Healthcare Humbled, But Not Knocked Out

The Health Care SPDR (ETF) (NYSE:XLV), the largest healthcare exchange-traded fund by assets, is off 9.3 percent over the past three months, a decline hastened in large part by the recent retrenchment in biotech stocks.

In a credit to XLV's strength through the first half of the year, the ETF is basically flat year-to-date. That does not sound like much, but consider this: XLV is the second-best of the nine sector SPDRs on a year-to-date basis. Only the Consumer Discretionary SPDR (ETF) (NYSE:XLY) is up on the year.

While XLV's 24.7 percent weight to biotech stocks the ETF's second-largest industry weight behind pharmaceuticals has been burdensome in recent weeks, the bull case for healthcare has not been eroded to the degree that naysayers are proclaiming. Perhaps no worse than a neutral view of XLV is warranted at the moment, which is the view of the ETF currently held by AltaVista Research.

AltaVista's Analysis

AltaVista's neutral rating implies average appreciation potential. A rating of NEUTRAL is assigned to funds with ALTAR Scores between 6.0 percent and 8.0 percent. This indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category, said the research firm in a recent note.

Richly Valued? Perhaps Not

Although XLV devotes nearly a quarter of its weight to biotech, a group that historically trades at a high premium to the broader market, and the ETF itself has been one of the best-performing sector funds for multiple years now, that does not mean XLV is richly valued.

Quite the contrary. AltaVista estimates XLV's 2015 price-to-earnings ratio at 16.3 compared to 16.2 for the S&P 500. By comparison, the slower-growing Consumer Staples Select Sect. SPDR (ETF)(NYSE:XLP) trades at 19.7 times earnings.

Just 14, or less than half of the members of the Dow Jones Industrial Average have traded higher this year. XLV is home to Pfizer Inc. (NYSE:PFE) and UnitedHealth Group Inc (NYSE:UNH). Those stocks combined for over 12.2 percent of the ETF's weight.

Until the recent plunge in biotech shares dragged the sector's overall P/E down, investors had been revaluing Health Care stocks with steadily higher multiples since late 2011. Yet the exceptionally high and steady profitability on which that revaluation was based remains intact, and if share prices had gotten a bit ahead of themselves recently, they now appear slightly more attractive than broader S&P 500, said AltaVista.

There is another sign traders might be down-slamming biotech and healthcare stocks. XLV's short interest, according to AltaVista data, has dwindled to 27 percent of shares outstanding, a total easily exceeded by three other sector SPDR ETFs.

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