Are Healthcare And Insurance Stocks Dead In The Water? – Seeking Alpha
Last week, President Trump declared his intention of dismantling the Affordable Care Act in piecemeal fashion by executive decree. In a move that jarred the insurance industry, he signed an order to halt subsidy payments to health insurers. The question confronting investors in the wake of this is what will the President’s move against Obamacare subsidies mean for the insurance industry? In this commentary I’ll address this issue as we examine some market clues for the most likely outcome.
The move wasn’t without controversy as Trump’s opponents in Congress said the move would translate into higher health care costs for the middle class. At least 20 states vowed to sue the Trump administration over the matter. However, it was announced on Oct. 17 that two senators on had finalized a rough outline of a bipartisan deal designed to resume billions of dollars in payments to insurers over the next two years while giving states more say in how they implement rules set out by the ACA.
The bill will now revert to the Senate as the healthcare debate continues. If Congress is unable to arrive at a compromise, however, the issue could become a sticking point in spending negotiations ahead of a Dec. 8 deadline to fund the government.
The President’s executive order did more than just create waves in Washington. In a move that rankled many on Wall Street, the President boasted about triggering a decline in health insurance stocks with his executive decision to end federal subsidies. Several leading insurance companies and hospital operators saw their shares tumble on Friday, Oct. 13, when the decision was made public, including Aetna (AET), Tenet Healthcare Corp. (THC), and Dow 30 component UnitedHealth Group (UNH). In the wake of Trump’s decision, analysts considered cutting fourth-quarter and year-ahead earnings estimates for insurers and hospitals.
Whenever a news-related selling event hits a stock or industry group, the first thing an investor should do to determine if the impact will be fatal to the stock’s established trend is to see how it reacts to the news over a 2-day period. Unexpectedly bad news normally has an unsettling effect on the stock’s price, and this was true for the life insurance stocks as a group on Friday. However, unless the stock or industry group in question is in a particularly vulnerable condition to begin with, bad news is seldom fatal to the established trend. That’s because the strong hands who own the stock(S) are usually informed well in advance of all developments which concern the industry before they hit the news wires.
It was clear to see that although news of Trump’s executive order caused some immediate selling among insurance stocks, most of the damage done to them last Friday was reversed by the close of the trading session.
Many life insurance stocks established a sideways trend in August and have lagged the S&P 500 ever since. This 2-month lateral trend is indicative of what happens when investors are uncertain as to the near-term outlook for the stocks or industry group in question. It’s likely that insiders and informed investors were aware of the Trump administration’s intention of taking executive action on the insurance subsidy issue, which would partly explain the temporary halt in the long-term uptrend for life insurance stocks as a group. Aetna (AET) is a case in point. Although the stock sold off sharply at the open of the Oct. 13 session, by the close it had recovered most of its earlier losses to finish only slightly below the previous day’s close. By Tuesday, Oct. 17, the damage caused by last week’s news shock was complete reversed (see chart below).
Now that the initial smoke has cleared and Congress is attempting to restore the Obamacare subsidies, selling pressure in the insurance stocks should subside even more. Some have already shown strength in the wake of last week’s news, with UnitedHealth Group (UNH) climbing over 5% on Oct. 17 after reporting a strong third quarter. The move was one of the biggest one-day price gains in the company’s 33-year history. UnitedHealth’s CEO David Wichmann said on Tuesday that the potential impact of cost-sharing reduction payments to insurers being withheld is expected to be “extremely small.”
The aggregate trading action of most actively traded insurance stocks this week suggests that investors have completely discounted the President’s executive order. What’s more, they don’t seem too worried about the threat to the subsidies for health insurers. The life insurance industry remains on track for growth in the months ahead, notwithstanding the recent threat to its Obamacare subsidies.
The gradual improvement of the interest rate environment has benefited the insurance industry due to its sensitivity to interest rates and its dependence on investment income. The fact that the Fed has raised benchmark rates three times since last December has benefited life insurers in particular since they have suffered from spread compression on products such as fixed annuities.
As a recent industry report by Zack’s Equity Research observed, “A progressing rate environment will lessen the pressure on the insurers’ investment income, thus boosting their earnings. This in turn will accelerate the insurance companies’ overall growth in the future.”
One of the best ways to play the improvement I expect among insurers in the coming year is the Health Care Select Sector SPDR ETF (XLV). This health care sector ETF is a better investment vehicle for technically minded investors since it has better relative strength versus most blue chip life insurance stocks. While XLV offers some exposure to life insurance companies through the fund’s stock holdings, its main emphasis is on healthcare providers, healthcare equipment and supplies, and pharmaceuticals. My expectation is for XLV to perform in line with or outperform the S&P 500, while making new highs between now and the end of 2017.
While the uncertain fate of Obamacare subsidies has caused many investors to doubt the longer-term prospects for healthcare and insurance companies, the “tape” tells a different story. Indeed, the recent action of healthcare and insurance stocks suggests that insiders and informed investors have already discounted the potential negatives to their industries and are focusing on the brighter prospects of buoyant demand for healthcare services and an improving interest rate environment. The weight of evidence points to continued improvement in both industries regardless of the final outcome of the Obamacare debate.
Disclosure: I am/we are long XLV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.