S&P Still Bullish on Health Care ETFs

With the short-term uncertainty of the Obamacare ruling by the Supreme Court in the rear view mirror, the 2012 presidential election is now the next major issue facing health care stocks and ETFs. To its credit, the sector has dealt with these issues with aplomb, but there are still things to consider.

"We believe the Court's ruling removed some of short-term uncertainty that has weighed on the Health Care sector since it agreed to hear the case in late 2011," S&P Capital IQ said in a research note. "However, the Court's ruling does not make the law any less contentious, and we expect continued ongoing battles, and potentially more uncertainty after this year's elections. Congressional Republicans, presumed Presidential candidate Mitt Romney, and others opposed to the law have stated plans to continue fighting it."

Despite the potential impact the election could have on the health care sector, S&P Capital IQ rated three major health care ETFs "Overweight." That trio includes the Health Care Select Sector SPDR (NYSE:XLV), the iShares Dow Jones US Healthcare Index Fund (NYSE:IYH) and the Vanguard Health Care ETF (NYSE:VHT).

All three ETFs are heavy on pharmaceuticals names, such as Abbott Labs (NYSE:ABT), Johnson & Johnson (NYSE:JNJ), Merck (NYSE:MRK) and Pfizer (NYSE:PFE).

"The Pharmaceuticals sub-industry, which represents the largest weighting within the Health Care sector at about 50%, gained 8.8% year-to-date through August 10, with the majority of the gain within the past 13 weeks where it gained 6.5%, vs. a 3.5% rise in the S&P 1500," S&P said in the note.

Even with a patent cliff that started last year that is expected to run through 2014, investors have embraced ETFs heavy on pharmaceuticals names. In the past three months, IYH and VHT are both up close to six percent while XLV is higher by 5.3 percent. S&P said the impact of the patent cliff has largely been accounted for in the share prices of pharmaceuticals stocks.

"Health Care Services, which is up 29 year-to-date. We attribute the strong performance in this group to the Healthcare Reform law, as we believe this sub-industry should benefit from the expected significant increase in Americans with health insurance," S&P said. "We believe this should drive demand while reducing bad debt expense. However, we note the sluggish economic recovery is adversely impacting physician office visits as some patients are deferring visits in spite of having health insurance because of rising co-pays and deductibles."

One ETF that is benefiting from that trend is the iShares Dow Jones U.S. Healthcare Providers Index Fund (NYSE:IHF). IHF is up nearly 11 percent year-to-date. UnitedHealth (NYSE:UNH) and Express Scripts (NASDAQ:ESRX) combine for over 26 percent of IHF's weight. Other top-10 holdings include Aetna (NYSE:AET), Cigna (NYSE:CIG) and Humana (NYSE:HUM).

"Overall, we believe health care valuations remain attractive, as the sector is trading below its historical level. Generally, we view balance sheets as solid, with large cash balances in Pharmaceuticals and Biotech driving higher dividend payments," S&P said.