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Supply Chain Risk

It Could be Time to Pay More Attention to Healthcare ETFs

The Health Care Select Sector SPDR ETF (NYSEArca: XLV) and other ETFs tracking the once-beloved sector could be worth revisiting following the Super Tuesday primaries, assuming some of the political risk baked into the sector ebbs.

Additionally, valuations on the S&P 500’s sector allocation look compelling. Furthermore, the healthcare sector appears cheap relative to the broader market as this segment has underperformed the run in the S&P 500. Healthcare stocks were among the second weakest performers among the 11 major sectors on the benchmark index. Looking ahead, healthcare companies are projected to generate annual earnings of 9% and revenue growth of 14%, the highest of all sectors in the S&P 500, according to FactSet data.

The largest healthcare ETF by assets, XLV seeks investment results that correspond generally to the Health Care Select Sector Index. The index includes companies from the following industries: pharmaceuticals; health care equipment & supplies; health care providers & services; biotechnology; life sciences tools & services; and health care technology.

Politics And Valuations

“You’d have to go back to mid-2013 to find the Health Care Select Sector SPDR ETF (XLV) trading at a significantly cheaper price-to-earnings (P/E) multiple than it does today at 14.6x forward earnings estimates,” according to the ETF Research Center. “This is quite a discount for a sector that, at the margin, may benefit from increased demand stemming from the Coronavirus epidemic, suggesting that the recent sell-off may have been overdone.”

However, the potential for political risk to affect the healthcare sector should not dissuade investors. Any major healthcare policy changes will unlikely go through a divided Congress, and more importantly, the sector will continue to find fundamental support over the long-term from increased drug innovation and an aging U.S. population.

Previously, investors embraced healthcare stocks for the sector’s growth and defensive characteristics, providing investors with yields and valuations that are less stretched than other yield-producing stocks like utilities. Some market observers believe the sector’s selloff is overdone and that healthcare stocks could be poised to bounce back.

Regarding XLV, “estimates have been stable over the past month, and sell-side analysts’ ratings on the companies in the fund have been turning more bullish. We currently have an OVERWEIGHT recommendation on the ETF,” notes the ETF Research Center.

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The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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