The case for health care — and how to play it

  • By Bill Luby,
  • Barron's
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There are a number of epic battles raging in the stock market right now, and it is not just a question of whether the bull market remains intact or the bears now have the upper hand. There are also debates related to growth versus value, momentum versus quality, domestic versus international, free trade versus protectionism, and other similar questions.

In the realm of domestic stocks, a schism separates those seeking the biggest opportunities from those whose primary goals are safety and capital preservation. Recently, much of this difference in approach has been playing out in sector rotation.

More-aggressive investors are yearning for the promise of secular growth stories that come from the sectors such as technology and communications—industries that have been the focus of selling programs recently. Another growth-oriented contingent is looking at cyclical names that should outperform as the economic expansion continues. Here, industrials, financials, and energy all look superficially appealing, but are at the mercy of vagaries of trade, interest rates, and geopolitics.

Finally, there are those who see the risk of recession looming large and are seeking shelter in higher-dividend and lower-beta names, which can be found in defensive sectors such as consumer staples and utilities—though these trades are getting crowded.

The result of all of this is a landscape where growth names still appear expensive and defensive names have been bid up to levels that are likely to be unsustainable.

Money needs somewhere to go, and at the moment, stocks look risky, expensive, or both, while bonds continue to grapple with the headwinds of rising interest rates. In the midst of all the turmoil, there is one sector that offers growth opportunities, has a solid grounding in value, is largely insulated from trade-war concerns, and has minimal exposure to rising interest rates and a stronger dollar: health care.

The case for health care is simple. It is an all-weather sector that somehow manages to avoid almost all of the threats that are currently ravaging the broader stock market.

An investor seeking to take advantage of the upside potential in health care can do so with a so-called long call spread in the Health Care Select Sector SPDR exchange-traded fund (XLV). With the ETF recently trading at $93.75, an investor can buy the Jan. 18 $94 call for $2.01 and sell the Jan. 18 $96 call for $1.10, for a net outlay of $91 cents.

This trade will make money if the SPDR ETF is above $96.91 at the January expiration. The position has a maximum gain of $1.09 and a maximum loss of the net purchase price of $0.91, should the ETF find itself below $94 at expiration.

Keep in mind that the SPDR is a broad health-care ETF with a domestic large-capitalization focus. Its country exposure is 98%-plus in the U.S., with the balance in Ireland and the United Kingdom. This means there is limited currency risk. From an industry perspective, the largest concentration for this broadly diversified ETF is in pharmaceuticals (32%), with smaller exposures to areas such as health-care providers, services, and equipment. The ETF has exposure to the more volatile biotechnology sector of 16%.

So, while China, the Federal Reserve, and the technology sector may dominate the headlines, investors are under no obligation to try to trade areas where emotions run the highest. Instead, steady growth opportunities that are largely immune to headline risk may prove to be more attractive as 2018 winds down and investment managers begin to reshuffle their portfolios to take advantage of the best opportunities that 2019 has to offer.

For that reason, the all-weather health-care sector should be on everyone’s radar.

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