Health Care Revenues Beckon
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Heavily indebted and increasingly unemployed consumers are curtailing spending. One non-discretionary sector, however, appears to have a solid revenue future. This coupled with reasonable valuations make health care ETFs potential candidates for overweighting long-term.
Health care is expected to see a steady 6.6%-6.7% annual growth rate from in 2008 through 2017, according to the latest report from the Federal Centers for Medicare and Medicaid Services (CMS). This will outpace the projected 4.9% growth rate of the US Gross Domestic Product. Health care spending is projected to climb from 16.3% of GDP in 2007 to an astounding $4.3 trillion representing 19.5% of GDP in 2017, according to the report.
Baby boomers, not surprisingly, will drive the growth. With the first wave now set to retire, their medical needs will grow. Amplifying this are generous Medicaid and Medicare entitlements whose implications may be forecast with precision. Medicare growth is expected to accelerate to 8.0% annual growth by 2017 as Baby Boomers start to enroll in the program. Medicaid spending, meanwhile, is anticipated to grow 7.9 % per year over the same period. Within 10 years almost 50% of the national health care tab will be picked up by the federal government. Other areas of health care also will experience robust growth, including private spending, hospitals, and prescription drugs. Revenue projections going out that far are notoriously difficult to make, but the CMS studies have been remarkably accurate in the past.
Another appealing feature of health care right now are reasonable valuations. Price/Earnings for SPDR Health Care Select Sector ETF (AMEX:XLV), for instance, were 15.45 at the end of February, which is down from previous years and low for a blue chip industrial sector. Explaining this are earnings which have proven steadier than prices. Health care has lagged the overall market, and recently it also failed to enjoy a sharp run-up of US markets.
The following graph shows health care's swoon from three broad-based ETFs against an S&P 500 proxy (SPY):
The three broad-based health care ETFs depicted above are SPDR Health Care Select Sector ETF(AMEX:XLV), iShares Dow Jones US Healthcare Sector ETF (NYSEArca:IYH), and Vanguard Health Care ETF (AMEX:VHT). All have three year track records and track each other closely. By default we must favor the two low-cost funds, VHT and XLV. (A drill-down analysis comparing health sub-sectors not conducted here might sway us otherwise).
A rough list of broad-based health care ETFs with returns follows:
| Ticker | Fees % | P/E | 1 Year | 3 Years | |
| SPDR Health Care Select Sector | XLV | .25 | 15.4 | -6.2 | 2.3 |
| iShares Dow Jones US Healthcare | IYH | .48 | 14.4 | -5.89 | 2.63 |
| Vanguard Health Care | VHT | .25 | 15 | -6.03 | 3.34 |
| PowerShars FTSE RAFI Health Care | PRFH | .6 | 14.8 | -7.74 | NA |
| PowerShares Dynamic Healthcare | PTH | .6 | 17.1 | -82.2 | NA |
| First Trust Health Care AlphaDEX | FXH | .7 | 18.31 | NA | NA |
The first three follow traditional indexes, while the last three are built around fundamental financial indexes. In the past 12 months the traditionalists won apparently by sticking to value stocks and by exploiting their fee advantange.
Clearly health care is out of favor, but why? A half-full pipeline of new drugs has dragged down big pharmaceutical earnings; star drugs have seen their patents expire without replacement. Employers have been trimming health care benefits and putting margin pressure on hospitals and insurers. A Democratic candidate may be expected to push volume discounts, which cut direclty into profits. A Republican candidate may be expected to quietly tighten down on Medicare benefits.
Still, it is hard to justify bailing out of health care at this point. With depressed prices and a low .6 beta (indicating defensive ability in a downturn), if a long-term portfolio is going to retain a major sector, this has to be one of them.