What is the health care sector?
It includes hospitals, health maintenance organizations (HMOs), health care technology and equipment, as well as pharmaceutical and biotechnology companies.
The COVID-19 pandemic has resulted in a breakdown of many historic relationships within the markets. While the virus has been disruptive, the Health Care sector has so far maintained many of its traditional non-cyclical properties. During the past several months of stronger markets, Health Care has underperformed most other sectors.
Amid the COVID-19 pandemic, there has been an assumption by many that the Health Care sector should fundamentally benefit. However, while there are pockets within the sector that have benefited, there is a mixed impact. Some companies had benefited from increased sales of over-the-counter drugs, as people stocked up on cold and flu medicines and other personal-care items. However, sales were simply brought forward and should equalize with a slowdown in sales going forward.
Mass job losses means insurance-premium income will decline. Many of the unemployed will be covered by Medicaid, which pays out claims for drugs and care at a much lower rate. With the sharp drop in doctor visits and delays in elective surgeries, insurance companies will make up for some of the lower premium income with lower claims payouts. However, fewer visits translates into fewer diagnostic tests and drug prescriptions, leading to hospitals with lower billable services and surgeries. As economies slowly reopen, we have seen some of this reverse, and indeed, the earnings outlook has improved.
Some companies within the biotech and pharma industries stand to benefit if they produce tests and vaccines for the virus, but at high cost and potential delays of other trials. And recently, the market has become much more selective in assessing the potential winners.
Beyond the COVID-19 impact, however, the Health Care sector has many long-term positives, including an aging global population and a growing middle class in emerging markets, all of whom will demand more extensive drug treatments and medical care over time. And balance sheets in the Health Care sector remain flush with cash, increasing the possibility of higher dividend payments, share-enhancing stock buybacks, and mergers and acquisitions.
In terms of risks, health care reform has become a focus during the run-up to the 2020 election, prompting volatility to increase. Proposals to cut costs, which could weigh on providers’ profitability, may come from both sides of the political aisle. In general, we believe the risk of major legislative changes is relatively low, and potential changes under discussion are well known. However, in the event of a sweep by either party, this sector can be one of the most exposed to political risks. One of those risks is a potential reversal of the corporate tax cuts implement in 2018—which dramatically lowered the sector’s effective tax rate. A reversal of those cuts could weigh heavily on expected earnings.
In terms of valuations, we compare the Health Care sector relative to its own history and other sectors, and they appear to be rather attractive.
The sector's macro impact is neutral, in the sense that the sector is not cyclical in nature. However, it does tend to trail when broad market is higher. With that said, we think that some of the more concentrated sectors that have led the rally could consolidate. If that results in outsized volatility, the macro component would then become a positive for the sector. We think valuations are attractive, and the sector's long-term and short-term fundamental are positive. And the sector’s long-term relative performance has been positive despite choppy short-term weakness, as some of the more cyclical sectors have taken the lead. While we still like the longer-term prospects for the sector, we think that a marketperform rating for our three- to six-month outlook is warranted at this time.
Sector Overview: Health Care
Note: Each of the sector lenses shown above—Macroeconomic, Value, Fundamental and Relative Strength—is both intuitive and evidenced-based in nature. Within each, there are a varying number of factors. The Macroeconomic lens includes sector sensitivities to interest rates, stocks and the value of the U.S. dollar; the outlook for each of these is determined by the Schwab Center for Financial Research (SCFR)’s Asset Allocation Working Group, which uses a mosaic approach of quantitative and qualitative considerations. Value includes six different valuation metrics that provide a holistic perspective on current valuations relative to each of the sectors’ own historical valuations, as well as relative to the other sectors. Fundamental provides insight as to how efficiently the companies within each sector use invested capital to produce earnings; this historically has been informative as to future relative performance of the sectors. Finally, Relative Strength measures momentum of the individual sectors against all of the other sectors. We also consider the data in the context of factors outside the scope of these indicators—for example, geopolitical risk or central bank policy changes.
Source: Charles Schwab, as of 09/10/2020
What do the ratings mean?
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 broader stock market*
- Underperform: likely to perform worse than the broader stock market
- Marketperform: likely to track the broader stock market
Want to learn more about a specific sector? Click on a link below for more information or visit Schwab Sector Views to see how they compare. Clients can log in to see our top-rated stocks in the Health Care sector.
* As represented by the S&P 500 index
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