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Sector Spotlight: Health Care Deserves a Close Exam for 2016

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February 1, 2016
Examining the health care sector for 2016: do these stocks need medicine or is the sector fit as a fiddle?

Last year the health care sector pumped out fit vital signs as one of the best-performing sectors of the 10 in the S&P 500 (SPX). Can this traditionally defensive sector, now juiced with healthy growth and momentum plays, do it again in 2016? The answer is a qualified maybe.

The Well-Being Back Story

The health care sector is big and diverse, and it includes industries that run the well-being gamut from managed health care to biotechnology, and, of course, big-name pharmaceutical companies. Each industry has its own unique flavor, and what Patrick O'Hare, chief market analyst at Briefing.com, calls the “sweet spot” for investors itching for perceived safety lined with growth opportunities. "There is growth to be found there based on demographics, but it is also regarded as a defensive play,” O’Hare says. “Relatively speaking, demand for health care holds pretty constant no matter what type of economic cycle you have going on."

The high-flying biotech space may spark memories of the dotcom era, as it’s become a magnet for growth and momentum investors. Many biotech firms are still in the story-stock stage: They do drug research and development, but have no profits or revenues. The managed health care industry, on the other hand, rocked in 2015 with double-digit gains. It includes names like UnitedHealth Group (UNH), Aetna (AET), and Anthem (ANTM). Others within the sector include health care distributors—think hospital systems like Tenet Healthcare Corp. (THC)—and health care equipment. The pharmaceuticals are marked with familiar names like Merck & Co. (MRK), Pfizer Inc. (PFE) and Eli Lilly and Co. (LLY).

Two Sides to the Thermometer

This won’t be an easy year for the health care sector, which will face conflicting headwinds of positive long-term influences from aging demographics and rising demand, coupled with a political arena charged with disapproval of drug pricing and of the Affordable Care Act, commonly referred to as Obamacare. "Politics will enter the fray in 2016,” O’Hare says. “You can already see it in the Democratic and Republican debates. You are hearing attention paid to the exorbitant pricing of drugs and the need to get that under control. And, on the Republican side, you are hearing about the repeal of Obamacare."

The political chatter will skew toward the negative for this sector throughout the year, but "I don't think it will be the undoing of the sector by any means," O'Hare adds.

On the plus side, "There will be some defensive positioning in this sector, as a lot of investors can identify it as having pretty good long-term growth demographics with the aging baby boomers, and the implementation of Obamacare brought more people into the health system," O'Hare says.

A Healthy Risk

Solid sales growth is projected in 2016 for the sector as a whole, according to S&P Capital IQ. International sales now account for more than 50% of sales for most large multinational drug and equipment companies, which leaves the sector poised to benefit from global expansion and sales efforts. And let’s not forget new lines of drugs. Through November 30, the FDA approved 40 new molecular entities (NMEs), or novel new drugs. That mirrors 2014, when the highest number of NMEs were approved in nearly 20 years, according to S&P Capital IQ data.

Within the sector, biotech stocks, considered “pure growth plays,” generate much investor interest from momentum traders, says O'Hare. A word of caution: without earnings, the stock prices are vulnerable to quick reversals if their drugs don't receive approval. "They have become very interesting trading vehicles,” O’Hare says. “But [biotech] is for people with a higher risk tolerance and a strong stomach to play short-term moves."

He warns investors to be picky because valuations could be at risk. "I don't think the market in 2016 will be of the mindset of paying up for growth at any price,” O’Hare says. “Investors will be more discerning across the landscape." 

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