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Health Care Sector Rating: Outperform

By

Brad Sorensen

photo
CFA, Managing Director of Market & Sector Analysis, Schwab Center for Financial Research

Brad Sorensen heads market and sector analysis for the Schwab Center for Financial Research and writes for several Schwab publications. He is a member of Schwab's Investment Strategy Council.

Before joining Schwab in 2004, he was a senior analyst at AMG Guaranty Trust, where he designed portfolio strategies for high-net-worth individuals. Sorensen graduated from the University of Colorado with a bachelor's degree in finance and master's degrees in business administration and finance. He is a Chartered Financial Analyst charterholder.

October 11, 2018
Submitted by satya.billa on October 11, 2018
Health Care Sector

Health care sector overview

In general, health care companies' balance sheets are solid, their stocks offer 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 and “Medicare for all” can be expected to fuel continued volatility.

Market outlook for the health care sector

The health care sector has been a bit volatile this year—outperforming the overall market over the past three months as investors appear to be reassessing the risk of “Medicare for all” while also potentially seeing the group as a bit of port in the trade-escalation storm, contrasting with bouts of concern with more government intervention. The former action is more in line with my beliefs, as I still believe with the rancor in Washington, the risks of major legislative changes coming to fruition are relatively low and those that are being discussed are well known and likely already reflected in stock prices, and that investor fears provide a potential opportunity for investors. 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. However, health care investors should always be prepared for volatility, given the influence the political arena can have on the health care world.

In our view, the health care sector still has a lot of positives going for it. 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 proposed actions continue to be likely 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 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.

We believe an outperform rating for the entire sector is appropriate, although at times, such as earlier this year, it will feel disappointing as the sector experiences short-term dips on speculation as to what changes may or may not occur. However, 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: As we are entering a political campaign season that includes a presidential election in which health care probably will be a focus, volatility is likely to increase at times. 
  • Government takeover concerns: If investors increasingly believe the “Medicare for all” rhetoric is going to come to fruition, it would likely be a very negative development for the health care sector. 
  • 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.

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.

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