Health care stocks are leading gains in U.S. equities this year for the first time since 1998 as companies cut costs and investors speculate an expansion of insurance programs will benefit hospitals and insurers.

Drugmakers, health insurers and biotechnology companies in the Standard & Poor’s 500 Index have returned 12% in 2013, including reinvested dividends, the most among the 10 main groups. That’s the first time in 15 years that the industry has led over the first 79 days into a year. Analysts project profits will rebound from this year’s zero growth in 2014, according to data compiled by Bloomberg.

 “There is certainly a re-acceleration in growth prospects,” says Timothy Hoyle, director of research and fund manager at Radnor, Pennsylvania-based Haverford Investments. His firm oversees $6 billion. “Most of the big drug companies have experienced patent cliffs and are now repositioning themselves for growth.”

Health care stocks are rallying as estimates from the Congressional Budget Office show President Barack Obama’s health law may extend insurance over the next decade to about 27 million people who are currently uninsured. Companies in the industry such as Pfizer Inc., the world’s biggest drugmaker, have cut jobs and sold off businesses to boost profits and fund share buybacks. U.S. regulators approved 39 new drugs last year, the most since 2000, data from Bloomberg Industries show.

Annual advance

The last time health care companies led the S&P 500 in the first three months of the year, in 1998, the industry surged 42% in the third-biggest gain on record, data compiled by Bloomberg show. The U.S. equity benchmark posted an annual gain of 27%.

The measure of drugmakers and biotechnology shares added 0.5% as of 10:43 a.m. in New York on Friday, poised for the 11th weekly gain in 12 weeks.

All but five of the 53 stocks in the S&P 500 Health Care Index have risen in 2013. Celgene Corp., a cancer-drug developer, and Tenet Healthcare Corp., a hospital chain, led the advance, surging 42% and 39%, respectively. That compares with a 8.4% advance in the S&P 500.

Profits from health care companies in the S&P 500 will climb 8.4% next year, according to analysts’ estimates compiled by Bloomberg. Growth stalled at 0.9% in 2012.

Pfizer has rallied 29% in the past year after the U.S. Food and Drug Administration has approved its arthritis and blood thinner drugs and the company divested its infant nutrition and animal health businesses.

Reduced Expenses

The New York-based company has reduced operating expenses by 13% since 2010 while cutting 30,500 jobs in the past nine years. Pfizer bought back $8.2 billion of its own stock in 2012 and announced a $10 billion repurchase program in November.

 “The industry is slimming down,” says Dan Popowics, a portfolio manager for Fifth Third Asset Management in Cincinnati. His firm oversees $8.1 billion. “You have a lot of large companies doing shareholder-friendly activities, and all are benefiting from new product flows.”

Health care shares are also catching up after trailing during the last bull market, Popowics says. The industry is among the three groups in the S&P 500 that didn’t make new highs during the 2002-2007 rally.

Abbott Laboratories split off AbbVie Inc., a drugmaker based largely around a rheumatoid arthritis injection, in January, leaving the rest of the company to focus on medical devices, diagnostics, nutrition and generic drugs. Since the split, Abbott has gained 6.8% and AbbVie is up 13%.

Amgen rally

Amgen Inc., the world’s largest biotechnology company, raised its quarterly dividend by 31% to 47 cents a share in December and said it would repurchase $2 billion in shares. Shares of the Thousand Oaks, California-based company are up 9.4% this year, extending a 34% rally in 2012.

Gains are poised to continue as Obama is seeking to deliver affordable health care to the nation’s 48.6 million uninsured, according to John Stoltzfus, chief market strategist at Oppenheimer & Co.

The Patient Protection and Affordable Care Act, which passed Congress in 2010, is the biggest change to the U.S. health care system since Medicare and Medicaid began providing taxpayer-funded services for the poor, elderly and disabled in 1965. Under the law, insurance plans will have to compete for the new customers on state-by- state exchanges where consumers can comparison-shop.

Expanding Medicaid

“In the long run the economic benefits of the states will be such that most states will eventually expand Medicaid and we’ll see significant growth not just in 2014 but beyond in this space,” Richard Zoretic, who heads the Medicaid business at WellPoint Inc., the second-biggest U.S. health insurer, said in a Jan. 23 conference call with analysts.

Federal spending cuts and efforts to rein in medical costs threaten sales for drugmakers and health insurers, according to Mike Binger, who helps oversee about $300 million as senior portfolio manager at Gradient Investments LLC in Shoreview, Minnesota.

 “It’s everyone’s mandate, whether you’re in the public sector or in the private sector, to try and control health-care costs,” says Binger. “How that’s done over time is probably the biggest risk.”

U.S. House Budget Committee Chairman Paul Ryan on March 12 unveiled a proposal in which $700 billion would be taken out of Medicaid, the health care program for low-income Americans. He also called for an overhaul to Medicare by giving people now under age 55 fixed sums. The program is currently open-ended.

Shares surge

Health care shares have more than doubled since March 2009 and in July became the third industry in the S&P 500 to hit an all-time high. The S&P 500 is about 1% below its 2007 record.

The rally has boosted valuations for health care shares to the highest in five years, narrowing its discount relative to the S&P 500. The industry trades at 15 times earnings, compared with a multiple of 15.2 for the U.S. equity benchmark, data compiled by Bloomberg show.

The last time that drugmakers and health insurers traded at a premium to the S&P 500 was between 1994 and 2008, when the valuation gap averaged 17%. The group had a discount as wide as 47% in 2009, according to data compiled by Bloomberg.

Expanded insurance coverage will bolster sales and help drive continued multiple expansions, according to Dan Teed, who helps oversee about $125 million as president of Wedgewood Investors Inc. in Erie, Pennsylvania.

 “This is the moment of the sun for the industry,” says Teed. “We’re looking at increasing the base of the entire industry, not just a few companies.”

To contact the reporter on this story: Lu Wang in New York at lwang8@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

Register or login for access to this item and much more

All Employee Benefit News content is archived after seven days.

Community members receive:
  • All recent and archived articles
  • Conference offers and updates
  • A full menu of enewsletter options
  • Web seminars, white papers, ebooks

Don't have an account? Register for Free Unlimited Access