Looking To Healthcare ETFs For Earnings Growth

The Health Care SPDR (ETF) (NYSE: XLV) was the third-best performer among the nine legacy sector SPDR exchange-traded funds last year, but 2016 has brought some turbulence for the largest healthcare ETF, as XLV has tumbled 7 percent.

Over the past five years, the healthcare sector, the third-largest sector weight in the S&P 500, has handily outperformed the S&P 1500 Composite Index, delivering better than double the returns of that broader equity benchmark. Driven in large part by the biotechnology boom, XLV and rival healthcare ETFs have been among the best-performing funds at the sector level, but the sector is fraught with risk this year.

Risk Ahead For 2016?

“The challenges we see include earnings growth deceleration, continued scrutiny over high drug prices, a likely decline in M&A deals, concerns over the number of people obtaining insurance via the healthcare exchanges, and presidential election year rhetoric that may increase perceived risks and increase uncertainty within the sector, including the survivability of the Affordable Care Act (ACA) or healthcare reform law,” said S&P Capital IQ in a new note.

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The research firm notes that the healthcare sector posted average earnings growth of about 15.5 percent in 2014 and 2015, but that number is expected to slide to 10.7 percent. That decrease is still better than the 6 percent earnings decline being forecast for the S&P 500 this year.

The 2016 presidential election is also expected to play a pivotal part in determining the healthcare sector's fortunes this year.

“Finally, we anticipate increased volatility as we believe healthcare will be a major focus of the presidential candidates. The Democrats have been arguing for cost containment, particularly for drug prices, and have voiced opposition to industry consolidation. The Republicans, on the other hand, have threatened to repeal and replace healthcare reform,” said S&P Capital IQ.

The research firm said the best-case political scenario for the healthcare sector is Hillary Clinton winning the White House with Republicans maintaining control of Congress.

A Few Positives Ahead As Well

On a positive note, the healthcare sector is trading at a slight discount to the broader market and, believe it or not, the historically richly valued biotech industry trades at an even steeper discount to expected 2016 profits.

S&P Capital IQ is bullish on Celgene Corporation (NASDAQ: CELG) and Gilead Sciences, Inc. (NASDAQ: GILD) with five-star ratings on both stocks. The research firm has a four-star rating on Regeneron Pharmaceuticals Inc (NASDAQ: REGN). Those stocks combine for nearly 9 percent of XLV's weight.

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