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.
Medtronic executives partly blamed reduced health-care spending for the weaker prospects. Speaking to analysts, Medtronic Chairman and Chief Executive William Hawkins said the softer sales expectations came from high unemployment rates, higher insurance-plan deductibles, and the expiration of health benefits under the COBRA program for laid-off workers. "I'm confident that we'll get through this," Hawkins said. "And that people will return [to] going to see the doctors, and doctors will then basically prescribe what's the right therapy."
Medtronic shares fell 10.8 percent on Aug. 24 in reaction to the forecast and second-quarter earnings, but then rebounded 3.4 percent on Aug. 25 and 26.
The economic woes add to other concerns about health-care stocks, especially the eventual impact of federal health-care reform approved in March. "Health-care reform has been a major headwind for the group," says Steven DeSanctis, a small-cap strategist at Bank of America Merrill Lynch.
The health-care law will not be fully implemented until 2014, leaving investors and executives with lots of questions about its final impact. "The devil is still in the details with regard to health-care reform," says Baird's Good.
Bucking the Trend
Some investors and analysts do see reasons to be optimistic about health-care stocks. DeSanctis says many health-care shares are now reasonably priced, and many health-care companies have strong balance sheets with low debt and high levels of cash.
Jim Thorne, portfolio manager of the MTB Small-Cap Growth Fund (ARPEX), says health-care sales could be boosted by the "globalization of health care," especially investments in new medical technology in such emerging economies as China.
Furthermore, health care is still less economically sensitive than other sectors in the stock market. Many health-care companies should be able to continue growing even if the economy remains weak, Thorne says. "Investors will recognize the historical ability of [health-care] companies to outperform in a slow-growth environment," he says.
Even health-care reform could boost health-care spending, although investors will need to be patient. Radinsky notes that the addition of millions of uninsured Americans to health insurance rolls in 2014 should stimulate "pent-up" demand for medical services.
Until then, though, "health care is a lagging indicator," Radinsky says. It's only after millions of Americans get new jobs—with good health insurance coverage—that they will feel comfortable splurging on expensive procedures.