Summary
- Healthcare is a defensive sector that enjoys major secular tailwinds. It is a veritable freight train when you look at the aging demographic trends that are estimated worldwide.
- IYH exhibits low volatility, a low beta, and is extremely resilient in recessionary periods. It sports a 10-year annualized return of 13.56%.
- The top holdings are multi-division juggernauts.
- The fund uniquely aggregates consistent high dividend growers – tickers which exhibit the best long-term performance.
- After a January lull, large-cap healthcare might see a new bid.
Mr. Market knows that "demographics are destiny" in the long run, but in the short run he can get easily distracted. "Squirrel!" he blurts, captivated by that new EV charging SPAC. Graham's weighing machine is left in the corner as he votes with his feet, running over to kick the tires of that new Rivian, visit the metaverse, or buy a Blue Apron subscription with Doge.
With the recent 8.4% rise since January 1, however, the market may have played out its New Year bounce. The last 45 days have all the earmarks of a bear market rally. Yes, the "soft landing / no landing" crowd has been winning the day, but the shorts seem to have reloaded as we enter a post-Valentine's Day seasonal lull pattern. Dan Niles is back on CNBC.
Of course, nobody is particularly scared right now; the recent pandemic has certainly fattened us up. American consumers actually saved quite a bit during their covid recess. Most homeowners refinanced at interest rates of such an epochal low that the Sumerians would have been aghast.
Everyone is shocked at the resilience of this economy in the face of high interest rates, but these things can go "gradually, then suddenly" like a municipal bankruptcy. Late 2023 / early 2024 might be the period when some of that comfortable bulk gets worked off. Credit card debt is way up , repossessions are up , and the plump consumer will run out of money by the summer . It takes a long winnowing after so many years of plumping.
Healthcare: Secular Drivers
The January bounce had a lot of people retreading their old tech winners, but if history is any guide the next three years belongs to healthcare. It represents a segment of economic spending that stays robust during downturns. It is impervious to fall-offs in software demand or home purchases. It holds up well in times of deteriorating credit conditions, when the economy is recessionary, and particularly well when all retail investor interest in the stock market has finally ebbed. It is a clear port in the storm for those mutual funds and active institutional investors that must stay in equities. Sobriety brings people back into the fold.
If demographics are destiny, then the iShares U.S. Healthcare ETF (IYH) is certainly destiny's favorite child. This large cap healthcare fund will be in the sweet spot for the next three years, taking center stage like a proverbial Beyonce? in sequins.
Two "big picture" secular factors that drive the healthcare sector are clear:
1. The aging population of the developed world (and more unexpectedly China) will continue to grow unabated. This UN graph suggests just how dramatically older the world population will be in the coming decades:
Life expectancy at birth --worldwide (United Nations)
In China, the average life expectancy has gone from 52 to 76 in sixty years. That is a billion + people. In the US, 55.7 million people -about 17% of the population- were 65 or older in 2020, up 38% from 2010.
2. The spending on pharmaceuticals and medical products is impervious to recession. Excepting the outlier of the pandemic shutdown period, the following graph is suggestive of its inexorable rise through every downturn since the 70s :
Personal Consumption of Pharmaceuticals and Medical Products ((FED))
Despite a record $372 million into lobbying efforts in Congress last year, the pharmaceutical industry suffered its first legislative defeat in decades. Signed into law by President Biden last August, the Inflation Reduction Act of 2022 allows for Medicare to negotiate the prices of certain prescription drugs, caps out-of-pocket spending for Medicare beneficiaries and insulin costs.
However, these provisions will go into effect gradually over the next three years, and even if personal consumption expenditures for pharmaceutical and other medical products flattens somewhat in the US, the number of elderly being adding to the ranks will continue for decades. US dollars per capita will continue to increase.
US dollars per capita (Nationmaster.com)
Each and every day this year (2023), approximately 11,000 baby boomers will turn 65, accelerating the trend. By 2030, all baby boomers will be 65. As about 50% of an average American's lifetime medical costs will occur while on Medicare, this means more wood on the proverbial fire.
Better diets might be part of this trend, but a lot of it is happening because of pharmaceutical use and available medical procedures. As one analyst has suggested , there is a feedback loop to it: "The more care you get, the longer you should survive; thus the more you might need additional medical care."
IYH: Intrinsic Elements
Since its inception in 2000, the IYH has sizeably lapped the S&P 500 in total return:
IYH versus S&P 500 --Total Return (2000 - 2023) (Seekingalpha.com)
The reason of outperformance is best explained by a series of four factors:
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It is resilient across all market conditions:
IYH embodies a sector that is resilient during both deflationary recessions and inflationary periods. During disinflationary recessions, Healthcare is less affected by corporate capex and discretionary consumer spending, both of which go into hibernation. During inflationary periods, healthcare is less exposed to "buyer boycotts": healthcare providers are typically able to pass-through inflationary price increases directly through to the consumer and their insurers.
2. It exhibits lower volatility and shorter drawdowns
With a low beta of .66, IYH exhibits classic resilience. IYH has a 3 year standard deviation of 16.21%, which is about 33% lower than the S&P 500 (24.19%) and the medium of all ETFs (24.24%). It has an alpha of 6.08, a Sharpe ratio of .66, a 5 yr Sortino of .78 , and a 10 year annualized return of 13.56% --all for an agreeable expensive ratio of .38.
In terms of drawdowns: comparing IYH to the S&P 500 in the last two bear markets, you see a vehicle that experiences a far shallower drop and a quicker resumption to positive returns - often by years.
Here is a chart that chronicles the Global Financial Crisis (and the market downturn that starts in mid-October 2007):
IYH performance during the Global Financial Crisis (October 2007 to March 2009) (Seekingalpha.com )
IYH fully moves into positive territory on November 28, 2011, years before the S&P 500 which was still down 23% that day and only goes positive on March 8, 2013.
The following is the Dotcom bust period, which, like our pandemic moment, had big "pull-forward" in corporate tech spending for another "force majeure" moment: Y2K.
IYH Performance during Y2K Downturn (March 2000 to October 2002) (Seekingalpha.com)
IYH held up far longer initially -only fully buckling in late 2001. But it was back in positive territory by May 3, 2005 (in terms of total return), 8 months before the S&P 500.
3. IYH holdings are large-sized, multi-division behemoths:
IYH is home to the largest healthcare companies. 52% of this ETF is in its top ten holdings, all of which put up massive top-line numbers. The ETF's #1 holding (8.91% weight), UnitedHealth Group (UNH) is expected to generate $355 billion FY23; # 2 (8.25%), [[JNJ]] is expected to make $97.73 Billion.
Top Holdings --IYH (Feb. 14, 2023) (Top holdings)
These firms are often so large and diversified that they are virtually like mutual funds unto themselves --in the way they have so many divisions hammering on different cylinders. UnitedHealth Group is a diversified health care company that operates through four segments: UnitedHealthcare, Optum Health, Optum Insight, and Optum Rx.
JNJ is so diversified -with wide ranging brands like Aveeno, Tylenol, and Nicorette- it will be breaking into three companies in November. (Probably helping to unlock value for IYH shareholders.)
4. Its holdings are companies that consistently pay dividends and --more importantly-- exhibit dividend growth .
IYH doesn't have the highest dividend payouts (1.11%), but it may offer the best dividend safety and growth in the vast ETF universe. In fact IYH, is unique to all major ETFs in its " number of Consecutive Years of Dividend Payments " - 20 years straight (as opposed to the ETF average of 3).
Though the yields are lower than other sectors, these healthcare companies might be preferred, as they provide impressive dividend growth with low payout ratios. Its top holding United Healthcare has a dividend growth rate of 17.36%:
United Healthcare Dividend Growth (10 year) (Seekingalpha.com)
UNH's current dividend is $6.60/share, which represents an estimated payout ratio of 28.84%.
Thermo Fisher ( TMO ) is another great dividend grower --with a 5 year growth rate of 14.87% and a low payout of 5.15%(!) as is Eli Lilly ( LLY ), with a 5 year growth rate of 13.91% with a 49% payout.
Merck (MRK) offers a better yield of 2.74%, higher than the prior three, with a growth rate of 9.21% and a 12 year track record.
MRK dividend growth (Seekingalpha.com)
The holdings of IYH exhibit a deep bench of stocks that have these characteristics.
It is well known that over the long term, companies that initiate and consistently grow their dividends have outperformed the broader market, and have significantly outperformed stocks that cut or don't pay dividends. Less known is that dividend growers consistently beat their brethren in total returns over the long run (in this case from 1972 to 2018)
Dividend Growers Prevail in the Long Term (Ned Davis )
Dividends provide investors with protection in down markets, giving investors an easy way to automatically "drip invest" into the stock at fallen prices. The fact that these dividends grow larger, adding further shares even in a fallow period, is a bonus.
Paying a dividend enacts discipline; it attracts investment and keeps management a bit more focused. By reducing the amount of cash it might spend on marginal projects, it forces them to focus only on the highest return opportunities. A low payout ratio, the ratio of dividends to earnings, is also critical to look for as it ensures perpetuity.
Near-Term Set Up
IYH clearly has secular tailwinds and several factors intrinsic to its makeup that make it a good ETF for a more risk-off environment. Now let's look at its near term technical set-up as a trade.
The three year weekly chart of IYH suggests a MACD that topped out 8/30/2021 at $296. The higher prices the ticker achieved in late December 2021 ($302) and again in April 2022 ($300) were not confirmed by the MACD, which fully bottomed with an abandoned baby doji on 9/26/2022 at $253.
IYH Two Year (Weekly) Chart --Feb 14, 2021 to Feb 17, 2023) (Schwab)
From early October to mid December, the stock climbed to $292, and since then has drifted down to its present price of $277.
IYH is now down -1.8% YTD and has been drifting in price incrementally since December 13, 2022. This is hardly panicked selling but rather disinterest (as the market reached for more speculative names in January), though a few tickers have seen a more pronounced sell-off --JNJ on legal issues and LLY for being so over-bought most of 2022 on anticipation of its obesity drug. (Ironically Surmount-2 results finally arrive in late April).
The near term chart of IYH suggests an entry point soon. It is approaching its 200 day ($271) and its slow stochastic is approaching oversold. After the recent two month lull, large cap healthcare might see a new bid as traders go risk-off.
For further details see:
IYH: Destiny's Favorite Child