Healthcare stocks: Are they a good bet to ride out volatility?

Investors and traders have turned their attention to healthcare stocks as major events including ongoing trade tensions between the US and China, expectations of slower global growth, Brexit and unrest in Hong Kong continue to cause market volatility, and push participants toward defensive stocks.

Healthcare stocks tend to be popular during periods of uncertainty. Because there is constant demand for such companies’ products and services, their share prices do not tend to vary much with market conditions. Investors often increase their holdings of defensive stocks during volatile periods to protect their portfolios from losses in other sectors.

In the US, as well as the UK and Hong Kong, this shift to defensive stocks has been as key healthcare companies have seen share price gains, as other sectors have struggled.

 

Stocks in rude health

In the US, the Health Care Select Sector SPDR Fund [XLV] is up by around 14% so far this year, while the S&P 500 Health Care Sector index has climbed by 11.6% on a year-to-date basis. The latter index has been boosted by strong performances from stocks including Cardinal Health [CAH], which has grown by 23% from the start of the year and McKesson [MCK], which has increased 33% in the same period. Biotech at stock Biogen [BIIB], on the other hand, has been performing somewhat more erratically. The share price shot up in October after Biogen announced it was seeking regulatory approval for Alzheimer’s treatment aducanumab, despite the stock having previously plummeted nearly 30% in March after the company announced it would be discontinuing its Alzheimer’s treatment.

 

In the UK meanwhile, UDG Healthcare [UDG], Abcam [ABC] and Smith & Nephew [SNN] have performed strongly, gaining by 30%, 16.2% and 16.5% YTD respectively.

In Hong Kong, the Hang Seng Healthcare Index has gained by 37.5% on a year-to-date basis against the wider index’s more moderate gain of 4%, and against the backdrop of ongoing political unrest and a subsequent recession. The Shandong Weigao Group [1066.HK], CSPC Pharmaceutical Group [1093.HK] and Sino Biopharmaceutical [1177.HK] were all up by 60%, 91% and 127% respectively at close on 19 November, again illustrating strong growth in the sector.

 

Stunted growth

Although healthcare stocks can be a stable investment, in the US, the sector was one of the worst-performing in the S&P 500 until last month.

Prior to companies like United Health Group [UNH] and Johnson & Johnson [JNJ] reporting strong third-quarter results in October, the sector had risen by just 5.7%, compared to a near 20% gain for the S&P 500 as a whole. Only energy fared worse, having gained by just 1.2% up to that point.

A factor contributing to these results was fear surrounding regulatory scrutiny as potential Democratic presidential candidates weigh in with various plans to reform the US healthcare industry, ahead of the 2020 election.

The industry has also faced headwinds due to ongoing litigation related to the opioid crisis in the US, which could result in costly settlements for more healthcare companies. Purdue Pharma, at the heart of the crisis due to its production of controversial painkiller Oxycontin, filed for bankruptcy in September amid an avalanche of lawsuits, while many more big drug companies have faced lawsuits and come to settlements since.

However, weakness in the healthcare space has led many investors and traders to buy up stocks in the sector at discount prices. In October, healthcare stocks in the S&P 500 were trading at around 14.4 times future earnings, according to FactSet estimates.

 

Enduring appeal

In September, stock brokerage Charles Schwab [SCHW] gave the healthcare sector an ‘outperform’ rating. It says the sector is expected to boom in the coming years due to an ageing global population and a rising middle class in emerging markets, which will demand more extensive drug treatments.

“The durability of healthcare-sector earnings during economic downturns tends to lead to outperformance during periods of economic weakness,” Charles Schwab noted.

“The durability of healthcare-sector earnings during economic downturns tends to lead to outperformance during periods of economic weakness” - Charles Schwab

 

It also suggested that healthcare companies can often pay out high dividends, which makes them attractive to investors and added that it believes the risk of major legislative changes is relatively low and openly known.

“We can see this in the current discount to the overall market of the healthcare sector’s price-to-earnings ratio; the sector has generally traded at a premium to the market over the past 20 years.”

Furthermore, as healthcare costs outpace the rise of inflation in the US, the nation will soon spend nearly 20% of its gross domestic product on healthcare, according to The Motley Fool.

  

Speaking at Reuters Global Investment Outlook 2020 Summit Rupal Bhansali, chief investment officer at Ariel Investments, explained that healthcare stocks have been pressured by US regulatory concerns, but companies that develop innovative drugs will be able to withstand these challenges heading into 2020.