Health-Care Carnage Is Another Case of Crowded Stocks Unwinding

(Bloomberg) -- Politics may be the root cause, but underlying the carnage in health-care stocks is a lesson investors seem to learn over and over: that too much love can be a bad thing.

Down about 3 percent Wednesday, the industry just wiped out its gains for the year, becoming the only group in the S&P 500 with negative returns. While the loss is less than 1 percent, it’s startling in a year when the broad market is up 16 percent. You have to go back to 1993 -- the year the failed Clinton health care plan was introduced -- to find a wider divergence between the S&P 500 and its health-care subindex at this time of a year.

It’s worth noting that the industry last year overtook technology and consumer discretionary as the most favored group among active managers. At the end of December, drugmakers accounted for 17 percent of hedge funds’ net exposure, the largest among industries, data compiled by Goldman showed.

Money is rushing out of industry-focused exchanged-traded funds and options traders are scrambling for cover. It smacks of the drubbing absorbed by another crowded group, tech megacaps, in the fourth quarter.

“I don’t think this is a deterioration in fundamentals. It’s a story, ‘Let’s lighten up on this area because who knows what’s going to come out of these political debates?”’ Hank Smith, co-chief investment officer at Haverford Trust, which manages $8.5 billion, said by phone. “It has everything to do with politics.”

The rout marks a stunning reversal from last year, when health-care ranked the best in the S&P 500, with gains bucking a broad market decline. At about 15 times earnings, the industry is trading at the biggest discount to the market since late 2017.

About $1 billion has been pulled out of health care ETFs over the past week, while the total market saw more than $5 billion of inflows. Investors are rushing to hedge, pushing the Health Care Select Sector SPDR Fund’s implied volatility to the highest in almost a year relative to the SPDR S&P 500 ETF.

Still, to Jared Holz, a Jefferies strategist who had timely calls on the managed care and hospital sell-off, now it’s too early to buy the dip.

"We believe the entire sector could still come in a bit as profits are taken especially in larger, liquid, well-owned names that have delivered solid returns" year-to-date, he wrote in a note. "We do not believe capitulation has even begun. At all."

Some long-term health investors are also staying on the sidelines into the long weekend. "We’re not buying today, we don’t want to be reactionary," said Christian Fay, who helps manage $3.5 billion at BNP Paribas Asset Management. "It makes me nervous, but ultimately, if you pick good companies with catalysts and high innovation, you’re still going to win. Hang in there," Fay said.

Cyclical Rotation

Helping compound the pain for health-care may be a return of love for stocks that are seen as better positioned to benefit from an economic upswing. As data from China improved and the Federal Reserve signaled its willingness to keep interest rates stable, shares that offer stable earnings and dividends have lagged behind this year’s rally.

Still, the gap between health-care and other defensive groups is wide enough to suggest the sell-off has gone beyond sector rotation. Utilities, the next worst industry, are up 8 percent this year, while consumer staples have climbed 12 percent.

Obamacare Parallel

Health-care has become a regular target during elections as everything from drug pricing to insurance coverage draws growing criticism from politicians. But few proposals have been passed into law. And even when they do, as in the case of Affordable Care Act, known as Obamacare, the pressure on the industry has proved fleeting.

In 2010, when Obamacare was signed into law, health-care stocks were the worst in the S&P 500, trailing the benchmark by 12 percentage points as investors wrung their hands that mandatory coverage would crimp profits at hospital owners and insurance providers.

That quickly dissipated, with the focus turning to overarching demographics that bode well for the group: an aging population. In each of the five years through 2015, health-care shares beat the market. Up 128 percent over that stretch, their return was double the broad index.

“It tends to be a popular topic as you get to election season because it’s one of the pinpoints in everybody’s financial life,” Michael Ball, managing director of Denver-based Weatherstone Capital Management Inc., said by phone. “When all is said and done, it’s not a significant issue,” he added. “You’ve got the demographics that supports health care virtually better than any other industries as far as the need and growth that’s going to be coming there over the next 20, 25 years.”

To contact the reporters on this story: Tatiana Darie in New York at tdarie1@bloomberg.net;Lu Wang in New York at lwang8@bloomberg.net

To contact the editors responsible for this story: Catherine Larkin at clarkin4@bloomberg.net, Scott Schnipper

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