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Is the Health Care Sector Doomed?

Is the Health Care Sector Doomed?
By Ron DeLegge, Editor
March 23, 2010

SAN DIEGO ( Ė The healthcare sector has never seen anything like this and neither has the American public.


After months of political wrangling, the Affordable Health Care for America Act was signed into law by the President.  

The Act will extend health insurance coverage to roughly 30 million Americans without it. The new law would also require most Americans to purchase health insurance coverage and it would provide subsidies for private healthcare to low and middle income families.

In the meantime, as the legislative details on the measure are worked out, investors are asking what does it mean for the health care sector? Is it doomed?

The two primary groups impacted by the new health care bill are health insurers and the broader healthcare arena, which encompasses hospitals, medical device makers and pharmaceutical companies.

Letís analyze the key healthcare ETFs.

Health Care Sector SPDR (NYSEArca: XLV)
This ETF follows health care stocks within the S&P 500. This particular industry sector covers stocks of companies involved in health care equipment and supplies, health care providers and services, biotechnology, and pharmaceuticals makers. The healthcare industry accounts for 12% of the S&P 500ís overall sector weighting, making it the third largest sector within the index just behind financial stocks (NYSEArca: XLF) technology (NYSEArca: XLK). With $2.7 billion in assets, XLV is the largest healthcare ETF.  

In 2009, XLV climbed 19.82% compared to a 26.37% gain in S&P 500 (NYSEArca: SPY). Johnson & Johnson, Pfizer and Abbot Laboratories are among the fundís largest holdings in order. XLVís annual expense ratio is currently 0.21%.

iShares Dow Jones U.S. Healthcare Sector Index Fund (NYSEArca: IYH)
The Dow Jones index behind this particular ETF follows contains market exposure to 131 health care stocks. Biotech and pharmaceutical stocks dominate IYHís sector exposure with a 61.44% weighting.  Health care services and equipment companies represent around 35% of IYHís weighting.

Companies within the index are selected passively and weighted according to their market capitalization or size. The median market size of healthcare stocks within IYH is around $2 billion.

In 2009, IYH rose 21.30% and the fundís annual expense ratio is 0.48%.

Vanguard Healthcare ETF (NYSEArca: VHT)
The Vanguard ETF follows the MSCI US Investable Market Health Care 25/50 Index,. This particular healthcare ETF is the most diversified among similar offerings and owns around 309 stocks. The median market size of healthcare stocks within VHT is around $39.5 billion.

In 2009, VHT rose 22% and the fundís annual expense ratio is 0.25%.

Rydex S&P Equal Weight Health Care ETF (NYSEArca: RYH)
This ETF shadows healthcare stocks within the S&P 500, but with a twist. Instead of weighting the companies by their market capitalization or size, it weights each stock equally. The net effect of equal weighting a stock index is a bias towards mid and small company stocks.

In 2009, RYH jumped 38.74% and each one of the 51 stocks within RYH receives an equal weighting and the underlying index is rebalanced every quarter. RYHís annual expense ratio is 0.50%.

SPDR KBW Insurance ETF (NYSEArca: KIE)
KIE follows the KBW insurance index, which contains market exposure to publicly traded companies involved in personal and commercial lines, property/casualty insurance, life insurance, reinsurance, insurance brokerage and financial guarantee. KIEís top holdings include AFLAC, Chubb, and Metlife.

In 2009, KIE rose 28.45%. The fund has $186 million in assets and owns around 26 stocks. KIEís annual expenses are 0.35%.

Bond Market Votes on Healthcare
In February, the cost of short-term borrowing for leading U.S. corporations was less than U.S. governmentís borrowing costs. Data compiled by Bloomberg showed that corporate debt from Berkshire Hathaway, Procter & Gamble, Johnson & Johnson and Loweís all traded at lower yields compared to U.S. Treasuries with similar short-term maturities. This extremely rare event signals a total lack of confidence in the creditworthiness of U.S. government debt, which at one time was believed to offer a risk free rate of return.

The U.S. governmentís budget deficit has soared to a record 10% of gross domestic product (GDP), levels not seen since the late 1940s.   

According to the non-partisan Congressional Budget Office (CBO), the cost of the new healthcare bill will be around $938 billion over 10 years and it will purportedly reduce the federal deficit by $138 billion over the same time frame. Good as it sounds, the bond market doesnít believe the CBO, proving once again the only place on the planet with more fuzzy math per capita than Wall Street is Washington D.C. Saving money by spending nearly a trillion dollars just doesnít add up.

Itís still too early to project the ultimate impact of the new health care bill on the overall health care sector. For example, with health coverage becoming a requirement, health insurers will have more customers, but they will also be forced to accept higher risk clients with pre-existing conditions. Additionally, health insurers will face new competition from government subsidized plans. 

According to New York-based AltaVista Research, health care stocks inside the S&P 500 are trading at a discount to the market. Based upon 2010 earnings estimates, health care stocks currently trade at a P/E ratio of 11.8, which is a discount to the S&P 500ís 14.1 multiple. Earnings per share (EPS) growth are expected to rise 7.5% based upon 2010 estimates.

A radical transformation of the healthcare sector is now underway. There will be losers and winners. And attempting to decipher which individual companies will lose and which ones will win is mostly a loserís game. Instead of trying to handpick health care stocks, diversified health care ETFs are a smart way to capitalize on the evolving dynamics within this industry sector.    

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