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Schwab Sector Views: Health Care Diagnosis—Acute or Chronic Problems?

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.

March 05, 2019

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2 years 6 months
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Submitted by Site Factory admin on March 5, 2019
Schwab Sector Views

The health care sector has had a rough few months. Concern about more government involvement appears to be the culprit. 

While a risk, we believe investors are pricing in too great a chance of substantial government intervention, creating a potential opportunity.

The fundamentals of the health care sector look solid to us and should reward patient investors. 

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. 

Listen to the latest audio Schwab Sector Views.

 

Acute or Chronic?

Acute—severe pain, brief and dangerous diseases. 

Chronic—a condition that lasts over a long period of time.

The last couple of months have been tough for the health care sector, although we have seen things stabilize as of late. The question is whether this recent weakness is more likely a short-term, albeit painful, occurrence, or the start of a longer-term problem that is going to weigh on the sector for a considerable time.

Before determining the answer, it’s important to diagnose the cause of the “disease”—then we can determine the future course of action. Coming into earnings season, earnings estimates were lowered for the health care sector, but to a lesser extent than for the broader market, according to FactSet, so it seems unlikely that was the cause of underperformance. And now that we’re in earnings season, the health care sector has actually done fairly well, with 85% of companies beating revenue forecasts through May 3, the best reading among the 11 sectors (Strategas). So that seems unlikely to be the cause, either. 

When we look back at the start of the severe pullback, it seems to me to have occurred in close proximity to a ramp up in the “Medicare for all” talk in the Democratic presidential campaign. Investors appear to have taken that phrase to mean a much more substantial involvement by the government in the health care sector, both in terms of potential price controls as well as the potential for getting rid of private insurance.

Health care’s severe underperformance seemed to begin when “Medicare for all” talk ramped up

S&P 500 Health care relative to S&P 500 Composite performance rebase 123112

I must admit two things. First, I was quite surprised at this reaction by investors. Second, I don’t love getting into this more-political angle, but given the action in the sector, it seems necessary. However, I come at this from the point of view of wanting you to potentially make money—with no political agenda. 

So how great a risk is “Medicare for all?” Well, that’s hard to say, as there are very few details as to what that phrase actually means. For some candidates it may mean Americans have the option to get into the existing Medicare system if they meet certain conditions. For others—and this seems to be where investors have jumped to—it means a near-complete government takeover of the medical system, with the attendant price controls and mandated care. We’re still well over a year away from the election and it is certainly not my expertise to predict such outcomes, but it would likely take a complete Democratic sweep next November for the second scenario to even have a whiff of a chance. If you think that is going to occur, than the recent acute pain in the sector is more likely to turn chronic, and you may want to consider reducing your health care holdings a bit. However, that’s not our position currently, and we believe the recent pain is creating a potential opportunity. 

For more on why we aren’t quite so worried about a complete government takeover of health care, let’s look a poll from the Kaiser Family Foundation. The headline reading is certainly concerning from an investing point of view, as 56% of respondents favored Medicare for all. But as mentioned above, what did they favor? It gets more interesting when we see that support drops to 37% if that means the elimination of private health insurance or that most Americans would have to pay more taxes; meanwhile, if it means more delays in getting tests and treatment, support drops to 26%. To us this illustrates that Americans want something done with the health care system, but not the complete government takeover that seems to be scaring investors. 

So if the recent problems are acute in nature, we think the fundamentals are shaping up nicely for the group. According to Ned Davis Research, the health care sector historically has been the best-performing sector in the 18 months following a yield curve inversion, while it has been the second-best performer in the period between April 30th and October 31st. Of course the past is no guarantee of future performance, but it can provide some valuable context, in our view. 

Additionally, there were a record number of drug approvals in 2018, according to the U.S. Food and Drug Administration. Meanwhile, in a recently rare bout of bipartisan agreement, the Right to Try law was passed, allowing people with critical illnesses to try experimental therapies. Both of these are positive signs for continued innovation in the space, in our view. We also believe that this race to find more effective treatments will help to fuel merger-and-acquisition activity in the sector. And for all the hand-wringing about the rising costs of health care, the percentage gain year-over-year in federal health care spending has been declining since the start of 2015 and recently moved below zero (Strategas).

Growth in federal spending on health care declining

Federal spending on Healthcare

We continue to be excited about the developments in much of the health care sector, and we believe the fear of more government involvement is pushing many parts of the sector to run more efficiently and with more consumer focus. There are likely to be continuing bumps, and if you believe government is going to be much more involved in American health care in the near future, we recommend trimming positions a bit so you can sleep a bit better. But for those who agree with us that government control seems unlikely, and that the innovations in the group are exciting, the recent weakness offers a potential opportunity to bring your health care position up to our continued outperform recommendation.

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 5/07/19

Communications Underperform 09/28/2018 10% 19.52%

Consumer discretionary

Marketperform

07/17/2014

10%

20.05%

Consumer staples

Marketperform

05/07/2015

7%

12.88%

Energy

Marketperform

11/20/2014

5%

12.19%

Financials

Marketperform

08/16/2018

13%

15.76%

Health care

Outperform

01/26/2017

14%

3.32%

Industrials

Marketperform

01/29/2015

10%

18.82%

Information technology

Marketperform

08/16/2018

22%

24.06%

Materials

Marketperform

01/31/2013

3%

9.18%

Real estate

Marketperform

08/16/2018

3%

15.45%

Utilities

Marketperform

08/16/2018

3%

10.06%

S&P 500®  Index (Large Cap)

 

 

 

15.80%

Source: Schwab Center for Financial Research and Standard and Poor’s as of 4/30/19.

 

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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