This Giant Healthcare ETF Eyes A Comeback

This is how terminal the effect of the August downturn for U.S. stocks was: Entering Tuesday, just two of the nine sector SPDR exchange traded funds -- the Consumer Discretionary Select Sector SPDR (NYSE:XLY) and the Health Care Select Sector SPDR (NYSE:XLV) -- were higher year-to-date.

XLV, the best of the nine SPDRs for much of this year, was stung by what was a positive trait for the ETF on the way up: A healthy biotechnology weight. XLV, the largest healthcare ETF by assets, allocates 21.5 percent of its weight to biotech stocks, only pharmaceuticals makers command a larger percentage of the funds, ensuring the ETF and others like it have to take the bad with the good when it comes to biotech sector price action.

XLV is off nearly 8 percent over the past month and now resides almost 10 percent below its 52-week high, data points that combined with some analysts' views that healthcare stocks are still expensive, muddle the near- to medium-term outlook for ETFs like XLV.

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Sales and profit growth are forecast to decelerate this year in the wake of tough comps for 2014. Nonetheless, P/E multiples have risen considerably over the past three years (even relative to the S&P500) as the Health Care sector has been revalued by investors, and multiples now exceed their pre-Financial Crisis levels. Higher share prices have in turn diminished the sector's attractiveness to about average in our opinion, said AltaVista Research in a recent note.

Based on 2015 estimates, AltaVista expects XLV to sport a price-to-earnings ratio of 17.2, slightly above the 16.7 P/E ratio the research firm is projecting for the S&P 500. Only XLY and the consumer staples and energy SPDRs are expected to trade at larger premiums to the S&P 500 than XLV, according to AltaVista data.

A case can be made that XLV warrants a higher multiple. After all, just 10 Dow stocks are higher this year, a group that includes XLV holdings Pfizer Inc. (NYSE:PFE) and UnitedHealth Inc. (NYSE:UNH). Those stocks combine for 11.6 percent XLV's weight. That also means 20 Dow stocks are in the red and that includes Johnson & Johnson (NYSE:JNJ) and Merck & Co. (NYSE:MRK). That duo combines for over 15 percent of XLV's weight.

Since the start of the current quarter, investors have pulled $285.2 million from XLV, but year-to-date, the ETF has added almost $2 billion in new assets, good for the best total among the nine sector SPDRs.

AltaVista has a Neutral rating on XLV, which is neither overly alarming nor cause for celebration. The research firm's Neutral rating indicates that valuations adequately reflect the fundamentals of stocks in these funds. The majority of funds we cover fall into this category.

Disclosure: The author owns shares of Johnson & Johnson.

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