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Why Health Care ETFs For Defense Now

Gary Stringer

This article is part of a regular series of thought leadership pieces from some of the more influential ETF strategists in the money management industry. Today's article features Gary Stringer, president and chief investment officer of Memphis, Tennessee-based Stringer Asset Management.

There’s plenty to like about the health care sector right now.

That may seem counterintuitive given that the sector has lagged the S&P 500 Index over the last year significantly, landing as the second-worst-performing sector of 2019. And health care can be a volatile space, especially coming into an election year.

But health care offers significant potential upside.

The sector is well-positioned to weather any economic shock, political risks notwithstanding. Plus, a lot of political risk is already priced into the sector. Major changes to the health care sector are unlikely regardless of who wins the race for the White House. Congress is still likely to be divided, and major reform will need to have enough votes to overcome a filibuster in the senate.

Strong Fundamentals

Meanwhile, fundamentals remain strong. In fact, over the last year, health care saw the strongest revenue growth of any S&P 500 Index sector, according to FactSet data. Earnings are expected to be up 6% over last year compared to -0.3% for the S&P 500 Index.

Health care companies can often be attractive during the later stages of the business cycle, especially while equity valuations look stretched. For example, while global equity markets have appreciated, the broad health care sector still trades at a discount to historical valuations, even while pricing in significant political risk.

As the graph below illustrates, the S&P 500 Index is trading at a premium (>100%) to its historical average forward price-to-earnings ratio (PE), while the broad health care space trades at a discount (<100%) to its historical average.

In addition, the health care space tends to have defensive characteristics that we find attractive at this stage of the business cycle, and usually sources the vast majority of its revenues from domestic sources rather than relying on foreign economies.

How To Access It

Given how depressed the entire sector is relative to the S&P 500, we favor a broad approach to covering health care rather than focusing on a specific health care industry.

There are several options for investors looking for ETFs that fit this health care theme.

Some that stand out to us due to their broad diversification include the Health Care Select SPDR Fund (XLV), one of the most popular and most traded health care sector ETFs, with $21 billion in assets and roughly $735 million in average daily trading volume; the iShares U.S. Healthcare ETF (IYH), which is a market-cap-weighted basket twice the size of XLV’s, with some of the largest pharma, health care and biotech companies in the U.S.; and the First Trust Health Care AlphaDEX Fund (FXH), which is a smart beta take on the space, tracking an alpha-seeking quant-driven index that selects and weights health care stocks based on growth and value factors.

At the time of writing, Stringer Asset Management held XLV among its universe of ETFs included in its suite of ETF Portfolios. Stringer Asset Management is a Memphis, Tennessee third-party investment manager and ETF strategist. Contact Stringer Asset Management at 901-800-2956 or at info@stringeram.com. For a complete list of relevant disclosures, please click here.

Index Definitions

S&P 500 Index: This Index is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of a broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

S&P Health Care Index: This Index is a capitalization-weighted index and is designed to track the performance of those companies in the S&P 500 Index that are classified as members of the GICS® health care sector.

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