Are Healthcare Stocks the Next Hot Sector?
By Ron DeLegge, Editor
April 2, 2009

SAN DIEGO (ETFguide.com) – Despite posting their best monthly performance in six years, U.S. stocks are not yet out of the woods. Sluggish performance still surrounds us.

On a year-to-date basis, the S&P 500 (NYSEArca: SPY) is down by 10.2%* and the Dow Jones Industrial Average (NYSEArca: DIA) is off by 11.4%. Even international stocks as measured by the popular MSCI EAFE index (NYSEArca: EFA) are down by 14.0%. What can you say? The stock market will do what the stock market does.

Nevertheless, pockets of market strength have been quietly manifesting themselves. In a previous article, I wrote about the strong relative performance of technology stocks. This time, I want to focus on another industry sector that’s been showing signs of strength; healthcare stocks.

Even with their defensive nature healthcare stocks have been laggards.

Over the past five years, key healthcare stocks like Amgen (NasdaqGS: AMGN), Merck & Co. (NYSE: MRK), and Pfizer (NYSE: PFE) have all performed the same or worse than their corresponding S&P Healthcare Industry Sector (NYSEArca: XLV). Put another way, it has not been a stock picker’s market. But the fortunes of healthcare stocks are looking much better.

One potential bright spot for healthcare investors has been increased merger and takeover activity. In January, Pfizer acquired Wyeth for a whopping $68 billion. Merck & Co. struck a mega-deal of its own by agreeing to buy Schering-Plough for $41 billion in stock and cash. More proposed deals are brewing. 

Another positive factor for healthcare investors is attractive valuations.

According to New York-based AltaVista Research, healthcare stocks based upon 2009 earnings estimates are currently trading at a P/E ratio of 9.8, which is a discount to the S&P 500’s 11.9 multiple.

Since the beginning of the year, S&P Healthcare Stocks are down 8.9%, which is slightly better than the broader market.

What are some of the top healthcare ETFs to invest in? Here’s a short list.

iShares Dow Jones U.S. Healthcare Sector Index Fund (NYSEArca: IYH)
The Dow Jones index behind this particular ETF follows contains market exposure to 139 healthcare stocks. Companies within the index are selected passively and weighted according to their market capitalization or size. The median market size of healthcare stocks within IYH is just over $2 billion.

In 2008, IYH declined by 23.10% compared to a 38.49% fall in the S&P 500. Johnson & Johnson (12.62%), Pfizer (9.27%), and Abbot Laboratories (6.04%) represent the fund’s three largest holdings in order. IYH’s annual expense ratio is currently 0.48%.

Health Care Select Sector SPDR (NYSEArca: XLV)
This ETF follows healthcare stocks within the S&P 500. This particular industry sector covers stocks of companies involved in health care equipment and supplies, health care providers and services, biotechnology, and pharmaceuticals makers. The healthcare industry accounts for almost 15% of the S&P 500’s overall sector weighting, making it the second largest sector within the index just behind technology. With just over $2 billion in assets, XLV is the largest healthcare ETF.  

In 2008, XLV declined by 23.15% compared to a 38.49% fall in the S&P 500. Johnson & Johnson (13.92%), Pfizer (8.96%), and Abbot Laboratories (5.81%) represent the fund’s three largest holdings in order. XLV’s annual expense ratio is currently 0.21%.

Vanguard Healthcare ETF (NYSEArca: VHT)
The Vanguard ETF follows the MSCI US Investable Market Health Care Index. This particular healthcare ETF is the most diversified among similar offerings and currently has 297 stocks. The median market size of healthcare stocks within VHT is around $45 billion.

In 2008, VHT declined by 23.48% compared to a 38.49% fall in the S&P 500. Johnson & Johnson (12.08%), Pfizer (8.62%), and Abbot Laboratories (5.94%) represent the fund’s three largest holdings in order. VHT’s annual expense ratio is 0.25%.

Rydex S&P Equal Weight Health Care ETF (NYSEArca: RYH)
This ETF shadows healthcare stocks within the S&P 500, but with a twist. Instead of weighting the companies by their market capitalization or size, it weights each stock equally. The net effect of equal weighting a stock index is a bias towards mid and small company stocks.

In 2008, RYH declined by 26.66% compared to a 38.49% fall in the S&P 500. Each one of the 54 stocks within RYH receives an equal weighting and the underlying index is rebalanced every quarter. RYH’s annual expense ratio is 0.50%.

PowerShares Dynamic Healthcare Sector Portfolio (NYSEArca: PTH)
This PowerShares Healthcare ETF is more of a portfolio strategy than a market index based strategy. Put another way, PTH isn’t just attempting to match the performance of major healthcare equity benchmarks, it’s trying to outperform them. Stocks within this ETF are selected using a secretive quantitative formula that screen for factors like fundamental growth and valuation.

In 2008, PTH declined by 34.89% compared to a 38.49% fall in the S&P 500. Each one of the 60 stocks within PTH receives a modified equal weighting and the underlying index is rebalanced every quarter. PTH’s annual expense ratio is 0.70%.

Your Healthcare Strategy
As we’ve covered, Healthcare ETFs are an excellent choice for value oriented and defensive investors. This particular sector is attractively priced and the demographic trends of an aging U.S. population favor it. Even though healthcare has yet to return to its former glory, better days are ahead.

Which healthcare ETFs are best for you?

In our Ready-To-Go ETF Portfolios we are using healthcare ETFs. So far this year, our Capital Defense portfolio is ahead by 6.49% and our Sector Savvy Portfolio is up by 4.90%. 

We’ve done most of the legwork, now it’s up to you to do the rest.

*All performance figures quoted through April 1st market close