Now more than ever, it seems that we are inundated with strategies designed to improve our health and make us more aware of our surroundings. Healthy eating, fitness, medical advances, and even technology such as the new “Healthkit” software from Apple Inc (AAPL) are all designed to improve our quality of life.
With healthy choices so prominently on display in our everyday lives, I felt it was a perfect time to revisit the healthcare sector that has been creeping higher over the last six weeks.
The Health Care Select Sector SPDR (XLV) is the largest ETF in this space with $9.5 billion invested in 56 large-cap health stocks. XLV charges an expense ratio of 0.16% and has a 30-day SEC yield of 1.45%. This index includes pharmaceutical, biotechnology, medical equipment, and health care provider companies. In addition, the top three holdings are comprised of: Johnson & Johnson (JNJ), Pfizer (PFE), and Merck & Co (MRK).
XLV jumped out of the gate to start the year, but found itself under pressure in March and April as the red-hot biotechnology industry stumbled. Some individual biotech stocks fell 20% or more in a short period of time, which capped the upside of broad-based healthcare indexes. However, since finding a bottom that has supported biotech prices, XLV has managed to quietly regain its prior highs.
So far this year, XLV has gained 8.36%, which is a significant level of outperformance versus the 4.90% gain in the SPDR S&P 500 ETF (SPY). However, when you dig below the surface you can really start to get a sense that there is more upside room to run if this equity rally continues.
While Johnson & Johnson makes up 12.55% of XLV and just recently hit a new all-time high this week, a look at the top 10 holdings shows that 6 of them are still well below their prior highs. Pfizer (PFE), Amgen (AMGN), and Bristol-Myers Squibb (BMY) in particular have a great deal of upside potential that could contribute additional gains to XLV moving forward. Together these three stocks make up more than 15% of the total asset allocation in this ETF.
The combination of our aging population and strong demand for medical services has combined to boost the aggregate prices of healthcare stocks to record levels. When you think about the path of Obamacare, shifting demographic trends, and future innovation in drugs and procedures, it becomes clear that the outlook in this sector is very bright.
Healthcare is also known as a defensive play because of its inelastic demand and non-cyclical nature. While certain sub-industries such as biotech can have spurts of unpredictability, as a whole this segment is often characterized as a low volatility option.
As with all things investing related, timing will be key to a successful outcome in this sector as well. Investors that are considering entering the healthcare sector may be inclined to initiate a new position on a pullback to enhance your chances for a prosperous long-term trade. The current lofty levels in stocks combined with the relative level of complacency in the market may conclude in a summer pullback that would illuminate a more attractive entry point.
I also recommend approaching any new investment theme with a risk management mindset that includes a trailing stop loss or other sell discipline. That way you have defined your risk in the event that health care stocks reverse direction and head lower.