Health Care Sector Rating: Outperform
Health care sector overview
In general, health care companies' balance sheets are solid, their stocks have offered attractive dividend yields and the sector's overall cost structure appears to have improved. Demand appears to be on the rise for health care products and services. On the other hand, political and legal rhetoric around the Affordable Care Act can be expected to fuel continued volatility.
Market outlook for the health care sector
The health care sector continues to be in the headlines, as drug pricing was mentioned in President Donald Trump’s State of the Union address, but with the rancor in Washington, we believe the risks of major legislative changes coming to fruition are relatively low. Also, we believe another area of risk that may be overdone is concern over the Affordable Care Act (ACA) and potential changes to it. The majority of the ACA will likely stay in place, in our view, either through legal or political means. Health care investors should always be prepared for volatility, given the influence the political arena can have on the health care world. However, we continue to believe the health care sector will benefit from good growth characteristics combined with the traditionally defensive nature of the sector.
In our view, the health care sector has a lot of positives going for it and has had good performance over the past year—and we think there’s likely continued solid performance to come. Balance sheets are solid, stocks in the group generally have good dividend yields, and the overall cost structure appears to be much improved. Also, demand appears to be on the rise for health care products and services, partly as a result of an aging population.
Government actions and potential actions continue to be potential sources of volatility for the sector, but we believe this creates potential opportunities for investors and are currently rating the group at outperform. While large-scale changes to the existing system seem highly unlikely in the near term given the environment in Washington and the split Congress that resulted from the midterm elections, there are smaller changes being made administratively and proposed legislatively that will likely continue to result in ebbs and flows in the sector as investors try to gauge the impact on various areas of the sector. This is a story that will continue to develop, with health care continuing to be at the center of many political debates and the mix in Washington changing but remaining divided. This will likely keep the health care sector more volatile than usual, but also create some opportunities for investors willing to ride the potential roller coaster.
Another factor potentially helping the group, the Federal Reserve has continued to raise rates and—according to BCA Research—the sector has outperformed during Fed hiking cycles on average since 1970. Since past performance does not guarantee future results, we acknowledge that there are risks and it could be a bit of a bumpy ride, but we believe that brighter prospects are ahead and remain comfortable with our outperform rating on the group.
We believe an outperform rating for the entire sector is appropriate, although at times it will feel disappointing as the sector experiences both short-term dips on speculation as to what changes may or may not occur, but we urge investors to remain patient and ride out these short-term potential storms.
Factors that may affect the health care sector
Positive factors for the health care sector include:
- Increased need for services: An aging population requires more extensive drug treatments and medical care. The health issues associated with obesity also could boost demand for medical services.
- Strong financials: 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.
Negative factors for the health care sector include:
- Regulatory uncertainty: Following an election where health care was a center of many political campaigns and a recent legal decision regarding the ACA, it seems likely that new proposals regarding the health care sector will be made, but with a split Washington, getting much done seems unlikely to us at this point.
- Fiscal policy concerns: The current fiscal situation in Washington creates uncertainty regarding the health care sector. Certain funding mechanisms could be changed as Congress deals with growing deficits.
Clients can see our top-rated stocks in the health care sector.
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