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
Source: FactSet, Conference Board. As of 3/14/2017.
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
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 View
Date of last change to Schwab Sector View
Share of the
Year-to-date total return as of 03/14/2017
S&P 500® Index (Large Cap)
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.
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Schwab Sector Views do not represent a personalized recommendation of a particular investment strategy to you. You should not buy or sell an investment without first considering whether it is appropriate for you and your portfolio. Additionally, you should review and consider any recent market news.
All expressions of opinion are subject to change without notice in reaction to shifting market, other conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.
Diversification strategies do not ensure a profit and do not protect against losses in declining markets.
Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly. Past performance is no guarantee of future results.
The S&P 500 Index is a market-capitalization-weighted index comprising 500 widely traded stocks chosen for market size, liquidity and industry group representation.
The NFIB Small Business Optimism Index is compiled from a survey that is conducted each month by the National Federation of Independent Business (NFIB) of its members
The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.
The IntercontinentalExchange (ICE) U.S. Dollar Index is an index of the of the United States dollar relative to a basket of foreign currencies, and is a weighted geometric mean of the dollar’s compared to the Euro (EUR), Japanese yen (JPY), Pound sterling (GBP), Canadian dollar (CAD), Swedish krona (SEK) and Swiss franc (CHF) relative to March 1973
The Global Industry Classification Standard (GICS) was developed by and is the exclusive property of Morgan Stanley Capital International Inc. (MSCI) and Standard & Poor's. GICS is a service mark of MSCI and S&P and has been licensed for use by Charles Schwab & Co., Inc.
The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.