Macro Wrap – My Bets on Health Care for 2014

by Enis December 20, 2013 6:53 am • Commentary

Today is the last major options expiry of 2013.  Options traders, including ourselves, will mostly be left with options positions in 2014 after today.  In preparation for the start of the new year, I wanted to take a look back at the best performing sectors of 2013.

For simple performance, the Global Macro Monitor blog posts a great recap each day, with yesterday’s year-to-date sector breakdown as follows:

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Consumer discretionary stocks have been the leader, though health care has not been far behind.  Industrials and financials have been the other 2 sectors to outperform the S&P 500 index.

The 35%+ return in the health care sector has perhaps been the most impressive, given its traditional label as a low-beta area of the market.  Part of the performance has been due to the secular tailwinds supporting health care (both in the U.S. and abroad), while part of the strength has likely also been due to cheaper valuations in health care vs. other sectors (I discussed this valuation discrepancy back in March).

Looking forward to 2014, I would still place my bets on health care for the best performing sector.  We continue to find more long ideas in that area of the market (most recently, here, here, and here) than in any other.  Financials are probably our second favorite, with valuations much better than other growth sectors too, but with more significant earnings risk, especially for those financial companies with more volatile earnings streams.

Interestingly, in the most recent BAML Fund Managers survey (courtesy of @ukarlewitz), health care is the one sector of the 4 that outperformed this year for which major portfolio managers are still underweight:

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Of course, not all health care stocks are created equal.  Some of the pharma mega caps (namely, PFE and MRK) are truly stagnant, inefficient bureaucracies rather than innovative growth companies, and a cheap valuation is not sufficient to justify investment.  Yet, when comparing the bulk of the stocks available in the mid- to large-cap arena, health care stocks generally win most relative valuation arguments.

While I would be quite surprised to see another 35% performance from the health care sector (its best annual performance in the past 15 years), I do expect significant outperformance vs. the S&P 500 once again.  We’ll have an especially close eye on the sector leaders in the first few weeks of the new year.