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The best stock sector for your money now

Health-care reform is anemic, but health-care stocks are robust.

  • By Howard Gold,
  • MarketWatch
  • – 11/15/2013
  • Health Care Sector
  • Investing Strategies
  • Investing in Sectors
  • Health Care Sector
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The almost five-year-old bull market is looking a bit tired, but one sector has come into its own.

Health-care stocks, which underperformed badly for almost a decade, have outpaced the overall market for more than two years. The Health Care Select Sector SPDR ETF (XLV) has gained 86% from August 10, 2011 through Tuesday. It beat the Standard & Poor's (.SPX) by nearly 30 percentage points and trailed only soaring consumer cyclicals during that time.

But whereas cyclicals have had a monster run, health-care stocks may have much further to go.


SECTOR ETF TICKER % GAIN*
Consumer Discretionary Select Sector SPDR XLY     92.0%
Health Care Select Sector SPDR XLV 85.7
Financial Select Sector SPDR XLK 76.5
Industrial Select Sector SPDR XLI 76.4
Standard & Poor's 500 Index .SPX 57.7

*10/10/11 to 11/12/13


This diverse sector, which includes red-hot biotechnology, Big Pharma, medical device makers, hospitals, health insurers, and other services, is profiting from structural shifts far beyond the changes brought in by the Affordable Care Act.

Competition, pricing pressures, growing efficiency and innovation are combining with an aging population and a burgeoning middle class in emerging markets to create new demand. Demographics and economics could propel this sector higher for years.

In fact, health-care stocks may have entered a new secular bull market, which is why you should take some profits on cyclicals and other market-sensitive stocks and reinvest the money into this group.

Three experts I spoke with stopped short of calling this a secular bull market, but they weren't shy about singing health care's praises.

"Health care has been an outperforming sector for a very long time," said Eddie Yoon, manager of Fidelity Select Health Care (FSPHX), which has beaten the market since its inception in 1981. (Yoon has run the portfolio for the past five years.) "It provides a lot of stability and a lot of exposure to tailwinds that are happening globally."

"We're clearly in a favorable environment," said Andy Acker, manager of Janus Global Life Sciences fund (JAGLX) since 2007. "We expect to see new therapies that can drive growth for many years for the sector."

Everyone I spoke with believed that the Affordable Care Act, though off to an abysmal start, will work sooner or later. (I have my doubts.)

"I think this is a question of when this gets resolved, not if," Acker said. "Millions of people will sign up for health care."

But Obamacare won't be the driving force for the industry, said Terry Hisey, who heads the U.S. Life Sciences Sector of Deloitte LLP. "Market forces in play…are actually having a bigger effect," he told me.

That's most evident in biotechnology, where Acker sees "an explosion of innovation." Six of the seven-biggest biotech companies have promising drugs that have been approved by the Food and Drug Administration and whose patents won't expire for a decade, Acker said.

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Last year, the FDA approved 39 new drugs, the most in 16 years, and 2013 is on a pace to be an "above-average year" in new drug approvals, Acker said. Many of them were discovered by biotech companies. Promising therapies for certain cancers, multiple myeloma and irritable bowel syndrome, among others, are in the works. "Biotech is definitely attractive in terms of the innovation that's happening," he told me.

Unfortunately much of that promise already is in biotech's share prices. The iShares Nasdaq Biotechnology ETF (IBB) has risen 53% so far this year, about double what the S&P 500 has done.

Surprisingly, staid Big Pharma stocks actually outperformed biotech from March 2009 through March of this year, and they continue to beat the overall health-care sector and the market. Yet the fundamentals are challenging.

The big drug companies are having a tough time replacing revenues lost to patent expirations. Pfizer's (PFE) monster cardiovascular drug Lipitor's patent expired in 2011 and its Celebrex pain relief drug loses protection next year. Altogether, some $250 billion in Big Pharma revenues are at risk from expirations and generic drug competition through 2015, according to U.S. Pharmacist.

Furthermore, Deloitte's Hisey said, "it's becoming increasingly difficult…to introduce new products into the marketplace. The bar has gotten higher for drug companies."

Big Pharma has responded with massive cost cuts, rationalizing both its sales forces and R&D, and the companies have expanded in emerging markets. Investors are looking beyond the so-called "patent cliff" and focusing on the nice dividends these blue-chip stocks have traditionally paid.

Still, the fund managers find better value elsewhere.

Fidelity's Yoon said he favors medical device stocks, for example, despite the controversial medical-device tax in the Affordable Care Act. Cost pressures on health providers will limit expansion in the U.S., but he looks for sales to grow in the high teens in emerging markets.

And the group's valuation is attractive. "They've been relative underperformers," he said.

Acker, meanwhile, likes health insurers, which have actually beaten the S&P 500 this year. Obamacare will hasten consolidation, producing "fewer larger insurers over the long term." He's waiting for a shakeout to buy in to a group he views as "an opportunistic investment."

Given all the moving parts, your best bets are broad-based sector funds like the Janus or Fidelity offerings, both of which have excellent track records and annual expense ratios under 1%. Among ETFs, Guggenheim S&P 500 Equal Weight Healthcare (RYH) has outperformed plain-vanilla XLV, but the latter has lower expenses and a higher yield.

My one reservation about health care is that it's come a long way. Some areas, particularly biotech, look ripe for a decent correction.

But the outlook remains solid. As Yoon summed up: "You can get a lot of growth exposure without a lot of economic risk."

Sounds like the best of both worlds, which is why health care should be a leading sector for quite a while.

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