The Health Care Select Sector SPDR ETF (NYSEArca: XLV), the largest healthcare exchange traded fund by assets, is up just 6.35% year-to-date, underscoring the healthcare sector’s laggard status through the first few months of 2019. However, selective investors can find opportunities in the S&P 500’s second-largest sector weight.

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.

“Overall, we view the healthcare sector as fairly valued,” said Morningstar in a recent note. “Our coverage trades in line with our overall estimate of intrinsic value, with the median price/fair value at 0.99. Given the current fair valuation in the space, we only see a few buys, with only 4% of our coverage rated 5 stars.”

Focus On Pharma

While considerable political attention is likely to be paid to drug prices, pharmaceuticals stocks could offer some upside. Pharmaceuticals is usually the largest industry in cap-weighted healthcare ETFs, such as XLV.

“Most 4- and 5-star healthcare stocks reside in the drug manufacturing and healthcare provider industries. In drug manufacturing, we believe the market is still ascribing too much valuation pressure on the industry due to potential negative drug pricing regulations,” according to Morningstar.

The silver lining is that healthcare has been one of the most beloved sectors during the current bull market, meaning many market observers see the group’s recent pullback as an opportunity to add to or initiate positions in healthcare stocks.

“In looking at our projected sales outlook for the Big Pharma and biotech companies, we expect recently launched in-line products and new pipeline drugs will more than offset drug sales lost to generic competition,” said Morningstar. “Overall, we expect the similar modest overall drug pricing pressures of the recent past to continue, but innovative drugs should continue to secure steady pricing power.”

For more information on the market sectors, visit our sector ETFs category.

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