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Deal or No Deal: Healthcare ETFs to Make a Sweep in 2020

Zacks Equity Research logoZacks Equity Research 12/10/2019 Sanghamitra Saha

We are now at a juncture when new U.S. tariffs on Chinese imports like smartphones, laptops and toys will be enacted this Sunday Dec 15, 2019 if the Phase-One trade deal does not get through.

Stocks could crash as much as 10% in a no-deal situation, per Matt Maley, the chief market strategist at Miller Tabak. He cautioned that stocks might retreat 4-6% even if the Dec 15 round of tariffs was deferred if not canceled.

Whatever be the case, alike many analysts, we too believe that one sector would stand tall amid trade tensions and that is, Healthcare.

In a no-deal scenario, a safe-haven rally will take place. Some sectors are normally steady irrespective of any geopolitical development. Healthcare is one. Below we highlight what can drive the healthcare sector in 2020 irrespective of a trade deal (read: Is Trade Scaring You? ETF Strategies for 2019 Holiday Season).

Inside the Drivers

The Earnings Trends issued on Dec 4 showed that total earnings of 98.1% from the entire healthcare market capitalization on the S&P 500 index have been up 6.1% so far on revenue growth of 7.2%. The earnings and revenue growth rates are the fifth highest among the 16 Zacks classified sectors. Meanwhile, the blended beat ratio of 70.6% is the third highest. Medical sector has the top Zacks rank at the current level.

There are about 13 industries in the broader medical sector, of which 11 carry a solid Zacks Rank. Below we highlight three key industries.

Medical — Drugs belongs to a favorable Zacks industry (placed at the top 24% of 250+ industries). Shares of the same industry can be availed at 17.37x forward P/E ratio against the S&P 500 ETF IVV’s P/E multiple of 19.16x. Though a low P/E is not indicative of the stock’s future performance, cheaper valuation is always good news. The projected EPS growth rate of the sector is 7.80% compared with 5.52% of IVV. The debt-to-equity ratio of the industry (0.03x) is much lower than 0.72x of IVV.

Large-Cap Pharmaceuticals also hails from a favorable Zacks industry (positioned at the top 24%). The industry has a forward P/E ratio of 14.85x, which reflects its undervalued status. The debt-to-equity ratio of the industry (0.68x) is slightly lower than that of the S&P 500.

Medical — Biomedical And Genetics also belongs to a favorable Zacks industry (top 23%). The forward P/E ratio of 25.12x is pretty higher than IVV’s average. Also, the projected EPS growth rate is above (12.76%) the S&P 500 (5.52%).

Solid M&A

The US healthcare market witnessed a 14.4% increase in mergers and acquisition activity from 2017 to 2018, per PricewaterhouseCoopers data. In total, there were 1,182 M&A deals in 2018. Deal volume exceeded 250 in the first three quarters of 2019.

Some notable mergers completed this year were the mega-merger deal between Bristol-Myers and Celgene, acquisition of Loxo Oncology by Eli Lilly and Company,  Roche’s buyout of Spark Therapeutics for $4.8 billion and Merck’s acquisition of Immune Design.

Other announcements include NextGen Healthcare’s (NXGN) purchase of Medfusion, a patient experience platform leader.Notably, the latest acquisition announcement was Merck taking over ArQule, strengthening its leadership role in Oncology (read: Value Biotech ETFs & Stocks to Buy Now).

Healthy Pace of FDA Drug Approvals

Apart from favorable financials and valuations as well as mergers and acquisitions, the sector is brimming with upbeat drug data. There were 46 drug approvals in 2017 followed by 59 and 41 drug nods to date in 2019. Though the momentum of approval wins slackened a bit, it can still be considered healthy.

Investors should also note that the healthcare sector offers a slightly defensive approach and thus could be a good bet if there is any uncertainty regarding the trade deal. In light of this, we choose five healthcare ETFs that could lead the market in 2020.

SPDR S&P Biotech ETF XBI — Zacks Rank #2 (Buy)

VanEck Vectors Biotech ETF BBH — Zacks Rank of 2

Vanguard Health Care ETF VHT —Zacks #2 Ranked

Health Care Select Sector SPDR Fund XLV — #2 Ranked

iShares U.S. Healthcare ETF IYH —Zacks Rank #2

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