According to an April 1st news reports from Bloomberg, the Whitehouse is preparing to engage Congress on proposals to replace Obamacare. The presidents acting chief of staff is said to be working on a set of “health care principles” that will shortly be sent to Congress for review and discussion. So, what does that mean for investors?
More volatility – especially in one of the hottest sectors in the S&P – Health Care!
Positioning your portfolios
For those that you who might not follow the health care sector too closely, let’s do a brief flashback to one very recent occurrence in the ongoing health care debate. Go back to Dec 17th, 2018.
The chart tells us a story of what happened to a broad collection of U.S. health care stocks, specifically in the health insurance sector, but also hospitals and other allied segments of the industry. The reason? A federal judge in Texas ruled that parts of the Affordable Care Act (ACA) were unconstitutional. Names like Centene Corp (CNC), Wellcare Group (WCG), Molina Healthcare Inc. (MOH) and Anthem Inc. (ANTM) took a beating, dragging the broader S&P health care index down by 2.5%.
The recent proposals from the Whitehouse, around the way forward for repealing and replacing the ACA, are likely to create similar – if not worse! – volatility among health care stocks in general, but more specifically to stocks that have greater ACA exposure.
But let’s see what health care did against the rest of the individual S&P sub-sectors:
- Materials Select Sector SPDR (XLB)
- Energy Select Sector SPDR (XLE)
- Financial Select Sector SPDR (XLF)
- Industrial Select Sector SPDR (XLI)
- Technology Select Sector SPDR (XLK)
- Consumer Staples Select Sector SPDR (XLP)
- Utilities Select Sector SPDR (XLU)
- Health Care Select Sector SPDR (XLV)
- Consumer Discretionary Select SPDR (XLY)
Interestingly enough, Health care has fared pretty well over the past two years, yielding investors over 14% and 24% in 1-year and 2-year returns respectively. So, if someone were to include health care in a portfolio, with vehicles like XLV, they’d do pretty well compared to, say, Energy (XLE), Consumer Staples (XLP) or even Financials (XLF).
But more specifically, let’s look at how one could position their portfolios to benefit from the oncoming volatility of a messy mud fight between Congress and the Whitehouse on health care reform. One sub-segment of the health care sector that’s been relatively outperforming the broader health care sector is Health Care Equipment & Device producers (XHE)
The case for health care device producers
When compared to its broader index, the health care devices segment has performed remarkably well over the last several months.
XHE has outperformed its parent index by nearly a factor of 2-times (5.3% versus 10.1%). This proves that there’s definitely some short-term momentum in the medical equipment space. The view over a 2-year period (24.33% vs. 44.92%) and 5-year (61.68% Vs. 110.81%) also favors XHE over the broader XLV. Once again, this underscores the strong case for betting on health care medical devices and equipment producers.
And though health care names like CNC, WCG, MOH, and ANTM may get caught in the storm that’s about to rage once again, because of their ACA exposure, health care device manufacturers are likely to remain relatively insulated from the ensuing volatility. Whatever form the final consensus legislation takes, one thing is almost certain: There will likely be more support for covering more lower-income patients with non-emergency conditions. So, what does that mean?
- More demand for diagnostic devices and tools like catheters
- Increased demand for dressings and syringes
- Spike in the number of patients fully or partially covered for neurostimulation devices, hip implants and implantable cardiac defibrillators (ICD)
And then, there are powerful lobby groups that will ensure medical device manufacturers will remain protected from any fall-out from the proposed legislation. The Consolidated Appropriations Act, 2016 (Pub. L. 114-113), that took effect Dec 18, 2015, included a 2-year moratorium on a proposed 2.5% excise tax on the sale of medical devices commencing in 2018. That moratorium was further extended by the Internal Revenue Service (IRS) – thanks to the lobbyists! – until the end of Dec 2019. It’ll likely never see the light of day – which bodes well for medical device producers.
The ongoing revolution in the Internet-of-Things (IoT) sector also means more medical device manufacturers will be producing intelligent devices that can contribute to the reduction of overall health costs for America. They’ll do this by helping patients monitor and diagnose their conditions from the comfort of their homes and sending data to physicians and healthcare providers remotely. This will reduce pressure on the health care system, resulting in a reduction in costs.
And that’s something that will drive up demand for intelligent medical devices, and further insulate the manufacturers from any potential ACA impact. The bottom line, therefore, is that shares of device producers are likely to continue their stellar upward march, propelling portfolios to relative outperformance.
The play on medical device producers
Buying a basket of sector-specific stocks, represented by an ETF, may be a great way for a diversified play on that sector. In the case of medical device manufacturers, XLV may be that vehicle. In fact, if you want to give your portfolio that exposure in a hands-off way, then there’s nothing wrong with XLV. However, if you are a more hands-on DIY portfolio owner, then you may want to pick individual names.
Our recommendation is to consider the following three names:
- Intuitive Surgical, Inc. (ISRG)
- Boston Scientific Corporation (BSX)
- Teleflex Incorporated (TFX)
Over a 1-year period, a portfolio consisting of just these three names (and not including XLV in the graph above) would have yielded a return of 34.18%. Compare that to just a 13.60% same-period return for the broader XLV. And over a 2-year horizon, our 3-stock portfolio would have yielded an average return of 234.42%, compared to the XLVs paltry 22.57%!
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The author does not have an investment in stock discussed in this article.