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The healthcare sector is most commonly represented by the Select Sector SPDR Healthcare ETF, XLV. It faced a challenging year in 2024, underperforming the S&P 500 Index by a staggering 22.4%. This massive performance shortfall resulted in $7.4 billion in outflows from XLV, marking the largest outflows among the 11 Select Sector SPDR ETFs sectors by a wide margin.

The significant underperformance of the Healthcare Select Sector Index can be attributed to numerous factors. The sector grappled with regulatory uncertainties, escalating operational costs, and shifting market sentiments. Despite a substantial increase in total US healthcare spending, which more than tripled from $1.4 trillion in 2000 to $4.9 trillion in 2023, the sector struggled to maintain investor confidence.

Healthcare sector's weight within the S&P 500 is approaching a 25-year low. This decline in weight indicates a reduced influence on the sector and contribution to the overall market performance. The juxtaposition of increasing healthcare expenses and declining market performance presents a paradox that warrants a deeper examination.

Several factors contributed to the significant outflows from Healthcare sector ETFs in 2024:

• Regulatory Uncertainties: The sector faced ongoing uncertainties regarding healthcare policies and regulations, which created an unpredictable environment for investors.
• Rising Operational Costs: Healthcare companies experienced escalating costs related to research and development, compliance, and labor, affecting their profitability and attractiveness to investors.
• Market Sentiments: Shifting market sentiments and diminished investor confidence in the sector's future prospects

In addition to XLV, the next two largest healthcare ETFs in terms of Assets Under Management (AUM) are:

• Vanguard Healthcare ETF (VHT): This ETF offers exposure to a broad range of healthcare-related stocks, including pharmaceuticals, biotechnology, medical devices, and healthcare providers.
• iShares U.S. Healthcare ETF (IYH): This ETF seeks to track the investment results of an index composed of U.S. equities in the healthcare sector.
• The broad healthcare industry contains an important high-growth-potential but high-risk subsector: biotech stocks. The biotech subsector represents a dynamic and rapidly evolving segment of the healthcare industry. This subsector is characterized by significant research and development activities, leading to groundbreaking innovations in medical treatments, diagnostics, and technologies. However, the biotech subsector is also associated with unique risks and opportunities that investors and stakeholders must navigate.

The risk associated with individual biotech stock investment is why many investors seeking exposure to the biotech subsector, and exchange-traded funds (ETFs) provide a diversified and relatively low-risk option.  The three largest biotech ETFs by AUM are the iShares Nasdaq Biotechnology ETF (IBB), SPDR S&P Biotech ETF (XBI) and the First Trust NYSE Arca Biotechnology Index Fund (FBT).

Comparing recent price performance compared with ETFs representing other S&P 500 Sectors reveals that the Healthcare Select Sector SPDR Fund (XLV) has shown a mixed performance relative to its peers. While sectors like Technology (XLK) and Consumer Discretionary (XLY) have experienced robust gains driven by strong earnings growth and consumer spending, XLV has faced headwinds due to regulatory concerns and cost pressures.

The Energy Select Sector SPDR Fund (XLE), on the other hand, benefited from rising oil prices and geopolitical tensions, resulting in significant outperformance. Conversely, the Financial Select Sector SPDR Fund (XLF) struggled amid economic uncertainties and interest rate fluctuations, mirroring some of the challenges faced by XLV.

This chart compares three broad healthcare ETFs and three biotech ETFs. Data is sourced from ETFdb.com, a VettaFI company. The SPDR Portfolio S&P 500 ETF (SPLG) is used instead of SPY due to its more efficient structure and lower expense ratio (0.02% for SPLG vs. 0.095% for SPY). Unlike the outdated SPY, SPLG can lend securities and reinvest dividends, reducing expenses. Alternatively, the S&P 500 ETF that now has the greater amount of ETF assets is the Vanguard S&P 500 ETF, VOO.  For most investors, the difference between the 0.03% and 0.02% is immaterial. If you prefer the Vanguard brand, VOO is just as good.  However, as a quant, I go for the lowest ER for my own accounts. For these reasons, I prefer using SPLG for comparative charts like this one in the healthcare industry.
 

All six healthcare industry ETFs have underperformed SPLG over the time periods shown. However, in January and February ("YTD" column), all these ETFs outperformed SPLG, which was affected by "Magnificent Seven" tech stocks. The First Trust NYSE Arca ETF, an equally weighted ETF with only 30 stocks, outperformed the S&P 500 in the past 12 months, which none of the others did. Over five years, XLV, the most-cited ETF for the sector, had the highest return among the six. 

The question is whether the technical strength shown by the two-month rebound for Healthcare ETFs will continue.  Fidelity released a recent research report making a bull case for the sector.  They refer to it as a very innovative sector with strong long-term drivers of growth.  They add that many of the stocks that comprise the sector are currently selling at cheap valuations and multiples relative to the market as a whole.  To me, this case is compelling for long term investors.

Unfortunately for the next one-month and twelve month periods, our models don’t agree with this assessment.  The consensus of analysts’ four-quarter earnings estimates do not indicate that an earnings growth spurt will happen during that period.  Consequently, the ValuEngine forecast ratings for these ETFs and the sector are mostly very poor.  Four of the six ETFs in this analysis get our Strong Sell rating of 1.  IYH, the iShares Healthcare ETF is slightly better in projected relative price change with a Sell rating of 2. 

The one ray of hope is the equally weighted First Trust NYSE Arca Biotechnology Fund (FBT) with a Buy rating of 4.  In fact, we rank four of the top 10 holdings either Buy (4) or Strong Buy (5). The Buy-ranked stocks are Beigene LTD (ONC), Corcept Therapeutic (CORT) and Exelixis (EXEL).  The Strong Buy (5) stock is Halozyme Therapeutic. One interesting characteristic about FBT is its Beta.  Typically, biotech stocks have high betas, quite a bit above 1.  However, the aggregate beta for this 30-stock ETF is quite low at 0.64.

The ValuEngine Sector Report rates Healthcare (Medical in the report) 12^th among our 15 sectors for relative year-ahead projected performance.  However, two large cap US healthcare stocks receive a 5 (Strong Buy) rating. The two stocks are Intuitive Surgical (ISRG) and Bristol Myers (BMY). 

Intuitive Surgical develops, manufactures, and markets products that enable physicians and healthcare providers to enhance the quality of and access to minimally invasive care in the United States and internationally. The company offers the da Vinci Surgical System that enables surgical procedures using a minimally invasive approach; and Ion endoluminal system, which extends its commercial offerings beyond surgery into diagnostic endoluminal procedures enabling minimally invasive biopsies in the lung. It also provides a suite of related products and services. IRSG was incorporated in Sunnyvale CA in 1995. On Feb. 28, IRSG was selling at $573.15.  This set its P/E multiple at an extremely pricy 89.9. Its advanced methods have caused it to trade like a cutting edge tech company than a healthcare company. 

Bristol Myers discovers, develops, licenses, manufactures, markets, distributes, and sells biopharmaceutical products worldwide. It offers products for oncology, hematology, immunology, cardiovascular, neuroscience, and other areas. The company's products include Eliquis for reduction in risk of stroke/systemic embolism in non-valvular atrial fibrillation and for the treatment of DVT/PE; Opdivo for various anti-cancer indications; Pomalyst/Imnovid for multiple myeloma; Orencia for active rheumatoid arthritis and psoriatic arthritis; and Sprycel to treat patients with Philadelphia chromosome-positive chronic myeloid leukemia. It also provides Yervoy for the treatment of patients with unresectable or metastatic melanoma; Empliciti for the treatment of relapsed/refractory multiple myeloma; Abecma for the treatment of patients with relapsed or refractory multiple myeloma; Reblozyl to treat anemia; Opdualag for the treatment of unresectable or metastatic melanoma; and Zeposia to treat relapsing forms of multiple sclerosis The company was founded in Princeton, NJ in 1889. Its P/E ratio is undefined due to a trailing 12-month earnings number of -$4.41, which reflects its previous troubles.  Removing extraordinary items that dragged the stock down, VE has its P/E ratio at 19.8.  Its forward P/E is quite low at 8.9.  Its PEG (price-to-earnings-growth) ratio is equally tantalizing at 0.2. Moreover, its current annual dividend yield of 4.2% cements its place as a value stock.  At the same time, analysts’ predictions of a jump in the 12-month ahead help BMY earn our highest ranking. Given the tariff tumults that have sent the S&P 500 Index plunging this week, BMY's low Beta, below 0.7, would also seem to be an attractive feature now.

My conclusion is that while a bullish case can be made for the Healthcare (or Medical) sector as a whole, I urge caution. Our model’s ratings of the ETFs representing the sector and our sector report as a whole indicate that investing in an eventual recovery for the sector may be a bit premature. While most sector reports are bullish, this is an exception. One of the distinguishing facets of ValuEngine is that we have an equal number of stocks that are rated 1 and 2 (Strong sell and sell, respectively) as are rated 4 and 5 (Strong buy and buy respectively).  The distribution resembles an elongated bell curve with the majority of stocks being rated 3 with about 30% rated either 2 or 4 as many rated and roughly 10% rated either 1 or 5.  The same methodology is used to rank the ETFs that contain these stocks but have separate patterns of price behavior. 

This gives us the ability to feature a sector that has absorbed a three-year decline while the market has been rising.  The decline has made many of the dividend yield and price/earnings multiples very attractive from a value perspective.  Even though most stocks in this sector have outperformed the S&P 500 during the first two months of 2025, our models see most of these stocks persisting as laggards in price performance.  However, there are a number of well-followed stocks to research and consider for investing including Intuitive Surgical and Bristol Myers. Again, to the point of the FIdelity research piece, this sector is comprised primarily of strong and high quality companies with strong balance sheets.  It almost always makes sense to be stocks of such companies when they are selling at attractive valuations since an eventual rebound seems inevitable even if an investor cannot be certain of the timing. 

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