Healthcare looking sick

The Healthcare Index chart is displaying a head and shoulders pattern. This long established and well known chart pattern is considered by some a reliable indicator of a change in trend, from positive to negative.

While some old school investors still think charts are a form of voodoo, most investors use charts to inform their market activities. Investors holding healthcare stocks should pay particular attention, as the long term chart is signalling a change of conditions for the sector.

Whether relying wholly on the price action or simply defining entry and exit points, more than 90% of CMC’s customers use charts in some way. Charts can be used in manners ranging from simple through sophisticated to insanely complex.  The underlying principle remains the same. A graph of price movement reveals the collective behaviour of those that deal in that market. At times, this behaviour shows patterns from which alert investors and traders may profit.

The Healthcare Index chart is displaying a head and shoulders pattern. This long established and well known chart pattern is considered by some a reliable indicator of a change in trend, from positive to negative.

Above is the weekly chart since 2011. Long term holders of healthcare stocks may view this chart fondly. The rise in the sector was relatively smooth and constant. The sector became a stand out investment, due to the Government paying the bills on an assured earnings streams and growth as the population bulge associated with the Baby Boomers moved into senior age groups.

On the right of the chart is the head and shoulders formation. The three peaks with the highest in the middle often represent the last gasps of a bull market. Chartists look for a break of the neckline – the low points of the shoulders – as a signal that the formation is complete. Yesterday’s selling of the sector pushed the index through this point, suggesting the start of a long term downtrend in healthcare stocks.

This technical sell signal comes as a number of fundamental factors weigh on the Australian healthcare industry. The government has taken steps to reel in the ever increasing taxpayer burden. This includes changes to the overall level of payment for healthcare services, individual payment schedules and methodologies. While the methods evolves with the politics, it’s clear the government wants to pay less, imperilling the  reliability of the earnings stream for companies involved in hospital care, aged care and pathology services.

The sector has a number of self-inflicted injuries. Newcomer Estia Health (EHE) has put itself out of favour with spectacular misses on earnings estimates. It is now trading at less than one third of the peak share price of $7.84 reached in November last year.  Residential aged care operator Japara (JHC) also roughly halved in share price over the same period.

Last week, hospital operator Healthscope warned patient growth was below expectations, and lowered earnings guidance. The stock plunged more than 25% on the news, and remains under selling pressure. While this is obviously bad news for HSO, it also speaks to the buoyant forecasts and stretched multiples of other healthcare stocks. If the assumptions about baby boomer patients are too optimistic the whole sector may take a downgrade.

Some stocks have already made the adjustment. Pathology group Sonic Healthcare is off 15% from its highs, bringing the PE multiple down to around 19x. This is much closer to the Australia 200 index PE around 16x. However, stcoks such as CSL, Cochlear (COH), Ramsay (RHC) and Fisher and Paykel (FPH) remain at higher multiples of 27x to 34x, despite similar share price corrections.

This could mean more selling of healthcare stocks. And a mass exit from a crowded trade can get very messy. Healthcare is one of the few sectors where buy and hold has paid off over the last five years. It all changed this year. The sector has become more volatile and has essentially traded sideways, with an up draft in April. At the time of writing, the sector is up just 2% for the year. Investors must make their own decisions, but an examination of healthcare holdings is called for, particularly where portfolios are overweight.