Retain Patience with Health Care Stocks

New York Times

Barron's

According to a report, the most recent informationfrom Medicare shows thatbillings from hospitals declined 4% thispast August compared with a year ago. Asecond article in reveals thatwhile the S&P 500 and Nasdaq have experiencedadvances of 17% and 40%,respectively, this year, leading drug stockshave largely remained unchanged. Whyare health care stocks receiving such apoor diagnosis?

Identifying Causes

Analysts point to the drug sector, inparticular, as having fallen out of favorwith Wall Street. The reasons range fromexpiring drug patents and uninspiring newdrug pipelines to the uncertainty overMedicare drug-benefit legislation andincreased competition in many therapeuticcategories. Many advisors now believethat health care stocks are no longerimmune to the overall economic climate.

Personal Perspective

Times

Dr. Uwe Reinhardt, a respected healtheconomist at Princeton University, has amore positive outlook. In the article,Dr. Reinhardt says that fewer people areusing hospitals because there have beenfewer cases of the flu and that expectationsfor the health care sector have beenoverblown in recent years. He also pointsout that the health care industry continuesto grow faster than the overall economy.

Apparently, the issue is not as simple asblack or white. Jordan Schreiber, whomanages the Merrill Lynch Healthcarefund, says it's a matter of carefully selectingstocks. She points out that many portfoliomanagers are focusing on rural hospitalsthat have less competition andcould be poised for growth.

Richard Evans, an analyst withSanford C. Bernstein, says the same istrue for drug company stocks. The key,he says, is product mix. Drug companiesthat rely heavily on products thataddress long-term prevention of "silentdiseases" like high cholesterol are morelikely to experience a drop in productdemand than those that lean towarddrugs that are more necessary for peopleto function on a daily basis.

Financial Diagnosis

Barron's

According to the article, certainadvisors believe that the recentweak showing by drug stocks reflectsinvestors' desire for "offensive" stocks(eg, technology and retail stocks). Thishas left the health care sector unusuallycheap compared to the overall market.But that could be a positive sign.

Traditionally, health care stocks havetraded at about the same price-to-earnings(P/E) ratio as technology stocks.However, the health care sector's currentP/E ratio of 18, which is based on projectedprofits over the next 12 months, isfar below the technology sector's P/E of29. That, some analysts say, is an indicationthat the health care sector couldoutperform the technology sector in thecoming years.

The rule of thumb that cast health carestocks as a perennial safe haven may nolonger be a solid rule of thumb. Althoughshades of gray may have filtered throughwhat used to be a black and white decision,it seems far too early to vote thumbsdown on what has historically been a reliableinvestment sector.