Since the Federal Reserve raised interest rates in mid-March, for the second time in three months, U.S. bond yields have declined, and despite expectations (until last Friday) for repeal of the Affordable Care Act, the S&P Large Cap Health Care sector has been the second best performing group in the S&P 500 year to date.
(Related on ThinkAdvisor: Fed Raises Rates; So What Should Clients Do?)
Both developments fly in the face of the conventional wisdom of the market, contradicting what the fundamental factors would seem to suggest, but if you dig a little deeper, those results are not so surprising.
Why Bond Yields Fell After Fed Hiked
“Rates will not move that much higher because the technicals are profound; the bids from pension funds and other institutional investors are extraordinary,” said Rick Rieder, chief investment officer, global fixed income at BlackRock, at a recent breakfast meeting with reporters. “There is not enough supply relative to demand.”
Rieder explained that in addition to U.S. institutional investors, investors across the globe — many from countries with lower and even negative interest rates — continue to purchase U.S. bonds.
As of the close on Friday, the 10-year Treasury was yielding 2.41%, down from 2.60% at the close on March 14, the night before the Fed raised rates. Even the yields on 3-, 6- and 12-month bills had fallen slightly from their closing level on March 14.
Why Health Care Is the Second Best Performing Sector YTD
Nick Colas, chief market strategist at Convergex, a global brokerage firm, wrote that there are several reasons health care stocks have been outperforming:
- They’re cheap. The average forward price-to-earnings ratio of the top five names in the sector, which gained an average 7.9% year to date through Thursday, is 14.5 times, compared with S&P 500’s forward P/E of 17.8 times.
- Many stocks in the sector were expected to perform better if Obamacare were repealed and replaced by the American Health Care Act, including pharmaceutical stocks, which comprise 41% of the sector; biotech stocks, which account for 21% of the sector and medical equipment stocks, with a 16% weighting. In addition, under an Obamacare repeal medical equipment stocks were expected to benefit from the elimination of the medical device tax while biotech companies were expected to benefit from less regulation, allowing companies to bring products to market faster.
- Health care services stocks, which account for 19% of the index, comprised the only major subsector (S&P calls it a “sub-industry”) that was expected to suffer under the Obamacare replacements, also known as Trumpcare or Ryancare.
What’s Next for the Stock Market
What happens now to health care stocks and the broader stock market will depend in large part on what happens to the Trump and the Republican agenda.