Even if the Federal Reserve begins hiking interest rates later this year, the healthcare sector, notably pharmaceutical stocks and related exchange traded funds, could outperform on greater merger and acquisition activity.
Barclays analyst Douglas Tsao argues that M&A activity will continue through a rising rate environment, reports Ben Levisohn for Barron’s.
“Given the importance of M&A to U.S. specialty pharmaceuticals, the prospect of higher interest rates as a result of Fed tightening has become an increasing source of concern for investors in recent weeks,” Tsao told Barron’s. “However, we expect the continued financial benefits realized through tax and operational cost synergies would overwhelm any sensitivity to interest rates.”
Specifically, Tsao points out that deal activity will be fueled by balance sheet capacity, tax synergies after the wave of inversions, and overcapacity of sales infrastructure, which has made cost synergies easily harvested. [Healthcare ETFs: Specialized Drugs in Greater Demand]
The Barclays analyst pointed to some standouts in the pharma space, including Valeant Pharmaceuticals (NasdaqGS: VRX) and Jazz Pharmaceuticals (NasdaqGS: JAZZ). Tsao contends that Valeant will continue to grow as the market factors in the company’s improved organic growth prospects, and Jazz remains a “best-in-class name in the U.S. specialty pharmaceuticals industry.”
Investors who would like broad exposure to the space could look at pharmaceutical ETFs, including Market Vectors Pharmaceutical ETF (NYSEArca: PPH), SPDR Pharmaceuticals ETF (NYSEArca: XPH), iShares U.S. Pharmaceuticals ETF (NYSEArca: IHE) and PowerShares Dynamic Pharmaceuticals Portfolio (NYSEArca: PJP).
PPH has the greatest tilt toward larger pharma stocks, including 77.1% mega-caps and 18.9% large-caps. PPH has a 4.5% weight in VRX and 0.7% in JAZZ.
PJP also includes 46.6% mega-caps and 14.5% large-caps, along with a significant 29% position in small-caps.