Health Care ETFs Face Lofty Valuations

February 18th at 11:19am by Todd Shriber

They have been the brightest spots among sector and sub-industry exchange traded funds this year, but a valuation anomaly could be cause for concern regarding health care ETFs.

For the first time since 2006, the health care sector is pricier, albeit slightly, than consumer staples. In terms of big-name ETFs, the Health Care Select Sector SPDR (NYSEArca: XLV) sports a P/E ratio of 17.54 compared to 17.5 for the Consumer Staples Select Sector SPDR (NYSEArca: XLP), according to State Street data.

The gap is small, but it does come at a time when XLV is printing new all-time highs and XLP is down 1.4% year-to-date. When accounting for dividends paid, XLV topped XLP by more than 1,500 basis points last year. [Staples ETFs Struggling in 2014]

The cautionary tale is that in 2006, XLP outpaced XLV by 810 basis points, the same margin by which the health care ETF lagged the S&P 500. Biotechnology stocks, which account for nearly 20% of XLV’s weight, explain a good part of XLV’s slight premium to XLP. [Health Care ETFs Show Strength]

Bank of America Merrill Lynch’s Savita Subramanian “points out that Healthcare is now trading at a premium to Consumer Staples for the first time since 2006. Biotechnology stocks within the Healthcare sector have had a lot to do with that. The report says that Biotech is now selling at a 60% premium to the S&P 500 on a forward PE basis – which is double the premium it has historically traded at,” according to Josh Brown on The Reformed Broker.

In 2006, the iShares Nasdaq Biotechnology ETF (NasdaqGS: IBB) and the SPDR S&P Biotech ETF (NYSEArca: XBI), which debuted in late January of that year, both finished in the red.

A couple of things are notable about health care’s premium to staples. First, as the chart here shows, the scenario, although not seen since 2006, is not all that rare. For example, from 1986 to 2003, health care was frequently more expensive than staples. Second, over the six years ending 2013, XLV and XLP’s head-to-head competition is a draw at three annual wins for each ETF.

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