Healthcare Sector Could Reward in Q1 and Beyond

Advisors that actively follow specific sectors – and data suggest plenty do – are likely realizing an obvious theme in the early stages of 2022.

Due to erosion in growth stocks, the technology sector is commanding plenty of headlines, though to its credit it rebounded a bit over the last couple of January trading sessions. And with so much talk of the Federal Reserve imminently raising interest rates, there's ample attention being lavished upon the financial services sector.

With those factors and others in mind, it's easy to understand how some of the other nine global industry classification system (GICS) sectors are getting lost in the shuffle. What's surprising is that healthcare is one. Surprising not only because it's the second-largest sector weight in the S&P 500, but also because the coronavirus pandemic continues commanding daily headlines.

Perhaps there are valid reasons why healthcare is being ignored today. It's not a stretch to say vaccine fatigue is probably setting in. Biotechnology stocks – one of the sexier corners of healthcare – are tumbling. Last year, healthcare delivered a solid though market-lagging showing. All of those factors could be conspiring to shift clients' attention away from the sector so it's on advisors to illuminate clients to still compelling healthcare opportunities.

Good Time to Consider Healthcare

Advisors have credible tools with which to articulate to clients the utility of healthcare stocks and funds, including the time being right for quality and attractive valuations in the sector.

“However, as earnings growth is expected to decelerate and monetary policies start normalizing this year, high quality and reasonable valuations may become a bigger focus in investors’ portfolios,” says Anqi Dong, senior research strategist at State Street Global Advisors. “Health Care’s strong balance sheets and reliable earnings, coupled with constructive valuations, may help investors manage the transition of economic cycles.”

Healthcare's earnings growth potential is an issue for advisors to consider because economic growth is slowing and analysts are paring forecasts for S&P 500 earning growth. However, sentiment for healthcare is far more positive.

“Over the past few months when the S&P 500 earnings growth estimates for 2022 were downgraded, the Health Care sector has shown stronger earnings sentiment, with 2022 EPS raised by 5.4%, the third-highest upward revision among 11 GICS sectors,” adds Dong.

In other words, healthcare is delivering earnings growth, but it's not richly valued. While market participants can make too much of frothy or inexpensive multiples, healthcare might be the rare example of a sector where it's worth getting excited about the available discounts.

“Compared to other high quality sectors, such as Technology and Communication Services, Health Care has exhibited more constructive valuations,” notes Dong. “The sector is trading at a 18% discount to the broad market, presenting a quality exposure with attractive valuations and alleviating investors’ concerns about multiple compression in a more constrained monetary environment.”

Making a Quality Call

Other factors bode well for the healthcare sector this year, including a lack of sensitivity to rising interest rates and impressive hoards of cash within the sector that speak to dividend consistency and, potentially, elevated share buyback plans.

“The sector usually exhibits less financial leverage, higher profitability and more earnings stability than most other sectors as evidenced in their higher free cash flow to debt ratio, higher return on equity and more stable year-over-year earnings growth,” concludes Dong.

Bottom line: At a time when markets are punishing unprofitable companies and those that could be negatively correlated to rising rates, it might not pay to go bottom-fishing when affordable quality is available in the healthcare sector.

Related: Tech Sector Will Survive Rising Rates