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From The No-Load Fund Investor, 8/15...
Growth Yes, Commodities No
The stock market was strong in July, but mainly in the large-cap area. The S&P 500 was up about 2%, while the Russell 2000 small-cap index was actually down more than 1%. For the year, the S&P 500 and the small-cap benchmark are about tied, with gains of approximately 3.6%, including dividends.
The performance of growth and value stocks continues to diverge. On average, the growth stock funds in our database produced a gain of 1.9% in July, while the value funds only broke even. For the first seven months of the year, growth beat value by 6.3 percentage points: 7.0% vs. 0.7%.
The best performing areas within the U.S. market in July were healthcare, especially biotechnology and pharmaceuticals. Financials also performed well, especially REITs. Most of the worst performers continue to be oriented toward commodities, especially metals & mining and energy. On average, the natural resources funds in our database produced a loss of more than 12% in July. Various emerging markets struggled in July, including such biggies as Brazil, China and South Korea. While commodities and export weakness are broad themes behind the problems, there are also country-specific issues across the emerging market investment universe.
Best Buys Commentary. We are making no changes this month in our Best Buys models, which have done reasonably well so far this year. Our more equity-heavy models (especially the Price models) tilt toward the growth style, which has helped, as has exposure to foreign developed markets. Of course, we also have been helped by not recommending (for several years) any pure commodities exposure, whether to energy gold/silver or natural resources funds of any kind. Many investment adviser firms and big brokerage firms include dedicated exposures to natural resource investments in their accounts for clients. They do this for diversification and inflation protection, and sometimes as a form of market timing
With the closure to new investors of Price Health Sciences (PRHSX) on June 1, several readers not already invested in this fund have contacted us for other healthcare offerings to consider.Their interest makes sense, for the following reasons:
Investment Performance. Over the past five years, healthcare has been the very best performing of all 10 sectors in the U.S. economy, edging out consumer discretionary while easily outpacing all others. The stock-price phenomenon has only increased so far in 2015, as broad portfolios of healthcare stocks have typically achieved total returns in the mid to high teens, while many sectors are down and the overall U.S. equity market is barely up at all.
Economic Independence. While the utilization of discretionary healthcare services falls during recessions, the essential nature of many treatments helps maintain demand and pricing even during difficult economic times. For example, total U.S. spending on healthcare increased by nearly 9% in 2009 from 2007, while the economy shrank overall.
Long-term growth in demand. According to the Henry J. Kaiser Family Foundation, spending on healthcare in the U.S. increased from just $27.4 billion in 1960 to nearly $3 trillion in 2013. Meanwhile, the aging of the population in the U.S. strongly suggests spending will continue to increase at rates faster than the economy at large, such that its percentage of GDP will increase from its current 17% up past 20% in less than a decade. Add in increases in market penetration into other aging countries abroad—including populous countries including China—and the growth potential is clearly considerably greater than the U.S. data alone suggest.
The robust investment returns from the sector have certainly been encouraged by strong operational performance: high profit margins among drug developers, for instance, as well as substantial growth in revenue and profit. However, increases in valuations— including dramatic ones, in some cases—also have contributed to the great performance in the stock market.
Actually, stretched valuations within the sector are cause for concern for investors getting in now, or for those with outsized exposure. At the end of June, for instance, Vanguard Health Care ETF (VHT) had a price/earnings ratio (P/E) on trailing earnings of 32.2, vs. 21.7 for the Vanguard Total StockMarket ETF (VTI). In fact, no other Vanguard ETF representing a major sector of the economy had a P/E of even as high as 25 at the end of June.
You can read more of our analysis of health care funds in the July issue of The No-Load Fund Investor.
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