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Health Care Stocks: Buy Them While They're Down

Steven Goldberg, Contributing Columnist, Kiplinger.com
Why this sector should outperform for years to come

Several Democratic presidential candidates have embraced "Medicare for all" as a rallying cry. Others are calling for a variety of health care reforms, such as lowering Medicare's eligibility age from the current 65 or offering a government-run "public option" in health insurance.

To health care stocks - especially insurance companies, which in theory could see their businesses shrink or even shut down - many of the proposals are a nightmare.

Investors, too, have contracted a bad case of anxiety. Many are dumping health care stocks. Standard & Poor's health sector has gained a measly 2.7% this year while the S&P 500 has rocketed ahead 17.1%. (All returns in this article are through April 29 unless otherwise indicated.)

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But the odds of any radical restructuring of the health care system are somewhere between slim and none. In fact, health care stocks are likely to return to their favored status in the years ahead.

Health Care: It's Still All About Politics

The political argument is short and likely won't please some people depending on their stance.

But as far as "Medicare for All" or any other type of single-payer medical insurance plan, forget about it - at least anytime soon.

The Affordable Care Act (aka "Obamacare") only managed to squeak through Congress because it had the backing of the health care industry. It also was to a large degree a proposal of the conservative Heritage Foundation and was first signed into law in Massachusetts by then-Gov. Mitt Romney.

There's no way conservative Republicans today, however, would back a huge government expansion in medical care.

Even in a best-case scenario for Democrats in which they hold the House and take the White House and the Senate in 2020, Republicans likely would hold enough Senate seats to, via filibuster, deny such a sweeping change in the health care system as anything remotely like Medicare for all.

What does seem likely, regardless of which party wins in the next elections, are small steps to cut the price of some prescription medications and, perhaps, incremental expansion of the Affordable Care Act to cover some of those who are currently still uninsured.

For the health care industry, that would mean slightly lower prices, but also more health care consumers.

The Sector's Woes Are an Outlier

This year marks a sharp reversal from 2018, when the S&P 500's health care stocks gained 4.6% - the best performance among all 11 sectors, and far better than the index's 6.2% decline. What's more, 2018 marked the fifth time in six years that health care stocks topped the S&P.

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Health care has long been my favorite sector because it tends to do well in both bull and bear markets. Why? Because demand for better medical treatments is extremely unlikely to stop growing, and health care is one of the last things people stop spending on when times are tight.

Ed Yardeni, a market strategist, points out that the oldest of the Baby Boomers - people born in the 20 years after 1945 when World War II ended - turned 65 in 2011. "Since the start of that year through March of this year, the number of seniors has increased by 13.3 million to 52.3 million," he writes.

That number is going to keep growing - and those seniors inevitably are going to need more medical care. As with consumer staples, people are going to seek health care if they can possibly afford it. That Tesla can wait; Grandma's heart condition cannot.

The other reason to buy health care stocks: the tremendous innovation in the sector - second only to technology.

New treatments for what used to be almost always fatal diseases are being developed at a rapid pace. The price tags on some of these treatments are outrageous and likely will come down a bit, but that'll hardly destroy the industry.

The proof in the pudding: Even as health care stocks have slumped, the sector is reporting the fastest year-over-year profit growth among all 11 S&P sectors at 4.4%, according to FactSet. Moreover, analysts are projecting that health care will finish the quarter with better earnings growth than all but one sector.

Put together lower stock prices and higher consensus earnings estimates, and you have the ingredients for a table-pounding investment.

And while health care might be overpriced, health care stocks are not. The S&P 500's health components trade at 14.6 times earnings forecasts for the coming 12 months, versus 16.8 for the broader index.

Two Ways to Play Health Care Stocks

Bottom line: Health care's woeful recent performance presents a wonderful buying opportunity.

Cautious investors should consider Vanguard Health Care Investor (VGHCX, $189.12), which is a broadly diversified, well-managed fund that includes the likes of AstraZeneca (AZN), Bristol-Myers Squibb (BMY) and UnitedHealth Group (UNH).

Aggressive investors should look at T. Rowe Price Health Sciences (PRHSX, $74.18). This fund has invested a large percentage of its assets (32%) in firms developing new biotechnology medicines, including Vertex Pharmaceuticals (VRTX) and Sage Therapeutics (SAGE). It has had significant manager turnover in the past several years, but T. Rowe's resources are broad and deep.

Steve Goldberg is an investment adviser in the Washington, D.C., area.

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