As biotech selling spreads, more weakness seen for U.S. health stocks

Print 28 October 2015
Caroline Valetkevitch and Caroline Humer / Reuters

Oct 23 After a four-year love affair with healthcare shares, investors are moving on.

Selling has spread from biotechs - shaken on Sept. 21 when Hillary Clinton first tweeted concerns about drug prices - to other areas of the healthcare sector. Investors have been dumping shares of everything from hospitals to traditional pharmaceutical companies and insurers in recent weeks.

Since peaking in July, the Nasdaq Biotech Index has fallen 23 percent, the broad S&P Health Care Index has lost 12 percent and the S&P 500 Health Care Facilities index is down 31 percent.

Fund managers now say they expect myriad pressures weighing on the sector for the rest of the year and possibly into 2016. They include regulatory threats on drug prices, disappointing earnings, higher interest rates that could hurt heavily-indebted hospitals, and the loss of the initial Obamacare bump in business.

Profit warnings from two companies since last week - HCA Holdings and Community Health Systems - have pummeled shares of hospital operators. The health facilities index is down 13 percent since its Oct. 14 close.

"The best case through the end of year is range-bound for healthcare, maybe biased downward slightly," said Les Funtleyder, healthcare portfolio manager at E Squared Asset Management in New York.

The cautious attitude of investors is new for the S&P 500 healthcare sector, which has provided double-digit returns every year since 2011.

That run-up, prompted in part by the addition of roughly 17 million people by the Affordable Care Act, as well as expectations of financially rewarding mergers, may have left the sector priced for only the best of news.

By July 20, the broad health care index was selling at a forward price-to-earnings ratio of 18.7, higher than most other sectors and a full percentage point higher than the broad S&P 500 index. That P/E ratio is down to about 16, in line with the broader market.

"I think the more general sector rotation has probably created a high bar for these companies, and I am a little worried that meeting expectations isn't even enough," said Jeff Jonas, portfolio manager at GAMCO Investors.

REASON FOR CAUTION

Third-quarter results could give investors further reason to be cautious. Only half of the health care companies that have reported their earnings thus far have beaten analysts estimates on revenues.

Next week brings results from hospital operator LifePoint Health as well as from insurers Anthem and Aetna. Shares of UnitedHealth Group Inc fell last week even though its third-quarter profit was slightly better-than-expected.

One issue for hospitals and insurers is that most of those healthcare consumers who were added because of the Affordable Care Act were already enrolled last year - so this year's revenues and earnings will be measured off of a fully-implemented baseline for the reform law.

In its forecast late Wednesday, Community Health Systems cited lower hospital admissions and estimated third-quarter revenue below analysts' expectations, while HCA blamed higher labor costs and more uninsured patients in its outlook last week.

To be sure, the health sector still is seen as profitable, with third-quarter earnings projected to be up 4.5 percent from the same quarter a year ago.

But the move out of the sector has been rapid. The iShares U.S. Pharmaceuticals exchange traded fund posted $77.8 million in outflows in the third quarter, its largest quarterly outflow since it started in 2006, and it has already lost $75 million in the first 22 days of the current quarter.

The iShares U.S. Health Care Providers ETF, which includes insurers and hospital operators, recorded its first withdrawals this year in that quarter, and investors are continuing to pull money out this quarter.

All of that is an especially sharp reversal of fortune from the summer, when health care shares rallied after the U.S. Supreme Court upheld the Obama health care law. 

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