SET Monthly Issue January 2017

| January 3, 2017

The Split Personality Sector

Investing in health care means riding two horses at once.  One is the hospital horse, the other is the pharmaceutical horse.

2016 was dreadful for health care stocks.  The sector wound up the year down 3.94%, the worst performing of the ten major sectors which make up the overall market.

Driving the downturn was a growing public resentment of price increases (that in some cases were highly publicized) along with uncertainties over the future of federal government policies on funding health care.

We spent the year on the sidelines.  We watched health care stock losses pile up, waiting for bargains.

And now… we won’t be surprised to see even more losses pile up in the months ahead.  We figure the anticipated dismantling of the Affordable Care Act will create new pain for hospitals and insurance companies.

But we believe the pharmaceutical sector is a much different story.  When we carve the big drug companies out of the health care pie, we see a slice of the sector that should do well, and make up lost ground.

This is why we are recommending the SPDR S&P Pharmaceuticals ETF (XPH).

IT’S ALL ABOUT PRESSURE ON PRICES

It’s no secret that the incoming Trump administration will do what it can to lighten regulatory burdens on the health care system.  Just how far it will go is uncertain.  But it’s not unreasonable to expect we won’t have to deal with significantly tighter price controls on drugs.

This doesn’t mean it’s about to be open season for price hikes.  President-elect Trump has already singled out Boeing for what he believes to be excessive charges, so it wouldn’t be out of character for him to launch a similar attack on a company such as Merck.

The political bark may prove worse than the bite.

But healthcare policymakers and the organizations that pay the bills, whether they’re insurance companies or the U.S. Department of Health and Human Services, aren’t about to sit back and let drug companies raise prices every quarter.

So we do not expect a fresh surge in revenue growth.  We do expect pharma companies to adjust their business models.

The days of making big bets on new blockbuster drugs could be fading away.  That’s not because of the expense of research or the complications of regulatory approval, but because of the market itself.

Moving forward, we may find payers in the health care system are no longer willing to pick up the tab for expensive new drugs.

So where does this leave the big drug companies?  Why is now a good time to invest in pharmaceutical stocks?

DEMOGRAPHICS, DISRUPTION, AND PRICES

The aging population is already reshaping the health care system.  Three million baby boomers will reach retirement age every year for the next 20 years.

But there’s another set of numbers which make an investment in pharma stocks attractive.

Take a look at the prices of stocks and you’ll only find two sectors where there’s value.  One is real estate and the other is health care.

The SPDR S&P Pharmaceuticals ETF (XPH) did not do well last year…

SPDR S&P Pharmaceuticals ETF

It’s hard not to miss the impact of politics and health care policy, is it?

Look at the plunge in October, and the post-election spike in November.  It’s noteworthy that the SPDR S&P Pharmaceuticals ETF didn’t hold onto these gains and consolidate in December.  This leads us to believe that now is a particularly good time to invest.

A CLOSER LOOK:  INSIDE THE SPDR S&P PHARMACEUTICALS ETF

The ETF has $30 billion in assets.  The expense rate is a low 0.12%.

There are 36 holdings, almost half concentrated in the top ten.

The top five holdings…

Company Name Sector % Weight
Horizon Pharma PLC Pharmaceuticals 5.79%
Bristol-Myers Squibb Company Pharmaceuticals 5.12%
Zoetis Inc. Pharmaceuticals 5.05%
Merck & Co Inc. Pharmaceuticals 4.94%
Perrigo Co PLC Pharmaceuticals 4.91%
12/30/16

PROFILE:  THE TOP 5 HOLDINGS

Horizon Pharma PLC (HZNP)

This Irish firm focuses on developing medicines for the treatment of arthritis, pain, and inflammatory disease.

The stock does not pay a dividend.

Bristol-Myers Squibb Company (BMY)

The 129 year-old company discovers, develops, licenses, manufactures, markets, and distributes biopharmaceutical products worldwide.

Yield:  2.66%

Zoetis Inc. (ZTS)

Zoetis Inc. engages in the discovery, development, manufacture, and commercialization of animal health medicines and vaccines for livestock and pets.

It also produces medicated feed additives that deliver medicines to livestock.

Yield:  0.79% 

Merck & Co Inc. (MRK)

The firm produces drugs to treat diseases ranging from cardiovascular conditions and type 2 diabetes, to asthma, chronic hepatitis C virus, and HIV-1 infections.

Yield:  3.17%

Perrigo Co PLC (PRGO)

The firm produces and distributes both prescribed and over the counter products.

OTC products include analgesics, cough and cold, sinus, gastrointestinal, smoking cessation, feminine hygiene, diabetes, and dermatological care.

The company was founded in 1887.

Yield:  0.70% 

THE ROLE OF XPH IN YOUR ETF PORTFOLIO

We’ve noted the yields for the top holdings because many of our subscribers are investing for income.  You’ll see from the low yields that the SPDR S&P Pharmaceuticals ETF is not a smart choice for income.

The yield of the ETF barely registers at 0.53%.

These stocks are all about growth, so if your portfolio’s asset allocation could use a spurt of growth, XPH makes sense.

Pharma stocks are volatile.  This is an ETF that should be a long-term hold.

Performance illuminates this.  The five-year return for the ETF is 68.83%, but the past year’s return is -25.00%.

Be prepared for price swings, especially given the unknowns of the broader health care sector. 

Trade Alert

Buy:  SPDR S&P Pharmaceuticals ETF (XPH) up to $41.00

Recent Price:  $40.09

Price Target:  $50.00

Stop Loss:  $37.50 

 

52-WEEK SECTOR PERFORMANCE

Consumer Discretionary XLY +3.10%
Consumer Staples XLP +1.27%
Energy XLE +25.43%
Financials XLF +19.03%
Health Care XLV -5.15%
Industrials XLI +16.52%
Materials XLB +13.47%
Real Estate XLRE -2.19%
Technology XLK +11.33%
Utilities XLU +11.02%

 

 PORTFOLIO UPDATES 

. . . . Vanguard REIT ETF (VNQ) – HOLD

We’ve seen VNQ edge above the buy up to price.  Move to a hold.

. . . . PowerShares Dividend Achievers ETF $PFM – HOLD

PFM has now exceeded our buy up to price of $23.00.  Move from buy to hold, but monitor the price and acquire more shares on any dips.

. . . . First Trust ISE Global Engineering & Construction Index Fund $FLM – BUY

In mid-December, the ETF hit a high of $50.92.  It has given back some gains, but we anticipate stronger performance in the spring when the extent of federal funding for U.S. infrastructure projects becomes more clear.

. . . . Vanguard High Dividend Yield ETF $VYM – BUY

More solid recent gains, and this ETF remains a long-term, core holding.  It is approaching the buy up to price of $77.00.

. . . . iShares MSCI Emerging Markets Minimum Volatility ETF $EEMV – SELL

This ETF has simply not done well.  When we made this recommendation in the summer, we did not foresee the sudden surge in value of the U.S. dollar.  We’ll take a modest loss and move along, because we do not anticipate a rebound in emerging markets anytime soon.

 . . . . Vanguard Information Technology ETF $VGT – SELL

Tech stocks are now among the most expensive on the market, so we’ll play it safe and take our double-digit profits.  There may be some modest, additional growth, but for now, we’re inclined to be cautious.

. . . . First Trust ISE-Revere Natural Gas Index Fund $FCG – HOLD

Natural gas prices soared, and then gave up some gains.  This is the pattern we expect to see played out repeatedly, along with gradual growth in the price of the ETF.

. . . . PowerShares S&P SmallCap Energy ETF $PSCE – HOLD

Steady as she goes.  We’ll hold as the sector continues to perform well given increases in crude oil prices and expectations of less stringent federal regulation.

. . . . Aberdeen Chile Fund $CH – SELL

We’re recommending a sell for the ETF.  The softness in global markets prompts us to take our profits now.  We do not see the strength of the U.S. dollar weakening, and we do not see a rebound in manufacturing in China.

. . . . Utilities Select Sector SPD $XLU – HOLD

It’s the same repetitive story… continue holding.  This ETF remains a solid defensive, long-term position.

Portfolio Changes

  • This month we’re buying SPDR S&P Pharmaceuticals ETF (XPH) up to $41.00
  • SELL Aberdeen Chile Fund Inc. (CH)
  • Move Vanguard REIT ETF (VNQ) from Buy to Hold
  • Move PowerShares Dividend Achievers (PFM) from Buy to Hold
  • SELL Vanguard Information Technology ETF (VGT)
  • SELL MSCI Emerging Markets Minimum Volatility ETF (EEMV)

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