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Quoted in The Wall Street Journal: A Case for Health-Care Stocks

As published 6/6/14 in the

The Wall Street Journal:

Health-care stocks are outperforming the broader market, at least in part because investors see the Affordable Care Act spurring more business for medical-device, pharmaceutical and other companies in the group.

The health-care law is just one of the tailwinds that financial advisers and other professional investors expect to propel some health-care companies’ stocks upward in coming years. Aging baby boomers and growing affluence in some emerging-market economies also are seen helping lift the shares.

In the 12 months ended May 31, health-care stocks in the S&P 500 gained 24%, beating the large-cap index’s 18% return. Such stocks made up 13% of the S&P 500’s market capitalization.

More than $6.91 billion flowed into U.S. health-care mutual funds and $6.97 billion into U.S. health-care ETFs in the 12 months ended April 30, according to Chicago-based research firm Morningstar.

“Love it or hate it, the Affordable Care Act…has created coverage for a lot more folks, and therefore created a lot more customers for a number of companies in the health-care business,” says Joe Heider, a principal and partner at Rehmann Financial, a Cleveland firm managing $2.2 billion.

Mr. Heider’s clients’ holdings are focused on four blue-chip stocks he has bulked up on over the past few years: Bristol-Myers Squibb, Eli Lilly, Johnson & Johnson and Merck.  His firm also is recommending that clients invest in the iShares U.S. Healthcare ETF.

Ben Marks, chief investment officer at Marks Group Wealth Management in Minnetonka, Minn., which oversees $335 million, says his clients have about 11% of their assets invested in health-care stocks, depending on their risk appetite and other holdings. He continues to look for opportunities but says the market isn’t cheap.

Global Demand

He expects health-care companies to benefit as more individuals enter the U.S. health-care system over the next few years, but believes investors are too focused on the Affordable Care Act. They should be looking at other factors, specifically global demand, he says.

As emerging markets become more affluent and health-care becomes more affordable, Mr. Marks says that many of the companies his clients now hold—such as medical-device manufacturer Medtronic, French pharmaceutical giant Sanofi and managed-care company UnitedHealth Group—stand to benefit.

But there are skeptics who argue that the health-care overhaul could cut into revenues by pressuring costs, and that the increasingly affluent emerging-market consumer may not end up being as big a buyer of health-care products and services as expected.

Brad Evans, co-portfolio manager of the $1.2 billion Heartland Value and the $3 billion Heartland Value Plus funds, says valuations in the sector are high and has trimmed his funds’ health-care holdings significantly over the past 18 months.

Price/earnings ratios in the health-care sector have risen 4% over the past 12 months to 21, according to FactSet. That compares to a 2% rise in the S&P 500 to 17.

“The excitement around the group is driving a lot of merger-and-acquisition activity, which is being transacted at very, very high multiples, which are hard to understand,” he says.

There are better opportunities in other sectors, such as energy, materials, industrials and retail, Mr. Evans says.

Terry Sandven, chief equity strategist at U.S. Bank Wealth Management, remains bullish. The health-care sector is positioned to perform well relative to other sectors in the second half of 2014 and beyond, he says.

Looking for Growth

There was a rotation within the sector earlier this year, as investors shed stocks with stretched valuations and moved into more defensive shares, such as those of pharmaceutical and distribution companies, Mr. Sandven says. That pattern is likely to continue this year.

Since the selloff this spring, there has also been some rotation back into “growthier names,” particularly some biotech stocks, he says.

In the first quarter, Art Barry, co-portfolio manager of the $2.3 billion Loomis Sayles Value Fund, trimmed back the fund’s health-care winners, including Merck, and moved into pharmaceutical stocks that hadn’t done as well as others, such as Pfizer.

Health-care stocks are still trading at a discount to what Mr. Barry believes they are worth compared with other defensive stocks, such as those of utilities and telecom and consumer-staples companies.

Two broad health-care ETFs Morningstar likes are Vanguard Health Care and the Health Care Select Sector SPDR, which charge annual fees of 0.14% and 0.16%, respectively, or $14 and $16 per $10,000 invested. Both allocate to stocks according to their market capitalization and offer strong exposure to the sector, says Robert Goldsborough, a fund analyst at Morningstar.

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The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The mention of individual companies is for illustrative purposes and is not a recommendation to buy or sell. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.

An investment in Exchange Traded Funds (ETF), structured as a mutual fund or unit investment trust, involves the risk of losing money and should be considered as part of an overall program, not a complete investment program. An investment in ETFs involves additional risks such as not diversified, price volatility, competitive industry pressure, international political and economic developments, possible trading halts, and index tracking errors.

Exchange Traded Funds concentrating in specific industries are subject to higher risks and volatility than those that invest more broadly.

International investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

 

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