Improve Your Portfolio’s Health By Investing In Health Care Stocks

Investors have weathered an incredible storm of volatility so far in 2022. The year started with a rapid surge of COVID driven by the Omicron variant, supply chain issues continued to plague the global economy leading to high inflation, Russia invaded the Ukraine spiking raw material prices further and, finally, the U.S. Federal Reserve began to raise the Fed Funds interest rate. All of this has led to a double-digit decline in the NASDAQ NDAQ NDAQ Composite and Russell 2000 Stock Indexes, and mid-single digit losses for the Dow Jones Industrial Average and the S&P 500. Given the uncertainty with inflation, and the Ukraine war combined with additional expected Fed rate increases, U.S. equity markets are likely to remain volatile at best, and could face significant declines at worst.

In this environment, finding companies that have stable revenue growth and earnings is critical. One area O’Neil and Company favors is Health Care. Even in recessionary periods, Health Care earnings tend to be more stable than the earnings of the overall stock market. In addition, Health Care companies should see less margin compression than many companies affected by rising raw material prices.

Currently, relative to much of the US market, Health Care stocks seem to be responding to this. This can be seen on the Datagraph below, where the Health Care sector is represented by the S&P Health Care Select Sector ETF, XLV. The ETF has a strong absolute price and volume pattern and is attempting to breakout above its old highs. Relative Strength for the sector has improved over the past two quarters. Also as shown on the Datagraph, the Relative Strength line has risen sharply over the past several weeks, even as the overall market rally has faltered.

SPDR Health Care Select Sector ETF (XLV) Weekly Chart

Below, I display the proprietary William O’Neil and Company Sector Rotation Graph. This graphic displays sector performance in two ways. First, it shows the best performing sectors (top and bottom right quadrants outperforming over a 6-month time period; and the top left/right outperforming over the short-term). Second, it shows the sectors best positioned to gain in relative terms (typically near the center of the graphic and moving up and to the right). Health Care is well positioned, yet still offers plenty of room to run before becoming extended. A good example of an extended sector right now would be Energy.

O’Neil Relative Sector Rotation Graphic

Relative Performance Graph-Health Care vs S&P 500

Relative to the overall S&P 500, Health Care is still trailing on a one-year basis, but has been coming back from extreme levels of underperformance (down -20% or more, through January 2022). It has recovered to near par, and still has potential further upside. We expect a move at least above the Zero or Neutral level for the sector.

Relative Performance Graph-Health Care vs S&P 500

Relative to the overall S&P 500, Health Care is still trailing on a one-year basis, but has been coming back from extreme levels of underperformance (down -20% or more, through January 2022). It has recovered to near par, and still has potential further upside. We expect a move at least above the Zero or Neutral level for the sector.

Stocks of interest are all large caps, and from the services, drugs and products groups.

United Health (UNH) – $512B market cap – Largest health insurance provider in the U.S., with a 13% market share. Served 51M customers at the end of 2021, including from Medicare (45% of total), Medicaid 25%), and employer/individual (30%). Sees market opportunity of 85M people in the U.S. Also owns Optum (care facilities, pharmacies, data services, etc.). In January 2021, UNH acquired Change Healthcare (data analytics, research/advisory) for $13B, which will be included in the Optum segment, and will be ~$0.50/share earnings accretive. Company expects 2022 revenue growth of 11%-13%, roughly in-line with three-and-five-year growth rates, respectively.

Vertex Pharmaceutical VRTX s (VRTX) – $71B market cap – Global leader in cystic fibrosis (CF) treatment. Its main triple-combo drug, Trikafta (75% of revenues), reduces risk of death by 74%. Stable, recurring revenue stream as CF is non-curable. Targeting five life-threatening diseases in its pipeline, including a candidate for sickle cell disease treatment. In 2019, also acquired a Company with a type-1 diabetes candidate. Five-year sales/EPS growth of 35% and 70%, respectively. 2022 guidance for 12% revenue growth. Has $7.5B in cash currently.

Horizon Pharmaceutical (HZNP) – $26B market cap – Focus on rheumatic diseases (autoimmune and inflammatory conditions). Largest selling drug Tepezza treats thyroid-related eye disease (~60% of revenues), and is on target to grow to an annual peak of $3.5B (nearly double the current). The market remains under 15% penetrated. Also, has the only FDA-approved treatment for chronic refractory gout. From 2022, revenue expectation of $680M (+22% y/y), expects peak annual sales of $1B. Bought Viela Bio (severe inflammatory diseases) for $3B in 2021, and has multiple collaboration programs in place. Five-year sales/EPS growth of 25% and 25% respectively. Expects 2022 sales/adjusted EBITDA growth of 22% and 30%, respectively.

Novo Nordis NVO k (NON.DK; NVO) – $278B market cap – Global leader in branded diabetes market, with a 30% U.S. share. Glucagon-like peptide (GLP-1, for type-2 diabetes) and insulin make up 80% of sales. Also, global leader in obesity prescription drug market, with a 78% share. The two markets are more than $100B combined and growing by double-digits annually. By 2025, aims to extend into cardiovascular and chronic kidney disease treatments, among others. Nearly 10% sales CAGR over past decade+, including 11% growth in 2021. Expects 6-10% sales growth in 2022.

Edwards Lifescience EW s (EW) – $75B market cap – Leading in transcatheter aortic valves (TAVR), with a 60% U.S. market share. TAVR is FDA approved for patients with symptomatic aortic stenosis (AS) at risk for open-heart surgery. Penetration rate is still below 40%, while the global opportunity will double to $10B by 2028. Further market potential in asymptomatic patients who have moderate/severe AS. Five-year annual sales and EPS growth of 11% and 17%, respectively. 2022 guidance for 10% revenue and 15% EPS growth.

In conclusion, I presently favor investing in the US Health Care sector for several reasons. First, with a growing risk of a U.S. economic slowdown due to the global environment, and the Fed tightening cycle, Health Care offers secure, secular growth. Second, the sector is coming off a period of dramatic underperformance. Finally, Health Care looks good when examined through the O’Neil technical lens in terms of price and volume patterns, as well as Relative Strength. I would urge investors to consider increasing exposure to the sector in their U.S. portfolios at this time.

Co-author statement:

Kenley Scott, Research Analyst, Director, Global Equity Research, William O’Neil + Co., made significant contributions to the data compilation, analysis, and writing for this article.

Disclosure:

No part of the authors’ compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed herein. O’Neil Global Advisors, its affiliates, and/or their respective officers, directors, or employees may have interests, or long or short positions, and may at any time make purchases or sales as a principal or agent of the securities referred to herein.