Health care stocks endure turmoil better than most

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Health care stocks historically provide a relatively safe haven in roiling markets. They’re less tethered to the economy’s every movement than other stocks and tend to be less volatile.

Anxious investors might be considering putting money in the sector, but the current outlook is complicated by uncertainty over the government’s changing involvement in health care. The wild card is potential cuts to Medicare or Medicaid, soon to be considered by Congress’ new debt-reduction supercommittee.

Health care stocks may bounce around more than usual for awhile because of the questions. They still have a strong chance to outperform other sectors in a down market, however.

Q: Is health care still a good defensive play given the possible reductions to entitlement programs?

A: Although extra caution is merited, health care still looks better than most other sectors from a defensive standpoint.

Health care companies’ recent earnings and full-year outlooks have been strong. And although volatility has been high, the sector’s swings have been less severe than in others. The Standards & Poor’s 500 index is down about 5 percent in 2011, for example, while its health care components were up 2 percent through Monday.

One big concern is the hit that pharmaceutical stocks could take. A cutback in the $55 billion a year that the federal government spends on Medicare Part D, its five-year-old prescription drug plan, would likely affect prices.

The impact has to do with the difference between Medicare, which is designed to help with long-term care for the elderly, and Medicaid, which covers health care costs for the poor. Seniors who are eligible for both government programs currently are reimbursed at Medicare rates, which are more profitable for pharmaceutical firms, notes Damien Conover, associate director of equity research at Morningstar. If reductions are made, these seniors could be reimbursed at the less generous Medicaid rates instead.

Another problem that could hurt the stocks is the flood of patent expirations and the shift toward generics. Generic versions of seven of the world’s 20 top-selling drugs will come on the market in the next 14 months, which will further hurt drugmakers’ profit margins.

Still another issue is that health care companies count on the government for more money than any other sector, according to Goldman Sachs, and those amounts are now vulnerable to cuts. It’s not just the drug manufacturers, such as Baxter International Inc. (68 percent of revenue), but a wide range of firms from insurers Humana Inc. (79 percent) and UnitedHealth Group (35 percent) to medical device makers Becton Dickinson & Co. (66 percent) and Medtronic Inc. (61 percent) to for-profit hospital chain HCA Holdings Inc. (41 percent).

The good news is that stock-watchers say the uncertainties already are factored into stock prices.

Better-than-average cash flows and dividends make health care more defensive than the market as a whole, says Mitch Schlesinger, chief investment officer at FBB Capital Partners, an investment management firm in Bethesda, Md.

Among strong companies with attractive dividend yields are Johnson & Johnson (3.6 percent), Novartis (3.6 percent) and Pfizer (4.5 percent). Those looking to buy a fund should consider the iShares S&P Global Healthcare exchange-traded fund (IXJ), which is down 11 percent since early July but still up 0.9 percent this year.

“Health care isn’t what it used to be in the ’90s, when pharmas were coming out with all kinds of miracle drugs and they were considered sexy growth companies,” says Russ Koesterich, global chief investment strategist for BlackRock Inc.’s iShares. “But it’s a reasonable place to hide given the volatility.”