Is This the Right Time to Consider Healthcare ETFs?

U.S. healthcare stocks are currently trading at the biggest discount relative to the broader market in 30 years, according to Barrons, presenting a solid opportunity for investors looking for stability and potential growth. 

The Health Care Select Sector SPDR XLV, which mirrors the sector’s performance, has fallen 9.6% over the past year while the broad SPDR S&P 500 ETF Trust SPY climbed about 16%. This has pushed healthcare stocks to trade at a historic valuation discount compared to the broader market. 

The sector has been struggling due to concerns over political and regulatory uncertainties, including government policies targeting prescription drug prices, tariffs on pharmaceuticals, and reduced funding in health research and Medicaid. The expiry of drug patents and setbacks faced by major companies have contributed to the sector's struggles.

In another sign of waning investor interest, healthcare ETFs have recorded 12 straight months of net outflows through July, totaling $11.5 billion. This represents the largest outflow of any sector, according to State Street Investment Management.

Is the Sector Ready for a Rebound?

The healthcare sector has gathered momentum with XLV gaining 4.2% over the past week versus a decline of 0.5% for SPY. This signals potential turnaround and came on the back of attractive valuation and growing hedge fund’s exposure.

Attractive Valuation

The sector is currently trading at a forward P/E ratio of around 16, substantially lower than the S&P 500's P/E ratio of about 22 and far below technology's P/E ratio of 30. This discount is the widest seen in three decades, making healthcare stocks some of the most undervalued in the market relative to their earnings potential.

Buffett Entry Provides A Major Boost

Warren Buffett’s Berkshire Hathaway investment in UnitedHealth UNH lifted sentiment, bolstering confidence in managed-care names. In the latest 13F filing, Berkshire Hathaway disclosed that it bought more than 5 million shares in UNH in the second quarter, valued at approximately $1.6 billion. The stock has soared more than 10% in a week (read: Insights Into 13F Filings: ETFs to Invest in Like Billionaires).

Other Hedge Funds Increase Exposure

Per the latest 13F filings, most hedge funds ramped up exposure to healthcare stocks. Stanley Druckenmiller, renowned investor and head of Duquesne Family Office, has increased his exposure to healthcare stocks as part of a strategic portfolio adjustment during the second quarter. His portfolio, valued at around $3.06 billion, shows a prominent tilt toward innovative healthcare and pharmaceuticals, reflecting his confidence in the sector's growth potential.

Fund managers also highlighted exposure to Regeneron REGN and other life sciences names via both equity and calls, showing targeted science-driven bets.

Corporate Action

Stocks like CVS Health CVS gained on analyst upgrades. Novo Nordisk NVO surged following the FDA approval for a new use of its weight-loss drug (read: NVO Wins FDA Approval for MASH Treatment: ETFs Likely to Gain).

Rotation to Defensive Sectors

Amid growing skepticism over lofty tech valuations, investors are shifting toward more stable, defensive sectors. This has helped healthcare stocks attract renewed attention as a safer haven. Healthcare generally outperforms during periods of low growth and high uncertainty, as evidenced in the current macro environment.

AI and Technology Integration in Healthcare

The emergence of AI-driven healthcare initiatives, such as the Stargate project, promised to revolutionize cancer research and healthcare technologies. This created optimism about innovation-led growth in the sector, attracting investments focused on AI and biotech companies advancing healthcare solutions.

Solid Zacks Sector Rank

The potential upside to the healthcare sector is confirmed by the Zacks Sector Rank in the top 44%, with about 75% of the industries ranking in the top 41%. This suggests that the momentum built up in the healthcare space lately will likely continue in the coming weeks. 

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This article originally published on Zacks Investment Research (zacks.com).

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