March 25, 2019: Health Care Sector Review

Mar 26, 2019 | Asset-Allocation, Bonds, Economy, Feature, Gold, Headline, Income, Investments, IRA, Markets, Mutual-Funds, Newsletter, Retirement

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Health Care Sector Review

We continue our in depth examination on another stock sector: health care stocks. Like consumer staples stocks, health care stocks are viewed as defensive at times of market stress. But it’s more than that. 

Health care spending has outpaced US GDP growth

The following two charts, based on Kaiser Family foundation reports, depict the US healthcare spending growth since 1970: 

It’s amazing that healthcare spending has grown from around 7% of GDP in 1970 to about 18% in 2017. Anecdotally, we all feel that health care cost has risen dramatically too.  

The major forces behind the faster growth of health care spending include demographic change and the health care technology innovation. Demographically, we are entering an aging society. Baby boomers are now in retirement or near retirement. They create a huge health care demand. In the meantime, biotechnology and drug development have advanced rapidly and people are demanding better and more expensive care. 

 The above trends are also present globally. They will continue in the future and the healthcare spending will only grow in a healthy pace, if not in a faster one than general economy. 

Stable and faster earnings growth

Health care sector is one of the two sectors among S&P 500 companies that have stable earnings growth. The other sector, consumer staples, was discussed in our previous newsletter March 11, 2019: Consumer Staples Sector Review. 

The following 3 charts show the earnings growth for healthcare, consumer staples and S&P 500:

Similar to consumer staples stocks, the growth of the aggregate earnings of health care companies not only outpaced that of S&P 500, they are much more smooth. 

Better stock returns

This translates into better stock returns for healthcare stocks: 

Healthcare, consumer staples and S&P 500 returns (as of 3/25/2019):
Ticker/Portfolio Name Max Drawdown 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15 Yr AR
XLV (Health Care Select Sector SPDR ETF) 39% 13.2% 12.0% 11.0% 16.4% 9.7%
XLP (Consumer Staples Select Sector SPDR ETF) 36% 10.1% 4.7% 8.3% 13.5% 8.9%
SPY (SPDR S&P 500 ETF) 55% 8.0% 13.3% 10.7% 16.2% 8.5%

One of the best health care sector funds is from index fund powerhouse Vanguard. The VGHCX (Vanguard Health Care Inv) is dated back to 1987. Unlike Vanguard healthcare ETF VHT, this fund is an active managed fund. Nevertheless, let’s look at its long history performance: 

VFINX-VGHCX returns (as of 3/25/2019):
Ticker/Portfolio Name 1Yr AR 3Yr AR 5Yr AR 10Yr AR 15 Yr AR Since 9/1/87 AR
VGHCX (Vanguard Health Care Inv) 11.3% 8.3% 9.1% 15.5% 10.9% 14.4%
VFINX (Vanguard 500 Index Investor) 10.2% 13.3% 10.6% 15.3% 8.5% 9.3%

It’s compelling enough to treat health care stocks seriously. 

To summarize, we believe that it’s compelling to overweight both health care and consumer staples sectors for a long term strategic (buy and hold) investor. Both sectors have strong intuitive fundamental backings. Of course, the above analysis is only for a very long term investor’s portfolio. For example, it’s easy to see that a 10 year term is not long enough. However, for a holding period longer than 15 or better 20 years, overweighting these two sectors can be beneficial. Furthermore, these two sectors are also good candidates for an actively sector/stock rotation portfolio. 

Market overview

Last week, a serious indicator was triggered: the yield curve (difference) between 10 year and 3 month Treasury bonds is inverted, meaning that the yield of 10 year Treasury note is less than 3 month Treasury bill! Such an inverted yield curve has preceded every recession since 1962. Furthermore, long term global interest rates have all come down significantly. This, coupled with high stock valuation, global trade and economic slowdown, does not bode well with risk asset prices. On the other hand, however, one shouldn’t automatically assume a bear market will come right away. Nevertheless, it’s an important development and we call for following a well defined investment plan rigorously. 

For more detailed asset trend scores, please refer to 360° Market Overview. 

In terms of investments, even after the recent retreat, U.S. stock valuation is still at a historically high level and a bigger correction is still waiting to happen. It is thus not a good time to take excessive risk. However, we remain optimistic about U.S. economy in the long term and believe much better investment opportunities will arise in the future. 

We again would like to stress for any new investor and new money, the best way to step into this kind of markets is through dollar cost average (DCA), i.e. invest and/or follow a model portfolio in several phases (such as 2 or 3 months) instead of the whole sum at one shot. 

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