Is it Time to Rotate to Health Care? | ETF Trends

Key Takeaways

Fundamental Context

The CFRA Focus ETF for May is Health Care Select Sector SPDR (XLV). In rating equity ETFs, CFRA combines fund-level attributes, including performance and costs, with holdings-level risk and reward analysis to provide a second opinion on what is inside the fund. XLV is appealing to CFRA as we look forward. Sam Stovall, CFRA’s Chief Investment Strategist, noted that the S&P 500 Index has typically struggled during the seasonally weak May-October period of the year, rising only 2.2% on average since 1990. However, the S&P 500 Health Care sector was the best performing sector gaining 4.8%.

The S&P 500 Health Care sector, which XLV seeks to replicate is diversified across key health care industries. Health Care Equipment & Supplies (29% of assets), Pharmaceuticals (27%), Health Care Providers & Services (20%) are the largest, but the ETF has meaningful exposure to Biotechnology (14%) and Life Sciences Tools & Services (9%) as well. The ETF is market-cap weighted with 51% of assets invested in the top-10 securities such as Abbot Laboratories (ABT), Johnson & Johnson (JNJ), and United Health Group (UNH). Yet, the fund has slight exposure to more moderately sized health care companies such as Perrigo (PRGO) and United Health Services (UHS 146 ****).

While XLV has underperformed the S&P 500 Index in the last three years, rising just 16% compared 19% for the broader market, on a risk-adjusted basis XLV generated a higher Sharpe ratio aided by its low volatility. Yet, CFRA does not rely solely on past performance to provide a star rating on an ETF.

For example, CFRA has Buy or Strong Buy recommendations on eight of XLV’s top-10 holdings. In addition, eight of these top-10 positions earn favorable CFRA Earnings Quality scores. Beyond, ABT, JNJ, and UNH, the top positions include Strong Buy recommended on Eli Lilly (LLY), Medtronic (MDT), and Thermo Fisher Scientific (TMO).

CFRA Equity Analyst Sel Hardy raised the recommendation on JNJ to Buy from Hold in April following stronger growth prospects following better-than-expected first-quarter earnings results. Hardy forecasts 10% sales growth in 2021 driven by gains in the core Pharma segment and strong recovery in Medical Devices sales. Hardy expects the pharma segment will continue to have a promising outlook due to strong prospects on existing key drugs such as Stelara, Imbruvica, Darzalex, and a robust drug pipeline with 14 novel drug launches expected by end of 2023. Furthermore, JNJ’s strong balance sheet provides ample liquidity for unexpected cash outflows.

Hardy also reiterated a CFRA Strong Buy recommendation UNH in April but raised the 12-month target price justified by its solid growth prospects. Hardy sees the acquisition of Change Healthcare, a major health care technology firm, as the main near-term catalyst. The deal will allow Optum, UNH’s health care services provider, to expand technological processes and achieve cost synergies. In the first quarter of 2021, UNH generated strong revenues than CFRA and consensus estimates forecast. Furthermore, with the increase in Covid-19 vaccinations, Hardy expects increased utilizations resulting from missed medical visits and delayed electives.

Meanwhile, CFRA Equity Analyst Kevin Huang maintained his Buy recommendation and target price on ABT in April. In the near-term, Huang expects ABT to enjoy significantly elevated revenues because of Covid-19 test-related sales. In the long run, shares of ABT have plenty of upside potential due to the company’s earnings growth power, which is driven by a plethora of innovative recent and upcoming offerings, such as Freestyle Libre 3 and structural heart products, across all the company’s divisions.

CFRA does not include technical analysis in our star rating for XLV or sector ETF peers, but we realize some investors look to the charts to understand what is ahead. According to Lowry Research, a CFRA business, XLV appears poised for further gains on an intermediate-term basis backed by strong demand trends and an intact intermediate-term price uptrend. The ETF’s Lowry Power Rating climbed from 77 (out of 99) to 91 over the past three weeks, consistent with its relative strength. In addition, on April 15 the ETF broke out in price above $119, triggering 26- and 52-week highs.


While XLV incurred $1.5 billion of net outflows year-to-date through April 26, CFRA thinks the ETF is positioned to outperform the broader U.S. sector equity ETF category over the next nine months. The ETF has strong reward potential, limited risks, and has a modest 0.12% expense ratio. Further, it has seasonality and technical analysis on its side.

Todd Rosenbluth is Director of ETF & Mutual Fund Research at CFRA.