Why Health Care Stocks Are Outshining The Techs

Health care stocks have made a sharp break to the upside so far in the third quarter, leading the S&P 500 Index (SPX) and outpacing tech stocks in the process. As measured by both the S&P 500 Health Care Index and the Health Care Select Sector SPDR ETF (XLV), health care stocks closed Monday just 1.8% below their record highs set in January. "Overall they look quite good," said Matt Maley, equity strategist at Miller Tabak, in an interview with CNBC. The health care ETF, he adds, has "been making a nice series of higher highs and higher lows." Among the big health care stocks posting strong gains recently are Bristol-Myers Squibb Co. (BMY), Celgene Corp. (CELG), Eli Lilly and Co. (LLY), Gilead Sciences Inc. (GILD), Merck & Co. Inc. (MRK) and Pfizer Inc. (PFE).

Healthy Start For The Third Quarter

Stock Gain Since June 29
Bristol-Myers Squibb 8.1%
Celgene 12.4%
Eli Lilly 19.5%
Gilead 9.9%
Merck 9.1%
Pfizer 14.1%
Health Care SPDR ETF (XLV) 7.8%
S&P 500 Health Care Index 7.7%
S&P 500 Information Technology Index 5.4%
S&P 500 Index 4.9%

Sources: Yahoo Finance, S&P Dow Jones Indices; calculations through the close on August 6 based on adjusted close data.

Maley added, "if you see areas like the FANGs and some of these others see a downdraft, that money I think...will continue to flow into some of these health care names." The so-called FANG group of leading tech stocks includes Facebook Inc. (FB), Amazon.com Inc. (AMZN), Netflix Inc. (NFLX) and Google parent Alphabet Inc. (GOOGL). Gina Sanchez, CEO of investment management firm Chantico Global, offered a similar opinion to CNBC, saying, "what we're seeing right now is...a general rotation, not just from technology to health care, but really from 'growthy' stocks to sort of more robust stocks."

Rising Revenues and Earnings

A strong second quarter reporting season is a factor in the recent rise of health care stocks. On a year-over-year (YOY) basis, revenues were up by nearly 9% for the sector, while earnings, boosted to a large extent by federal tax reform, surged ahead by almost 27%, per CSI Market. On a sequential basis, compared to the the first quarter, the increases were approximately 6% and 4%, respectively.

The largest health insurance company in the U.S., UnitedHealth Group Inc. (UNH), also rode these trends, though its stock price gain of 4.7% so far in the third quarter has trailed the health care sector as a whole. UnitedHealth beat analysts' profit estimates partly through an effective tax rate that was even lower than anticipated, The Wall Street Journal reports. Among the stocks listed above, Eli Lilly and Gilead offer representative cases.

Eli Lilly

Eli Lilly's shares are leading the health care stock boom, surging nearly 20% since the beginning of July. One reason is the company's treatments for diabetes, a growing health problem in the U.S. Eli Lilly provides two widely-prescribed drugs to treat the problem: Trulicity and Jardiance, Seeking Alpha reports. Trulicity is projected to post sales growth between 20% and 30% in 2018. The same article indicates that "the company has strengthened its position in [the] inflammation and immunology segment," that it "has some very interesting oncology [anti-cancer] drugs in its portfolio," and that some new drugs launched in the first quarter are enjoying "robust performance."

While Lilly's patents on several major drugs have expired, and its erectile dysfunction treatment Cialis is facing competition from cheaper generics, the company has a target of 5% compound annual growth rate (CAGR) in revenues from 2015 to 2020 that Seeking Alpha believes is in reach. Moreover, the company's guidance on revenues and earnings for 2018 has been increased significantly, with the new lower bounds now above the previous upper bounds of their projections.

Gilead

Biotech stock Gilead has also surged by nearly 10% since the start of July. The company is an important provider of treatments for HIV and cancer, with a "robust drug pipeline" overall, according to a report from Okapi Research republished by Seeking Alpha. Partially a victim of its own success, sales of the company's treatment for the potentially deadly Hepatitis C virus (HCV) have been in steep decline as a result of high cure rates and a decreasing volume of new patients. However, Okapi notes, the HCV business is now so small a part of Gilead's portfolio that it is no longer a major driver of future earnings.

With a large cash hoard, Gilead is in a strong position to buy other companies with attractive drug pipelines and to fund clinical trials, Okapi indicates. As of June 30, Gilead held nearly $32 billion in cash, per Yahoo Finance. Additionally, Okapi sees the potential for a 50% gain in the stock price during the next 18 months, if Gilead's valuation rises to meet that of its peer group, on the basis of enterprise value to EBIT ratios.

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