August was a blood bath for the S&P 500 (-6.3%) and none of its ten industries were left unscathed. Most unsettling was the 8.1% decline the health care sector suffered (the largest sector deterioration), especially as the move was not reflective of the old Wall Street adage that states price will lead fundamentals. This price performance--or lack thereof--occurred despite the group's outstanding second-quarter reporting season in which growth far outpaced that of any other sector.
We could reasonably understand the stock weakness if the outlook for these health care companies had moved substantially to the downside throughout the reporting period. But it was confirmed that higher enrollments, cost management, and prescription drug sales growth will continue to drive the best growth in the index.
Given the lack of fundamental changes, we view the pullback in health care shares as a profit-taking exercise for investors of what was a high-flying sector ahead of the market plunge that began on August 20th because of worries that China's slowdown would spread. The S&P 500 and the health care index both bottomed on August 25th. Since correcting 10.3% over that period, the sector has regained about half of that decline. Although, we still believe it is attractively valued at 16.8x not only because it's trading at a discount to its historic 15-year average of 17.1x but also because it's trading at its lowest multiple all year.
P/E Ratios by Sub-Sector vs. the Historical Average
We entered 2015 with an overweight recommendation on the sector and we continue to maintain that position now. Remember, according to Sam Stovall, S&P Capital IQ U.S. Equity Strategist, the health care sector has beaten the S&P 500 in each of the past five calendar years (including this one), something no other sector can boast.
Please see our report titled “Health Care Prognosis: Tip Top Condition” published September 17, for a more detailed analysis, including a discussion of fundamental drivers by health care subsectors, a historical valuation table (incl. all subsectors) and which subsectors we favor.