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Why Health Care Is The Top Sector Of 2017

Sumit Roy

What's the best-performing sector of the year? Health care―but probably not for the reasons you might expect.

Surprisingly, the approaching repeal and replacement of the Affordable Care Act (ACA), popularly known as “Obamacare,” hasn't had much of an impact on the sector at all.

On the surface, that's strange, considering it's the biggest news in health care since ... well, the passage of the ACA in 2010. Now that the controversial law may be repealed and replaced by an equally controversial Republican health care law called the American Health Care Act (AHCA), health care stocks aren't reacting.

Since the unveiling of the AHCA on March 6, the Health Care Select Sector SPDR Fund (XLV) is up 0.6%, not much different than the 0.1% gain for the SPDR S&P 500 ETF (SPY) in the same period.

Year-to-date, the difference is larger. XLV is up 10.2% compared with 6.3% for SPY.

YTD Returns For SPY, XLV

Health Care Bill A Wash For Sector

There are two potential reasons for the market's muted reaction to the GOP bill. For one, given the resistance to the bill from conservatives in the House, moderate Republicans in the Senate and almost all Democrats, it may not pass in its current form.

A health care plan that ultimately garners enough votes to replace Obamacare may look significantly different than the current version of the AHCA, according to analysts.

Secondly, any new health care law―whether it's the current AHCA or something else―may end up being a wash for the sector, as benefits for certain health care industries are offset by costs for others.


According to the Congressional Budget Office, the number of uninsured Americans would increase by 14 million next year and by 24 million by 2026 under the current form of the AHCA, potentially increasing the burden on hospitals that treat uninsured patients who can't pay their bills.

The jump in the number of the uninsured may also mean "lower volume for the health insurers," Vishnu Lekraj, an equity analyst at Morningstar, told Reuters. Lekraj believes that the AHCA would "[dismantle] the individual insurance market, which again means lower revenues and the loss of the individual market for the most part for the insurers."

Responding to this possibility, the iShares U.S. Healthcare Providers ETF (IHF), a fund that provides exposure to insurers and hospitals, dropped 1% since last week, notably underperforming the broader health care sector.


Little Impact To Drugmakers

On the flip side, the GOP health care bill may be neutral-to-modestly positive for other health care industries such as drugmakers and medical device makers, which are likely to see billions of dollars in tax savings.

A repeal of taxes on medical devices and prescriptions drugs will help these industries that are otherwise unaffected by the AHCA and that make up the vast majority of the weighting in the broader health care sector.

Pharma and biotech stocks, for example, make up 57% of XLV, while health care equipment and supplies companies make up another 18%.

Source: SSgA


Shares of biotechnology companies and medical device makers have surged more than 13% so far this year, pushing the broader health care sector sharply higher despite all the uncertainty and controversy surrounding the health care bill.

The iShares Nasdaq Biotechnology ETF (IBB) and the iShares U.S. Medical Devices ETF (IHI) have increased by 13% and 13.9%, respectively, year-to-date.

For these companies, the GOP health care bill is not a concern―at least not yet. President Trump has promised to bring health care costs down, and on many occasions he's targeted drug prices as being too high. If he acts to fulfill that promise and ends up hurting profits for drug companies, the market will take notice.

Indeed, the White House said that the current version of the AHCA is just the first of a three-phase health care overhaul. Phase two will include deregulation, while phase three will potentially address high drug prices and the ability to sell insurance across state lines.

Bargain Hunting Fueling Outperformance

In the meantime, the health care sector, led by biotech, is seeing a resurgence in 2017 after a poor showing in 2016. Health care was the only sector within the S&P 500 to decline last year, as XLV shed 2.8%. Biotech fared even worse, losing 21.4%.

Thus, the year-to-date rally may have more to do with investors buying up beaten-up names than anything to do with potential changes in health care laws.

As Charles Schwab's Brad Sorensen notes, for health care stocks, "valuations appear fair to slightly below average, balance sheets are solid, stocks generally have good dividend yields, and the overall cost structure appears to be much improved. Also, demand appears to be on the rise for health care products and services, partly as a result of an aging population."

That thesis will remain largely intact regardless of how the Republican health care bill shakes out, says Sorensen, who gives the health care sector an "outperform" rating. Based on the performance of health care ETFs this year, investors seem to agree.

Contact Sumit Roy at sroy@etf.com


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