For the first time in a LONG time, energy stocks were not the biggest losers last week and while most of the lower volatility sectors outperformed, healthcare stocks continued to lose momentum.
One of 2014’s biggest winners, healthcare stocks, continued to sell-off on a combination of year-end profit taking and negative announcements affecting Gilead Science (GILD.) Making up over 6.5% of the Healthcare Select Sector SPDR (XLV) and 15.25% of the Market Vectors Biotech ETF (BBH), the recent deal between AbbeVie and Express Scripts put the hurt on the healthcare sector and has led to a war of words online about whether healthcare stocks can continue to outperform in 2015.
While we wait to see if healthcare stocks underperform the broader market for the third time in three weeks (something they haven’t done since mid-2013), one area where healthcare names continue to dominate is in valuations. The recent sell-off has helped take down some of the premium valuations but with the broad XLV is currently trading at a trailing P/E multiple of 21.32 and BBH at 29.77 versus SPY at 17.6. It wouldn’t be a stretch to say that healthcare values are…well stretched and both ETFs are trading in the upper half of their historic P/E multiple trading range. These high multiples have also helped push down our ETFG Green Diamond Reward rankings for the broader healthcare ETFs to below that for the S&P 500, although Gilead Science again might be to blame for much of that. According to the December 19th edition of Factset Earnings Insight, Gilead was expected to be the single biggest contributor to healthcare sectors double digit earnings growth rate. In fact, if Gilead was excluded, the growth rate would fall from 16.8% to 8.3%! If Gilead does see weaker earnings growth going forward, the broader sector could feel the pain for some time to come.
What about those investors who are looking for lower volatility and the heartache that often comes with biotech investments; is there no where for them to turn to in the healthcare sector? While biotechnology names may have seen the worst of the sell-off, another one of this year’s higher fliers, pharmaceuticals, haven’t been spared either with the iShares DJ U.S. Pharmaceuticals ETF (IHE) up nearly .2% over the last month while the S&P 500 has been up over 1%. While sporting an ETFG Risk Rating nearly twice that of XLV, IHE also continues to trade at the highest earnings multiples in its history, seemingly offering an unattractive mix of risk and reward. The same can be said for the SPDR S&P Health Care Services ETF (XHS) and the SPDR S&P Health Care Equipment ETF (XHE) who also trade at close to historic multiples resulting in Red Diamond Risk ratings that are higher than their Green Diamond Reward scores.
At the end of the day, investors might be better off seeking to diversify their portfolio away from further healthcare exposure in 2015, but that might be easier said than done. After four solid years of outperformance, healthcare stocks now make up 14.8% of the benchmark and trail behind the #2 sector, Financials, by around a tenth of a percent while energy stocks have dropped to 8.39% of the S&P 500. That large weighting within the benchmark might be why we saw the largest fundamental score drops (potentially indicating strong buying) occurring either in low volatility domestic sectors or in international equity such as the Deutsche X-trackers MSCI Europe Hedged Equity ETF (DBEU). Could the early asset allocators be preparing themselves for a more lackluster year in 2015?
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