Healthcare sector stocks have been under tremendous selling pressure over the last few weeks, and there are questions as to why. Is it political with all the talk of “Medicare for all” and President Trump making statements about bringing down drug prices? Is it simply a matter of sector rotation? Could it be profit taking ahead of upcoming earnings reports?
There isn’t a clear cut answer on that question, but it could be that all three are to blame. Regardless of the reason, from April 10 through April 22 the sector saw huge downward moves in some of its top stocks. To give you an idea of how bad it was, during the period listed the S&P was up 0.68%, but the Healthcare Select Sector SPDR (NYSE: XLV) was down 6.32%. That was by far the worst performance of any of the sectors during the time in question.
What baffled me even more was the stocks that got hit the hardest. Companies like Intuitive Surgical, Eli Lilly, Amgen, and Becton Dickinson are among the top rated stocks in the Investor’s Business Daily stock tables. IBD assigns companies an EPS rating and an SMR rating. These ratings rate the stocks based on earnings growth, sales growth, profit margin, and return on equity. The four companies listed above get EPS ratings in the top quartile, and they all have SMR ratings of an A—the highest rating a company can get.
During the selloff, these four companies got hit harder than the average. Intuitive Surgical was down 16.2%, Eli Lilly dropped 9.2%, Amgen was down 9.0%, and Becton Dickinson was down 8.9%. It really doesn’t make any sense that the strongest companies would get hit the hardest. At least not under the three possible reasons I listed earlier—political, sector rotation, or profit taking.
These four companies aren’t even in the same sub-sectors, so placing the blame on political pressure doesn’t make sense. Amgen is a biotech firm that develops therapeutics. Becton Dickinson is a member of the medical supply sub-sector and it develops devices and instruments, not pharmaceuticals. Intuitive Surgical is in the medical equipment sub-sector and it is known for its advanced surgical system. The only one of these four that is in the pharmaceutical sub-sector is Eli Lilly.
The profit taking argument doesn’t really hold water either. In addition to the EPS rating and the SMR rating, IBD has a relative price strength rating system that compares a stock’s price performance to all other stocks over the past year. The ratings range from 0 to 99. In the case of these four, the only one that ranks in the top quartile on price performance is Eli Lilly with an RS rating of 86. The other three have RS ratings in the bottom half and one has an RS rating in the bottom quartile—Amgen (22), Becton Dickinson (27), Intuitive Surgical (31).
The sector rotation argument might be the most valid, but I have my doubts. If we look at the sector performances for 2018, the healthcare sector was the top performer, but it only gained 6.3%. It just happened to be up for the year while a number of other sectors were down sharply on the year.
If we look at those same sectors and the year to date performances, the healthcare sector is the worst performer and it has been lagging for most of the year. As early as mid-January the sector was among the bottom two sectors and it continued into February.
If it is sector rotation, why did it start with such gusto all of a sudden? I don’t think it did.
Personally, I think it was a combination of the three possible reasons. It was part political, part sector rotation, and part profit taking. That created the perfect storm for a few days and investors started to panic a little. You also have to consider the program trading playing a role. The algorithms see weakness in the sector and start selling, the selling triggers another alarm and more selling hits the market and the selling snowballs.
One of the reasons I decided to write this article was due to the fact that I had several healthcare stocks in my model portfolio. I run a newsletter called The Hedged Alpha Strategy on Seeking Alpha and I had four healthcare stocks in the portfolio including Amgen and Becton Dickinson. I did have one healthcare stock that hit its stop-loss point and got closed out, but I didn’t panic and suggest selling the others. That is the wrong thing to do—panic.
Does anyone think we are anywhere close to having Medicare for all? I don’t see that happening at any point in the next few years. Even if investors were taking profits, why would you sell the companies with the best fundamentals? You wouldn’t. If it was profit taking, wouldn’t you sell the stocks that have outperformed the market and were in overbought territory?
I think the reason for the selling was three-fold and that triggered additional selling from the program trading which snowballed. The lesson for investors is that you shouldn’t panic and don’t get emotional. If you have a plan and you invest in companies with strong fundamentals, stick with the plan.