Stocks & Markets August 26, 2010, 7:31PM EST

Frugal Consumers Hurt Health-Care Stocks

Amid angst that the U.S. economy might be slowing, health care—a sector usually billed as resistant to economic downturns—is feeling the effects

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Investors traditionally have viewed shares of health-care companies as havens from economic concerns. Now, many parts of the sector have drawn concern from investors amid worries the U.S. economy will slow in the second half of the year.

"Health-care stocks are much more sensitive to the economy today than they've been in the past," says Jonathan Good, a research analyst at investment manager Robert W. Baird in Milwaukee.

So far this year, U.S. patient visits to doctors' offices fell 7.5 percent to 10 percent in the second quarter from a year ago, according to estimates by Elie Radinsky, a health-care analyst and managing director at Chapdelaine Credit Partners.

For a variety of reasons, Americans seem to be using health-care services less than in the past—a metric health-care experts call "utilization." Says Radinsky: "We've actually seen a decline in medical utilization at a relatively fast clip."

What the Numbers Show

Government data still show spending on health care continuing to rise, but at a slower rate. According to the U.S. Bureau of Economic Analysis, Americans in June spent at an annual rate of $1.68 trillion on health care, the most recent figure available. Spending rose 3.2 percent from the previous year, however, slower than the 5 percent rate in the previous 12 months. That matches the rate of health-care inflation, as captured in a 3.2 percent rise in consumer prices for both medical care and products in the 12 months ended July, according Consumer Price Index data from the Bureau of Labor Statistics.

"I don't think we've suddenly gotten healthier," says J.B. Taylor, portfolio manager of the Wasatch Core Growth Fund (WGROX), of slower growth in health-care spending. Rather, consumers may be skipping doctor's visits and delaying procedures to save money.

Not all industries within the health-care sector feel the economic slowdown equally. Health insurers actually benefit when their insured patients see the doctor less often. Biotech companies can ignore the macroeconomic environment if they benefit from particular drug discoveries.

"You have to look at health care on a case by case basis," says Eric Marshall, co-manager of the Hodges Small Cap Fund (HDPSX).

Some Doing Better Than Others

Within the small-cap Russell 2000 index, companies in the pharmaceutical, biotech, and life science categories boosted sales 19 percent last quarter from a year ago. Companies in health-care equipment and services, however, increased sales only 5.4 percent, a steep drop from their 19.8 percent growth rate two years ago.

Since the beginning of 2010, the health-care sector of the Russell 2000 is down 6.9 percent, the second-worst performer among nine sectors. In the large-cap Standard & Poor's 500 index, the health-care sector has fallen 9.7 percent, the third-worst performer among 10 sectors.

Some groups within the sector have been even harder hit. The S&P 500's Health Care Equipment index is down 18.8 percent since the start of 2010, while the S&P Health Care Supplies index is off 19.2 percent.

While consumers who lose their health insurance are often forced to skip treatments, Radinsky believes the biggest cost-cutting is driven by consumers who have commercial insurance. They may skip doctor's visits to avoid paying higher insurance copayments, or worried about their jobs, they may be reluctant to miss work for major procedures.

Cutting Back Forecasts

On Aug. 24, Medtronic (MDT), the world's largest maker of heart devices, said it expected sales growth of 2 percent to 5 percent in 2011 on a constant currency basis. In June, the company was predicting growth of 5 percent to 8 percent.