Healthcare stocks have the potential to reach new highs, benefiting from various macroeconomic factors as well as specific circumstances within the sector.
In recent times, defensive stocks have seen an upswing in performance as investors seek refuge in assets that are less affected by weakening demand. Healthcare stocks, among other defensive options, are particularly attractive in light of concerns about the economy following 11 interest-rate increases by the Federal Reserve since March 2022. Furthermore, with growing doubts about the timing of future rate cuts, owning defensives seems even more prudent.
Presently, the healthcare ETF is trading at $140, just shy of its previous record closing high of $142 achieved at the beginning of 2022. However, caution arose as the fund approached this level, causing a prompt drop in price due to the perceived overvaluation of the stocks held within the fund.
A further weakening of the economy could potentially drive a rally in defensive stocks. If indicators demonstrate a decline in hiring or reduced consumer spending, market expectations for profits in sectors sensitive to economic fluctuations will diminish. Consequently, the appeal of defensive names will grow.
Although such a scenario would likely increase the likelihood of rate cuts, benefiting all stocks, it would also result in a temporary reduction in profit forecasts. However, healthcare stocks with their stable earnings would become relatively more attractive.
Historical data corroborates this trend. On average, during the period from the Fed’s final rate increase in an upward cycle to its first rate cut, which generally corresponds to an economic slowdown, the S&P 500 healthcare sector has recorded a monthly return of just over 1%. This outperforms the S&P 500’s average monthly gain of approximately 0.8%, as reported by Evercore.
Conclusion
With their defensive nature and stable earnings, healthcare stocks have the potential to outperform and reach new highs. Investors looking for relatively safer options within the market should consider capitalizing on this trend.
The Importance of Healthcare Earnings
The healthcare industry plays a crucial role in our society, and it’s equally important that the earnings within this sector meet or exceed expectations. Currently, the healthcare ETF (Exchange Traded Fund) is trading at a valuation of just over 18 times the aggregate per-share earnings that its constituent companies are projected to generate over the next twelve months. This places it near its highest valuation in the past five years, coming in just slightly under the S&P 500’s multiple of over 19 times. Consequently, the healthcare ETF is currently offering a narrow discount compared to the broader market.
What does this mean for investors? It indicates that much of the anticipated earnings growth for healthcare stocks has already been factored into the market. For these stocks to continue to gain value, we need to see a significant rise in both earnings and profit expectations, rather than just a marginal increase.
However, there is potential for this growth to occur over the next few quarters, particularly for the large insurers operating within the healthcare sector. These insurers account for more than 12% of the sector’s total market value, giving them substantial influence over the healthcare ETF’s performance.
One key driver of growth for these insurers is the consistent influx of new seniors becoming members of Medicare Advantage each year. This demographic shift ensures perpetual sales growth for the cash-rich insurance companies. Additionally, these financially robust companies have the resources to buy back their own stock, which further boosts per-share earnings. As a result, analyst expectations for earnings per share (EPS) in the coming year tend to increase periodically, as they anticipate relatively manageable challenges from factors such as higher payouts, other costs, or regulatory rulings that could potentially lower premiums.
UnitedHealth Group serves as an example of this growth potential. Analysts are anticipating nearly 10% annual sales growth for the company, amounting to $532 billion by 2027, according to FactSet. With the ongoing stock buybacks, UnitedHealth Group’s EPS is projected to grow at an impressive annual rate of almost 14%, reaching nearly $28 by 2027. Similar growth stories are also expected for Humana and Cigna, making these stocks attractive for potential gains in the coming years.
Gabelli Funds portfolio manager Jeff Jonas shares his belief in the growth of Medicare Advantage, with more seniors opting for this healthcare option over traditional Medicare. He remains confident in Cigna, which is among the companies held in his fund.
To stay informed about the healthcare industry’s future trajectory, it’s crucial for investors to closely monitor the retiree population and the overall state of the economy.
