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Schwab Sector Views: Health Care—The Right Prescription for Your Portfolio?

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.

May 10, 2018

Member for

1 year 2 months
A095922
Submitted by jib.butterworth on Thu, 05/10/2018 - 16:54
Schwab Sector Views

The health care sector has outperformed year to date, and investors may be wondering whether the strong performance can continue.

We believe the sector has further upside left, and its defensive characteristics may become more attractive if economic growth slows.

However, the group has seen a nice surge over the past few months, which could lead to a pullback in the near term as investors look to take some profits.

Schwab Sector Views is our three- to six-month outlook for 11 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

Health care looks healthy

The health care sector had struggled at times over the past few years, as investors have expressed concerns about issues ranging from cost controls, changes in government regulations, and pricing power. Those concerns seem to have faded this year, especially during the past few months—the health care sector has outperformed year to date, and is the best-performing sector over the past three months. At this point, investors may be wondering whether the good performance can continue. Our answer is yes!

Health care has outperformed

Don’t get greedy…or fearful!

We always recommend a balanced approach, and this time is no different. If your health care holdings have grown excessively, it may be time to take some profits and pare back to just a modest overweight. We remain positive on the sector, but you know the old saying: “bulls make money, bears make money, pigs get slaughtered.” Not the most elegant of phrases—but a good reminder for us not to be piggish!

Given the run that the sector has had recently, we expect to see a modest pullback in the near term as investors take some profits. Going back to 1989, there have been five instances in which the health care sector has been up for six consecutive months and gained 15% or more, as it has done recently (Cornerstone Macro). Three weeks after these periods, the sector has lost an average of 1%, according to Cornerstone. This is not a reason to underweight the sector, in our view—five instances aren’t enough to be statistically significant (and past performance is no guarantee of future results), but it does suggest the prudent course might be to take some profits now.

However, looking at the bigger picture, we remain positive on the health care sector and believe that during the next six to 12 months the sector is poised to continue to outperform. First, there is the macro environment. Readers of our Schwab Market Perspective know that we have become a bit more cautious on the overall market due to elevated expectations and risks of underperforming those expectations. With that view in place, the health care sector appears to be a good place to try to gain some likely outperformance. The group has some good defensive characteristics, as consumers typically continue to use health care services even when the economy slows. It also has some growth characteristics, given the potential for new drugs and treatments coming to market. We don’t know that we’re at the peak of this economic cycle in terms of growth, but it is possible. It is interesting to note that the health care sector has been by far the best performer from the point of the peak of the Institute for Supply Management’s Manufacturing Index to the next recession, according to BCA Research.

ISM peak?  Could be a positive for health care

Also, although the sector’s price-to-earnings ratio is now 16.3, up from 14.6 in May, that’s still below both the overall market’s P/E of 16.9 and the sector’s average of 17.8 (ThomsonReuters, BCA Research). To us, this suggests that the group is no longer undervalued, but also is not close to being overvalued despite the move higher. In fact, one of the mistakes investors can make, in our view, is overreacting to a run in stocks by completely dumping a sector or industry, missing out on potential further gains.

We are also encouraged by what we see as a more-friendly stance from the Food and Drug Administration (FDA). Commissioner Scott Gottlieb has noted many times that speeding up the approval process is a priority, while maintaining safety. And we’ve seen evidence of that in new processes such as the Limited Population Pathway for Antibacterial and Antifungal Drugs, real-time oncology review and the designating of certain generic drugs as a Competitive Generic Therapy (Wall Street Journal). Faster paths to market can mean better treatments for patients and the potential for more profitability to companies.

Additionally, there may be a bit of a tailwind from the recent trade agreement between the United States, Mexico and Canada that boosts the protection period for an expensive class of drugs knows as biologics, used to treat such things as cancer, arthritis and multiple sclerosis, from eight years to 10 years (CBC News). Longtime readers of this publication know that I love to read about the new treatments and therapies that are coming out and will potentially help to fuel future growth. In fact, we just saw the Nobel Prize in Physiology or Medicine awarded to a scientist involved with immune checkpoint therapy, which addresses some of the weaknesses of CAR T-cell therapies, which uses a person’s own cells to fight cancer. We’ve also seen a new migraine drug approved that could alleviate the suffering of millions of Americans (Wall Street Journal). As I’ve noted before, however, exciting treatments aren’t in and of themselves enough to warrant an outperform rating, but given the other fundamentals we see in place, they are a nice cherry on top!

Of course there are risks, which is one of the reasons we remain bullish, as it helps to keep overly optimistic sentiment from developing. Chief among them, in our view, is politics. A shift in congressional power after the midterm elections could put health care in the spotlight. But with a Republican president and at best a narrow majority for either party in the Senate, it seems unlikely to us that major changes are very likely during the next couple of years. While there could be some increased volatility in the group as political rhetoric ramps up, we continue to believe that riding out the bumps can be worthwhile. But of course, remain tuned in, because things can and do change quickly and we will adjust our outlook as new data comes in.

 

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date total return as of 10/09/18

Communications Underperform 09/28/2018 10% N/A*

Consumer discretionary

Marketperform

07/17/2014

10%

15.15%

Consumer staples

Marketperform

05/07/2015

7%

-3.08%

Energy

Marketperform

11/20/2014

6%

10.49%

Financials

Marketperform

08/16/2018

13%

1.93%

Health care

Outperform

01/26/2017

15%

15.78%

Industrials

Marketperform

01/29/2015

10%

4.26%

Information technology

Marketperform

08/16/2018

21%

16.99%

Materials

Marketperform

01/31/2013

2%

-6.52%

Real estate

Marketperform

08/16/2018

3%

0.62%

Utilities

Marketperform

08/16/2018

3%

5.87%

S&P 500®  Index (Large Cap)

 

 

 

9.35%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 09/28/18.

.*The Communications Sector came into existence on 9/28/18, and the year-to-date information is not comparable to rest of the groups so we are omitting it until the end of the year.

 

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 11 stock market sectors, which are based on the 11 broad sectors of the economy.

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 rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor’s 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio can use Schwab Sector Views’ outperform, underperform and marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it’s time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks.

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