Playing Defense through Healthcare
The healthcare sector has historically been one of the most defensive places to park investment dollars over the past three decades. Since 1986, the healthcare sector has only suffered five losing years (table).
|
1987 |
-1.16% |
|
1992 |
-6.65% |
|
2001 |
-12.55% |
|
2002 |
-18.85% |
|
2008 |
-23.43% |
This is the lowest number of negative return years of any of the major sectors within the S&P 500 stock index. The sector also fared well in 1990, 1994, and 2000 — losing years in the general market. Healthcare stocks generally outperform the market when the economy is heading into recession and many other stocks are losing value.
Healthcare struggled in 2010 with the fallout of Obamacare and poor earnings guidance. With the Republicans gaining the house back in last year’s November elections, the political cloud over the sector was lifted while surprisingly earnings have begun to pick up. In the third quarter, a wide swath of large healthcare firms posted higher than expected earnings including Pfizer, Merck, Wellpoint, Novartis, and Cardinal Health. As the sector was beaten down and expectations were very low last year, many healthcare companies had an easy time jumping over 2011 analysts estimates.
Healthcare generally outperforms late in the economic cycle or when growth in GDP is slowing. This is the case in 2011, as the quarterly U.S. GDP estimates have been coming down all year. Today, the Commerce Department said gross domestic product climbed at a 2 percent annual rate from July through September, less than projected. Europe is most likely ahead of the U.S. and a mild recession is almost a certainty. The European composite purchasing managers’ index dropped from 50.7 in August to 49.2 in September, falling below the 50 level for the first time since the summer of 2009. The European Central Bank’s October lending survey showed that banks cut net credit to businesses by 16 percent in the July-September quarter. Germany and France, the only economies with growth in Europe, now are looking to be stagnating. A recession in Europe could easily carry over to our shores as approximately 23 percent, or $412 billion worth, of U.S. exports in goods and services went to the European Union last year. Investors are sensing the increasing odds of a recession and more turmoil from Europe. This is one reason why 10-Year Treasury yields in the U.S. have dropped from a high of 3.72% earlier this year to back under 2%.
With the political deadlock in Washington and world growth slowing, playing defense in your portfolio makes sense. 2011 is proving healthcare’s defensive case once again, up 2.3% on a year-to-date basis. Despite this gain, many stocks within the sector are still priced at very attractive leve;s. So within healthcare where should you look? With the rapid price rise in the sector during 2011, certain industries such as the HMOs look overextended. Within pharmaceuticals, several firms look like long term winners including Novartis, GlaxoSmithKline, and Merck. Novartis (NVS) is my favorite among the bunch. The pharmaceutical firm has the most diversified operating platform which includes branded pharmaceuticals, generics, vaccines, diagnostics, and consumer products. The generic segment offers exposure to the billions of dollars in branded pharmaceuticals going off-patent during the next several years while the company’s acquisition of Alcon in 2011 will increase its exposure to the higher margin and growing eye care business. The stock trades at only 10 times earnings, a discount of 30% to the market. I put fair value at $75.
Another compelling area is within the medical distribution arena. My top pick here is Cardinal Health (CAH). Its principal business is to act as a middleman between drugmakers and pharmacies. Three recent acquisitions – Healthcare Solutions, an oncology services firm; Kinray, a drug distributor serving over 2,000 independent retail pharmacies in the NYC metropolitan area; and Yong Yu, a leading pharmaceutical distributor in China – should lead to continued expansion of earnings and share price. If you are looking to have some portfolio protection against an economic slowdown, buy these defensive stalwarts. It will be good for your portfolio’s health.
Disclosure: The author, Timothy McIntosh, SIPCO, and/or clients may hold positions in securities mentioned in this article at time of writing. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.
