Healthcare, the second-largest sector weight in the S&P 500, was the best-performing sector in the U.S. last year and that strength is carrying over to 2019. The Health Care Select Sector SPDR ETF (NYSEArca: XLV), the largest healthcare ETF by assets, is up 4.13% to start the new year.
XLV allocates about two-thirds of its combined weight to pharmaceuticals and biotechnology stocks. There are other catalysts to consider, including that the U.S. economy is moving into the late-cycle phase, overall growth may slow and signs of an economic slowdown could pop up. Consequently, investors may also turn to defensive sectors that are less economically sensitive, such as health care.
“While analysts have downgraded S&P 500® Index earnings for 2019, earnings growth in the Heath Care sector remains intact on the back of stable demand and strong product pipeline,” said State Street in a recent note.
Industry observers argue that medical technology companies can tap into increased healthcare spending among emerging economies while the U.S. market has matured and could experience slower growth. Looking ahead, in the years through 2024, spending growth is projected to average 5.8% and peak at 6.3% in 2020.
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Increased drug approvals could be another factor boosting XLV and rival healthcare ETFs this year.
“In 2018, the FDA approved 59 novel drugs, exceeding last year’s record for the second consecutive year,” said State Street. “A record number of FDA novel drug approvals over the past two years is likely to fuel sales for new drugs in coming years. In addition, with an aging population driving demand for more medical services and products, US national health spending is projected to grow at a faster rate than normal GDP growth between 2017 and 2026 and more rapidly than the 2008–2016 period, benefiting the sector on a broad basis.”
Along with possessing defensive traits, the healthcare sector also sports quality characteristics, an investment style that is currently receiving renewed attention.
“Lastly, the Health Care sector also tends to have higher return to equity and stronger balance sheet than the broader equity market, exemplified by high free-cash-flow-to-debt and low debt-to-EBITDA ratios,” according to State Street. “In a late cycle environment with financial conditions becoming tighter and economic growth decelerating, Health Care’s high-quality balance sheet may better position portfolios to navigate a downhill climb.”
For more information on the market sectors, visit our sector ETFs category.