health care stocks. The sector offers some defensive characteristics. After all, sickness and injury don’t take a break during economic downturns. But exciting developments in the pharmaceutical and biotech industries also offer growth potential. The combination of defensive and growth characteristics seems like the perfect prescription for a sluggish economic backdrop. So what’s ailing the sector?

First, a couple of the major developments in our country that could benefit the sector may actually be hindering performance—aging and obesity.

An aging population should need more health care

Source: FactSet, U.S. Census Bureau. As of Sept. 13, 2016.

As should a “growing” one

Source: Behavioral Risk Factor Surveillance System, Center for Disease Control and Prevention. Data for 2014.

†Obese is defined as body mass index (BMI) ≥ 30.0; BMI was calculated from self-reported weight and height (weight [kg]/ height [m²). Respondents reporting weight < 50 pounds or ≥ 650 pounds; height < 3 feet or ≥ 8 feet; or BMI: <12 or ≥ 100 were excluded. Pregnant respondents were also excluded. Washington D.C. falls in the 20 -< 25 category.

But the health care sector may now have too much of a “good” thing. As more folks demand health care services, they become more interested in the costs of the products and services they receive. And when there is unhappiness with those costs, they often turn to the government in an attempt to get satisfaction. Politicians who need votes are quite interested in garnering favor from this growing group. This brings us to the elephant in the room—the Affordable Care Act (ACA).

We know readers fall on both sides of the aisle, with some despising the ACA and others loving it. We offer no opinion on the validity of either side, but simply look at the economic and investment developments. Proponents of the ACA, including many in the health care industry, promised that consumers would have more choices for insurance, use emergency rooms less and have lower costs. And investors believed many of those assurances, as stocks in much of the health care sector rallied in the years following the 2010 passage of the ACA.

Health care stocks had a good run after ACA passage

Source: FactSet, Standard & Poor's. As of Sept. 13, 2016.

Unfortunately for investors, those promises haven’t come to fruition yet. There is no doubt that more Americans now have insurance: The nation’s uninsured rate has dropped to 8.6%, the lowest level on record, according to the Department of Health and Human Services. The department credits the ACA with adding 20 million to the ranks of the insured. But many have not ended up with more insurance options. The problem stems from the estimated 30 million that remain uninsured. Many who have failed to get insurance are healthier, younger consumers. Insurance companies were expecting that group to seek insurance and help subsidize the costs of consumers with immediate health care needs who were quick to seek insurance coverage on the exchanges. With a lower-than-projected number of younger, healthier patients seeking coverage, several major insurers have taken financial losses and exited the so-called ACA health care exchanges. This has resulted in a projection of about 31% of rural customers having only one insurance provider option in 2017, up from 7.8% in 2015, according to Healthcare.gov.

It doesn’t appear the ACA has led to fewer emergency room visits or lower health care costs either. A 2015 survey of the American College of Emergency Physicians shows emergency room visits rose over the previous 18 months.1 And the average insurance premium increase requested for 2017 is roughly 23%.2 It’s not just insurance premiums that are rising. Out-of-pocket health care payments are increasing at an annual rate of 5.1%,3 more than twice the rate of inflation.

So now there are growing calls to “fix” the ACA, with one group calling for more government intervention and another calling for completely scrapping the system. And the recent EpiPen controversy has dragged politicians even further into the fray, with politicians from various corners calling for price caps and more regulation. This raises our level of concern as government involvement typically doesn’t bode well for corporate profitability.

But while things have looked dour recently, we aren’t quite ready to throw in the towel on an industry that means so much to the vast majority of consumers and are keeping our marketperform rating on the group … for now. Drugmakers have quickly responded to the government threats by walking back some recent price increases and promising more restraint in the future, which could lessen the furor toward the group. Additionally, we are seeing great potential in the biotech area, where stocks have fallen recently, but are starting to look more reasonably valued. And there are few doubts that given the above demographic trends, demand for health care services will increase in the coming decades. In fact, the Bureau of Labor Statistics estimates that 50% of the fastest-growing occupations between 2012 and 2022 will come from health care industries. With that amount of industry growth forecasted, it is difficult for us to downgrade the group, despite recent disappointing performance. But if the tide toward more government involvement grows, we would likely be forced to do just that.

1 The Wall Street Journal

2 New York Times

3 Ned Davis Research

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 return as of 08/30/2016

Consumer discretionary

Marketperform

07/17/2014

12%

1,11%

Consumer staples

Marketperform

05/07/2015

10%

6.38%

Energy

Marketperform

11/20/2014

7%

14.39%

Financials

Outperform

05/07/2015

13%**

1.38%

Health care

Marketperform

12/13/2012

15%

0.22%

Industrials

Marketperform

01/29/2015

10%

7.88%

Information technology

Outperform

04/29/2010

21%

9.00%

Materials

Marketperform

01/31/2013

3%

9.08%

Real estate

Marketperform

09/01/2016

3%**

N/A*

Telecom

Underperform

09/12/2013

3%

16.64%

Utilities

Underperform

05/23/2013

3%

14.29%

S&P 500®  Index (Large Cap)

 

 

 

5.71%

Source: Schwab Center for Financial Research and Standard and Poor's as of 08/31//2016.

*The Real Estate Sector was not established until September 1, 2016.

** Percentages are estimated-S&P will not publish official weightings until after September 19, 2016.

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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