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Health Care ETFs Outperforming: Will the Rally Last?

Sanghamitra Saha
3M's (MMM) rewards to shareholders, including quarterly dividend payment and repurchase of shares worth $10 billion, are in compliance with its sound capital-allocation strategies.

Health care ETFs are red hot right now. SPDR Health Care Select Sector ETF XLV. The fund has gained 8.4% in the past three-month period and SPDR S&P Pharmaceuticals ETF XPH has added about 16.1%.

Very few sectors tried to match this solid performance as the next best returns came from Consumer Staples Select Sector SPDR ETF XLP (up 8.3%), Consumer Discretionary Select Sector SPDR ETF XLY (up 7.8%) and Utilities Select Sector SPDR ETF XLU (up 6.1%) (as of Aug 10, 2018).

Let’s take a look what’s led to this solid performance.

Defensive Appeal

The sector is viewed as a defensive one which has helped it to shine amid market doldrums emanating from trade war tensions between the United States and China. After targeting each other’s $34-billion worth of imports, China announced on Aug 8 that it would enact a 25% tariff on U.S. imports worth $16 billion in retaliation to the tax on an equal amount of imports to be enacted by U.S. authorities from Aug 23. Meanwhile, the United States is also considering a 25% tariff on additional $200 billion of Chinese goods (read: 5 ETF Ways to Bet on China's New Tariff Threats).

Trump's Drug Plan

President Trump’s announcement of the drug plans in May was in the best interest of pharma companies. The drug plans will likely put pressure on U.S. trading partners, forcing them to pay more for medicines (read: Pharma & Biotech ETFs Soar on Trump's Drug Plan).

M&A

The U.S. health care supply chain is consolidating fast, with deals across the industry ranging from insurers, pharmacies to drug distributors. Global M&A activity hit a 17-year-high-record in the first quarter of 2018 on jumbo U.S. health care deals. Amazon's foray into pharmaceuticals and the Cigna/Express Scripts transaction in Q1 deserve a mention in this context (read: Want to Tap Merger Mania? Play Top-Ranked Health Care ETFs).

Investors should note that the health care sector’s debt-to-equity levels are 30% lower than the broader S&P 500. The sector is estimated to see return-on-equity more than double to 27.2% by the end of 2019 against the 19.72% expected growth in the broad market. The factors have made the sector more attractive to companies that are eyeing inorganic expansion, per the source.

Tax Reform

If these were not enough, tax reform has perhaps proved to be a big boon to the sector. Per an article published on Reuters, domestically geared health care companies that focus on services are likely to benefit from a lower tax rate and generate superior cash flows. These companies have limited international exposure and considerable capital expenditure (read: Tax Bill: What ETF Investors Need to Know).

Many large drugmakers hold a huge overseas cash balance and a one-time repatriation tax would help them to bring back cash stashed abroad. This in turn could boost more dividend payments or repurchase activities.

Will the Rally Last?

While the rally is still intact, some industries are slowing down. In July, each of the industries of the health care industry -- pharmaceuticals, health care providers, medical devices and biotechnology – contributed to the rally, per MarketWatch.

But in the past one month (as of Aug 9, 2018), medical devices and biotech have been losing momentum. iShares US Medical Devices ETF IHI has gained about 1% and iShares Nasdaq Biotechnology ETF IBB has lost 1.2% past month compared with 5.2% gains in XPH and 2.7% advancement in XLV. So, like other analysts, we too believe that the overall bullishness of the sector may be ending, “when the current streak ends.”

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SPDR-CONS STPL (XLP): ETF Research Reports
 
SPDR-HLTH CR (XLV): ETF Research Reports
 
SPDR-UTIL SELS (XLU): ETF Research Reports
 
ISHARES NDQ BIO (IBB): ETF Research Reports
 
SPDR-CONS DISCR (XLY): ETF Research Reports
 
ISHARS-US MED D (IHI): ETF Research Reports
 
SPDR-SP PHARMA (XPH): ETF Research Reports
 
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