Improve the health of your portfolio by investing in healthcare stocks

Investors have weathered an incredible storm of volatility so far in 2022. The year began with a rapid COVID surge driven by the Omicron variant, supply chain issues continued to plague the global economy, leading to high inflation, Russia invaded Ukraine, sending commodity prices skyrocketing further, and finally the US Federal Reserve began raising the Fed Funds interest rate. All of this led to a double-digit drop in the NASDAQ

NDAQ

NDAQ
Composite and Russell 2000 Stock Index, and mid-single-digit losses for the Dow Jones Industrial Average and S&P 500. Given inflation uncertainty and the war in Ukraine combined with expected additional rate hikes from the Fed, US equity markets are expected to remain volatile at best, and could face significant declines at worst.

In this environment, it is essential to find companies that have stable revenue growth and profits. A focus area of ​​O’Neil and Company is healthcare. Even in a recession, health care earnings tend to be more stable than overall stock market earnings. Additionally, healthcare companies should see less margin compression than many companies affected by rising commodity prices.

Currently, relative to much of the US market, healthcare stocks seem to be reacting to this. This can be seen in the Datagraph below, where the healthcare sector is represented by the S&P Health Care Select Sector ETF, XLV. The ETF has a strong absolute price and volume pattern and is trying to break past its former highs. The sector’s relative strength has improved over the past two quarters. As the Datagraph also shows, the Relative Strength line has risen sharply over the past few weeks, even as the overall market rally has faltered.

SPDR Health Care Select Sector ETF (XLV) Weekly Chart

Below I display William O’Neil and Company’s proprietary sector rotation chart. This chart displays sector performance in two ways. First, it shows the best performing sectors (upper and lower right quadrants outperform over a 6-month period; and upper left/right quadrants outperform in the short term). Second, it shows the sectors best positioned to win in relative terms (usually near the center of the chart and moving up and to the right). Healthcare is well positioned, but still has plenty of room to run before expanding. A good example of an expanded sector right now would be energy.

O’Neil Sector Relative Rotation Chart

Relative Performance Chart – Health Care vs S&P 500

Compared to the broader S&P 500, health care is still lagging year over year, but is coming back from extreme levels of underperformance (down -20% or more, through January 2022). It has recovered to around par and still has further upside potential. We expect movement at least above the zero or neutral level for the sector.

Relative Performance Chart – Health Care vs S&P 500

Compared to the broader S&P 500, health care is still lagging year over year, but is coming back from extreme levels of underperformance (down -20% or more, through January 2022). It has recovered to around par and still has further upside potential. We expect movement at least above the zero or neutral level for the sector.

The stocks of interest are all large-cap and come from the service, drug and product groups.

United Health (UNH) – Market capitalization of $512 billion – Largest provider of health insurance in the United States, with a market share of 13%. Served 51 million customers at the end of 2021, including Medicare (45% of total), Medicaid 25%) and employer/individual (30%). Sees a market opportunity of 85 million people in the US Also owns Optum (health care facilities, pharmacies, data services, etc.). In January 2021, UNH acquired Change Healthcare (data analytics, research/advisory) for $13 billion, which will be included in the Optum segment, and will be accretive by approximately $0.50/share. The company expects revenue growth of 11% to 13% in 2022, roughly in line with the three- and five-year growth rates, respectively.

Vertex Pharmaceutical

VRTX
s (VRTX) – Market capitalization of $71 billion – World leader in the treatment of cystic fibrosis (CF). Its main triple combo drug, Trikafta (75% of earnings), reduces the risk of death by 74%. Stable and recurring income stream because CF is incurable. Targeting five life-threatening diseases in its pipeline, including a candidate for the treatment of sickle cell disease. In 2019, also acquired a company with a type 1 diabetes candidate. Five-year sales/EPS growth of 35% and 70%, respectively. 2022 forecast for 12% revenue growth. Has $7.5 billion in cash currently.

Pharmaceutical Horizon (HZNP) – Market capitalization of $26 billion – Focus on rheumatic diseases (autoimmune and inflammatory conditions). The top-selling drug, Tepezza, treats thyroid-related eye disease (~60% of revenue) and is expected to reach an annual peak of $3.5 billion (nearly double the current one). The market remains penetrated at less than 15%. Also, has the only FDA-approved treatment for chronic refractory gout. Starting in 2022, the revenue forecast of $680 million (+22% y/y) calls for peak annual sales of $1 billion. Purchased Viela Bio (serious inflammatory diseases) for $3 billion in 2021 and established several collaborative programs. Five-year sales/EPS growth of 25% and 25% respectively. Forecasts revenue and adjusted EBITDA growth of 22% and 30%, respectively, for 2022.

Novo Nordis

NVO
k (NON.DK; NVO) – Market capitalization of $278 billion – Global leader in the branded diabetes market, with a 30% market share in the United States. Glucagon-like peptide (GLP-1, for type 2 diabetes) and insulin account for 80% of sales. Also, world leader in the prescription obesity drug market, with a 78% market share. The two markets are worth more than $100 billion combined and are growing at double digits annually. By 2025, aims to expand to treatments for cardiovascular and chronic kidney disease, among others. CAGR of nearly 10% in sales over the past decade-plus, including 11% growth in 2021. Forecasts sales growth of 6-10% in 2022.

Edwards life sciences

EO
Sew) – Market capitalization of $75 billion – Leader in transcatheter aortic valves (TAVR), with a 60% market share in the United States. TAVR is FDA-approved for patients with symptomatic aortic stenosis (AS) at risk for open-heart surgery. Penetration rate is still below 40%, while global opportunity will double to $10 billion by 2028. Additional market potential in asymptomatic patients with moderate/severe AS. Five-year annual sales and EPS growth of 11% and 17%, respectively. 2022 forecast for 10% revenue and 15% EPS growth.

In conclusion, I currently favor investing in the US healthcare sector for several reasons. First, with a growing risk of a slowdown in the US economy due to the global environment and the Fed’s tightening cycle, healthcare offers safe, secular growth. Second, the sector is emerging from a period of dramatic underperformance. Finally, healthcare looks good when viewed through O’Neil’s technical lens in terms of price and volume patterns, as well as relative strength. I urge investors to consider increasing exposure to the sector in their US portfolios at this time.

Declaration of the co-author:

Kenley Scott, Research Analyst, Director, Global Equity Research, William O’Neil + Co., provided significant input in compiling, analyzing and editing the data for this article.

Disclosure:

No part of the authors’ compensation has been, is, or will be directly or indirectly related to the specific recommendations or opinions expressed herein. O’Neil Global Advisors, its affiliates and/or their respective officers, directors or employees may have long or short interests or positions and may at any time purchase or sell as principal or agent of the securities referred to in present. .