Will Tighter Government Regulation Test Health Care ETFs?

Whether the markets are roaring or experiencing doldrums, health care exchange-traded funds (ETFs) have been a paragon of reliability, but the sector could soon get tested with a forthcoming wave of government regulation.

In particular, the pharmaceutical business is experiencing a profit squeeze as a result of lesser-than-expected revenue from the sale of generic drugs. Big pharmacy chains like Walgreens Boots Alliance Inc and CVS Health Corp have lowered their earnings goals for 2019 as politicians clamor for an overhaul of the big pharma.

Political Backlash

Big pharmaceutical companies were on the hot seat at Capitol Hill last week with CVS Health, Cigna, Prime Therapeutics, Humana, and UnitedHealthcare’s OptumRx testifying before the Senate Finance Committee on the rising cost of prescription drugs. Among the topics discussed included rebates paid by drug makers contributing to the high costs and the drug industry’s pursuit of profits–all to shift the blame from the pharmaceutical companies to the drug makers.

U.S. President Donald Trump has already lambasted the pharmaceutical industry for the rising costs associated with prescription drugs. In 2017, health spending rose 3.9 percent and the trends is likely to persist.

“Investors are scared about the massive amount of uncertainty in terms of regulation,” said Brock Moseley, founder of Miracle Mile Advisors in Los Angeles. “There’s a critical eye around the health-care space and drug pricing. These challenging trends do give us some worry.”

That hasn’t stopped health care-focused ETFs from having a bad year. The Health Care Select Sector SPDR ETF (NYSEArca: XLV)–up 6.45 percent, Vanguard Health Care ETF (NYSEArca: VHT)–up 8.08 percent and the iShares US Medical Devices ETF (IHI)–up 0.21 percent.

However, from a macro perspective, the sector isn’t so hot. The Wall Street Journal reported that it’s the worst-performing sector in the S&P 500–up a paltry 3.8 percent compared to the broader index’s 16 percent.

Job Market Still Robust

Nonetheless, the job market for health care is still robust. The Labor Department reported better-than-expected payrolls for March, bringing the three-month average to a strong 180,000 jobs created per month. That number is lower than the 223,000 jobs created in 2018, but still fell in line with a strong labor market.

Meanwhile, the unemployment rate held steady at 3.8 percent, but lower-than-expected wage gain came in at just 0.1 percent after February’s better-than-expected 0.4 percent. Nonetheless, all signs still point to a strong labor market overall.

Of the 196,000 jobs created, over 35 percent came from the education and health services sector. Specifically, strong hiring came from ambulatory care, hospitals, and nursing and residential care facilities.

Related: What to Expect When Energy Earnings Roll In

Relative Value ETFs to Consider

Does the recent slump in health care speak to a broader narrative that cyclical sectors will overtake defensive sectors?

For investors looking for continued upside in U.S. cyclical sectors over defensive sectors, the Direxion MSCI Cyclicals Over Defensives ETF (NYSEArca: RWCD) offers them the ability to benefit not only from cyclical sectors potentially performing well, but from their outperformance compared to defensive sectors.

Conversely, if investors believe that U.S. defensive sectors will outperform cyclical sectors, the Direxion MSCI Defensives Over Cyclicals ETF (NYSEArca: RWDC) provides a means to not only see defensive sectors perform well, but a way to capitalize on their outperformance compared to cyclical sectors.

For more relative market trends, visit our Relative Value Channel.