Health Care

Health care facilities equities may become the odd man out in the overall health care sector bull market. While we are not concerned that hospitals will see a drop off in activity levels, slowing revenue growth may constrain incremental valuation expansion. Hospital procedures are labor-intensive, underscoring that business models are not scalable. Hospitals have hired at the most aggressive pace in the entire history of the BLS data. Other costs are also inflating. Hospitals are one of the largest buying groups for pharmaceuticals, and the relentless advance in drug prices is profit margin sapping. The producer price indexes for physician services and medical equipment, while still low in absolute terms, are beginning to accelerate. These forces will limit earnings growth potential, especially given that they appear to have been strong enough to offset the benefit from falling bad debt expenses and low capital spending. If operating margins and ROE cannot expand in the current environment, both are unlikely to improve much if overall employment growth continues to cool, as we expect, causing a second derivative slowdown in bad debt recoveries and surgical procedures. Downshift to neutral. The ticker symbols for the stocks in this index are: BLBG: S15HCFA - HCA, UHS, WOOF, AMSG, LPNT, THC, CYH, SCAI, SEM, KND, ENSG, USPH, QHC. bca.uses_in_2016_06_28_002_c1 bca.uses_in_2016_06_28_002_c1

A gap has opened between the Nasdaq and S&P biotech indices, suggesting broad-based selling has reached a stage where discrimination is occurring. The former is infused with concept stage companies with no revenue or earnings, while the latter comprises more mature, pharmaceutical-type firms. We are becoming more favorable toward the S&P biotech index. Using the tech bubble as a guide, on a relative price/sales basis, the S&P biotech group has deviated from fair value by more than the tech sector did after the turn of the century. With value fully restored and robust pharmaceutical industry fundamentals, buying interest should ensue. At least one potential threat to pricing power has been deferred, as the U.S. governments' drug pricing control measures have reportedly been delayed. Consequently, the risk premium associated with doubts about pricing power sustainability should lift. We recommended shifting from underweight to overweight in yesterday's Weekly. Please refer to that report for more details. The ticker symbols for the stocks in this index are: BLBG: S5BIOT - AMGN, GILD, ABBV, CELG, BIIB, REGN, ALXN, VRTX. Biotech Is Due For A Rebound Biotech Is Due For A Rebound

The health care sector is poised to resume its bull market, but the character of the rally will change. Sell hospitals and buy biotech.

The health care sector is slowly reclaiming ground lost on the back of the dip in the U.S. dollar and temporary rebound in inflation expectations (second panel). We expect this rebound to gather pace. Now that both the currency and inflation expectations are headed in a direction that suggests disinflation/deflation have not been overwhelmed by policy efforts and/or stronger global final demand, flows into the non-cyclical health care sector are likely to resume. Technically, the sector is improving. Participation is broadening following last year's wholesale flight out, as the number of groups trading above their 40-week moving average has climbed decisively above 50%. Our sector advance/decline (A/D) line, shown compared with our overall S&P 500 A/D line, is flirting with new cyclical highs. Strong breadth is essential to revitalizing the bull phase. Importantly, our Technical Indicator is rebounding, but remains in deeply oversold territory, underscoring that there is plenty of room for momentum to accelerate. Stick with a high conviction overweight. The ticker symbols for the stocks in this index are: BLBG: S5HLTH. bca.uses_in_2016_06_23_002_c1 bca.uses_in_2016_06_23_002_c1

The previous Insight showed that broad macro conditions point to a reduction in managed care risk premiums. This outlook brightens further when considering recent cost inflation trends. The latest inflation reports showed that the cost of physician services is growing at a slower rate, and the relentless advance in pharmaceutical price inflation is also finally cooling. With health insurance pricing power likely to stay on the upswing (third panel), given that premiums are set on a trailing cost basis, there is a window for the group to show more robust profit margins. As a result, industry return on equity (ROE) should continue to handily outpace overall ROE, arguing for a better-than-market valuation multiple. Stay overweight. The ticker symbols for the stocks in this index are: BLBG: S5MANH - UNH, AET, ANTM, CI, HUM, CNC. bca.uses_in_2016_06_16_002_c1 bca.uses_in_2016_06_16_002_c1

Health insurance equities are on the cusp of breaking out to new all-time highs relative to the broad market, despite the headwinds facing any net creditor, namely low running yields. The macro tide is turning decisively in favor of this non-cyclical group. The S&P managed care index outperforms when overall relative consumer spending on health care decelerates and/or contracts, as it implies that insurance claims will decelerate, reducing costs to managed care providers. When this occurs, the risk premium associated with the group diminishes. The opposite is also true. Thus, the decisive downturn in health care spending growth opens the door to a re-rating, particularly given that cost inflation appears to be ebbing, please see the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5MANH - UNH, AET, ANTM, CI, HUM, CNC. bca.uses_in_2016_06_16_001_c1 bca.uses_in_2016_06_16_001_c1

The latest conclusions from the sector-based (right) way to pick stock markets. Plus some important conclusions for credit markets.

Stocks whipsawed violently last week. Volatility could intensify if recent whiffs of a domestic economic slowdown proliferate and the Fed still adopts a more hawkish tone.

Pharmaceutical stocks are trading at historically cheap relative valuations on the back of political pressure on a few high-profile specialty pharma companies. We see this as an opportunity to add to positions in the more traditional pharma space. Our concerns about excessive drug pricing will only materialize when there is evidence that consumption patterns are changing. So far, there is scant evidence of higher prices choking consumption. Consumer spending on drugs is hitting new highs. That is true in both real and nominal terms, underscoring that higher outlays are not simply a reflection of rising drug prices. While the growth rate of drug consumption may slow, pent up demand from years of medical procedure deferral following the Great Recession will take time to play out. As such, soaring pharmaceutical shipments should be interpreted as demand-driven. Consequently, we expect profit outperformance to persist, and drive a sustained recovery in relative share prices. The ticker symbols for the stocks in this index are: BLBG: S5PHAR - JNJ, PFE, MRK, BMY, AGN, LLY, ZTS, MYL, PRGO, MNK, ENDP. bca.uses_in_2016_05_11_001_c1 bca.uses_in_2016_05_11_001_c1

A spate of mergers in the medical equipment space has helped propel relative performance to new cyclical highs. In our latest update, we noted our expectation for another upleg, but some niggling concerns about the future revenue outlook caused us to put the group on downgrade alert. However, recent data are supportive of a continuation of the uptrend. The medical equipment shipments-to-inventory ratio is trending steadily higher. Importantly, investment in medical equipment has reaccelerated, as has new health care facility construction. That bodes well for future equipment demand, and should keep factories operating at optimal rates. Consequently, we recommend maintaining overweight positions for a while longer, especially since value is not problematic. The ticker symbols for the stocks in this index are: BLBG: S5HCEP - MDT, ABT, SYK, BDX, BSX, BAX, ISRG, EW, STJ, ZBH, BCR, HOLX, VAR. Health Care Equipment Gets A New Lease On Life Health Care Equipment Gets A New Lease On Life