In down economic times, the healthcare industry (NYSEARCA:XLV) has been a safe haven for investors. With the baby boomer generation ageing, the demand for medical services is expected to increase as their health deteriorates. However, reality is not that straight forward. A variety of governmental and industry specific factors, prevent me as an institutional investor from either going long or short in healthcare.
Here are the reasons why investors should stay away from healthcare:
1) Risks of Obamacare- The new policies and constitutionality of Obamacare is a critical to the future of the healthcare industry. Whether the Supreme Court upholds the law, strikes it down, or just bans the mandate clause, it will have large implications for health providers. Maintaining the mandate seems positive for health insurers, but further government socialization in the industry can reduce long run profitability. The worst case scenario for the healthcare industry is removing solely the mandate as it increases regulatory costs without the guarantee of an increased client base for health insurers.
2) Other Regulatory Risk- Outside of the implications of Obamacare or any degree of socialized medicine, regulatory risks still dominate the healthcare industry. FDA rulings and patent judgments can make a pharmaceutical company or biotech firm gap up or down 20%+ on a given day. In addition the degree litigation in this industry and policies related to allowing foreign competition, hospital budgets, and other government barriers can easily derail a sound investment thesis.
3) Healthcare has Signs of a Bubble- Similar to the how society viewed housing and education, the healthcare industry has an aura of invincibility. Claims such as there is no limit of demand for healthcare and that there are no layoffs for healthcare workers reek of a bubble (add more examples from windows.) Healthcare costs have also risenthree times the rate of inflation since 2002 and has grown from 12% of GDP to over 16% of GDP since 1990 as well. Is that sustainable?
On the other side, there is theorectically not limit for healthcare demand as individuals will spend whatever it takes in medicine or surgery to survive. An ageing population also favors the industry. However, with the shortfall in retirement savings of the baby boomers and the future liabilities related to Medicare growing unsustainable, who will foot the bill for all of this healthcare?
4) Complexity of Product- As Peter Lynch famously wrote in his book One Up on Wall Street, invest in what you know. And unless if you are a practicing doctor or have a education in chemistry, it will tough for you to understand how advanced medicine and medical devices actually work. This is very important because there is no way to have an educated opinion on the effectiveness of a given product and how much value does it really contribute to the bottom line. Investors without a medical background can also have a hard time spotting potential fraud in this industry relating to issues such as undisclosed side effects in a pharmaceutical drugs.
Due to the complexity of the products and government interference in this industry, I cannot recommend investors to buy or short healthcare stocks. A better defensive play would be to either in the consumer staples industry, agriculture investments, or buy technology stocks (one of the few American industries with a global comparative advantage) with short position hedges during times of economic uncertainty.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.