Confronting Health Care ETF Valuations…Again

ETF Trends

A prime reason behind the biotechnology sell-off that afflicted a plethora of health care exchange traded funds earlier this year was valuation.

As in biotech, an industry with a reputation for being more expensive than the broader market, was trading at double its usual premium to the S&P 500. In early February, the Health Care Select Sector (XLV) was spotted trading at a slight premium to the Consumer Staples Select Sector SPDR (XLP) for the first time in eight years. [Health Care ETFs Deal With Lofty Valuations]

Aided by an unloved, often ignored resurgence in biotech names, major health care ETFs such as XLV and the iShares U.S. Healthcare ETF (IYH) currently reside near all-time highs and that has some analysts saying the sector’s valuations are again frothy. [Health Care ETFs Bounce Back]

BMO Capital’s Brian Belski says “The biggest problem is that people aren’t seeing that health care has become very expensive,” reports Bertha Coombs for CNBC. Belski adds “valuations on big-cap health stocks are less attractive after this year’s run-up” while small-caps, biotech names in particular, are too volatile.

Large-cap health care names have been strong performers this. Just seven of the 30 Dow stocks are up at least 10% this year with Johnson & Johnson (JNJ) and Merck (MRK) being two of those stocks. J&J and Merck are XLV’s largest and third-largest holdings, respectively, combining for 20% of the ETF’s weight. IYH allocates a combined 18.6% to those stocks.

Dinging the health care sector on valuation is not new. As is noted above, that is exactly what the naysayers did earlier this year, wantonly highlighting an alleged biotech bubble. The March/April swoon endured by biotech stocks and as a result, health care ETFs, indicates investors were concerned about valuations and bubble conditions. [Investors Depart Health Care ETFs]

However, biotech and health care naysayers have been awfully quiet in recent weeks. The iShares Nasdaq Biotechnology ETF (IBB) and the SPDR S&P Biotech ETF (XBI) gained 7.1% and 17.8%, respectively last month, but those that decried biotech’s valuations in February and March were nowhere to be found in May and June as the industry’s stocks and ETFs roared back. [The Biotech Rally No One Loves]

Some analysts and fund managers still see pockets of opportunity within the health care sector, including hospital stocks, CNBC reports. The SPDR S&P Health Care Services ETF (XHS) is one ETF with which to play that trend.

XHS sports a higher P/E ratio than XLV, but the former touched a new all-time high today, cementing its status as one of the more credible Obamacare ETFs most investors have not heard of. Nearly a third of the ETF’s weight is allocated to health care facilities operators. XHS has more than tripled in size since mid-December 2013.

Health Care Select Sector SPDR

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