Who is Mark Salzinger?
How to Order
From The No-Load Fund Investor, 11/16...
From Low Risk to High
October was a rough month for most areas of the U.S. stock market. Among the many segments we track in the U.S., the only one to exhibit strength was the financial sector, funds and ETFs for which gained an average of 1.1%. While the S&P 500 lost nearly 2%, small caps did appreciably worse. The Russell 2000 index, for example, dropped 4.8%. Many of the worst performers were in the healthcare sector, funds and ETFs for which dropped an average of 8.8%; REITS fell 4.8%. Besides financials, exceptions to the downward pull in October included some foreign markets, especially Brazil, which continued a politically inspired rally to gain more than 10%.
Though they rebounded somewhat late in October, we were struck mid-month by the declining performance over the past several months of the low-volatility equity strategies that had been all the rage for quite some time before then. Cases in point: Over the three-month period ended Oct. 18, 2016, the PowerShares S&P 500 Low Volatility ETF (SPLV) dropped 5.2%, vs. a fall of only 0.7% for the S&P 500; during this same period, the PowerShares S&P Small Cap Low Volatility ETF (XSLV) gained only 0.4%, vs. a gain of 1.2% for the iShares Russell 2000 ETF (IWM).
Because the performance disparity within the large-cap (S&P 500) space was more pronounced, letís focus there. Ordinarily, when the S&P 500 declines, the least volatile of its components fall less. Thatís because they have lower than average betas, which measure the fluctuations in their prices relative to those of the benchmark. However, that clearly wasnít the case for the period in question. The question is, why not?
We suspect two factors were at fault. The first is that after many months of above-average performance relative to the market and to their own earnings, stocks that are traditionally low in volatility had become quite expensive, as fearful investors favored them as Ďdefensiveí plays and bid them up during the recent years of uncertainty. For example, many stocks in such sectors as utilities and consumer staples, which combine for about 43% of SPLV (but only about 13% of the S&P 500), appreciated to the point where their price/earnings ratios exceeded 20, despite earnings growth of close to zero (in the case of many utilities) or in the mid-single-digits (consumer staples). Second, many stocks with below-average volatility also pay above-average dividend yields.
Vanguard Health: Fund & ETF
US Health Care Index fell more than 6.5% in October, during which virtually no healthcare sub-sector emerged unharmed from the carnage.
For example, pharmaceuticals within the S&P 500 were down 5.2%, while those within the S&P 400 mid-cap index fell more than 10%, on average. Indexes of U.S. biotechnology stocks also fell more than 10%. Many medical-device and healthcare delivery firms, including pharmacy-benefit managers, also dropped.
An interaction between drug pricing on the one hand and the political season on the other has caused investors to sour on the healthcare sector. Much of its increase in revenue and profit over the past several years has been the result of price increases on existing medicines far in excess of the rate of inflation in the overall economy. While pricing power is usually a positive for companies, in healthcare it can result in significant blowback, especially from politicians looking to attract voters during campaigns like the one we have been in lately. However, itís also true that some healthcare companies have been seeing more actual market resistance to price increases, and are responding by trimming growth in the increases, or even cutting prices.
Certainly, thereís a limit to the degree to which healthcare companies can continue growing by raising prices on existing treatments in lieu of introducing therapeutically beneficial new products. However, it seems to me (Editor Mark Salzinger) that current medical needs are so great, for so many afflictions for which there currently exists no very efficacious treatment, that therapeutically oriented healthcare companies have plenty of opportunities to profit from developing multiple new treatments. In fact, currently there are more than 7,000 medicines in development around the globe, according to the trade group Pharmaceutical Research and Manufacturers of America. Some of those most promising from a financial perspective attempt to address any one of sundry areas of inadequately unmet need, including pain management/migraines, next-generation antibiotics, vaccines for various viruses, oncology, autoimmune/inflammatory disorders, and Alzheimerís.
You can read our full analysis on investing in healthcare funds in the November issue of The No-Load Fund Investor.
Sample Model Portfolio from the Current Issue
Best Buy Portfolios
For questions regarding our services or a subscription,
Copyright 2006 The No-Load Fund Investor. All rights reserved.
The No-Load Fund Investor