The advantages behind ETF investing are difficult to refute. Instant diversification at low cost, proven outperformance versus highly paid mutual fund managers, and tax efficiency are just a few of the admirable qualities found in most ETFs. But another idea could even perform better in the current market environment, that is, after a large market drop.
Blue chip rebound
History tells us that bull markets follow bear markets. The difference between a blue chip stock and a speculative stock is, with few exceptions, the blue chip stock will recover from a major downturn. The speculative stock may, but quite often may not. An index ETF will contain both rebounding quality stocks and dead-in-the-water speculative stocks.
Looking to take advantage of the recently hard-hit healthcare sector, I compared the healthcare select SPDR (NYSEARCA:XLV) with two of the large blue chip names found in the ETF, Johnson and Johnson (NYSE:JNJ) and Abbott Laboratories (NYSE:ABT). Going back to the end of the last bear market, July 2002, to the market close on Friday, April 3, produced wide differences in performance. Excluding dividends, $10,000 invested in XLV would grow to $10,860 whereas $10,000 split equally between JNJ and ABT would grow to over $13,000. The difference in performance would even be greater when adding in dividends. Based on today’s dividend yields, owning JNJ and ABT pays 1% per year more than owning XLV and the pair have a history of increasing their dividend faster than the ETF.
The healthcare select SPDR holds 54 companies providing instant diversification with one purchase. But with the purchase of JNJ and ABT, the investor is well diversified in the healthcare segment. Both companies were founded more than 100 years ago and possess an extensive list of blockbuster drugs. Their consumer products divisions contain internationally recognized brands, and their diagnostic and medical device products offer additional diversification.
Time to buy?
Both companies are currently trading well below their historic P/E multiples and are forecasted to produce earnings growth better than 11% for the next five years. Technically, the charts indicate there could still be some downside in the 5 to 10% range over the next couple of months, but probably no more since their fundamentals are so attractive at this point.
What is the Obama risk for these companies? Considering the aging population and increasing longevity in the developed world, any tinkering with the healthcare system will still allow companies with strong R&D, intelligent management and respected brands to grow at healthy rates.
If you don’t already have sufficient exposure in the healthcare area, now is the time to start accumulating JNJ and ABT for excellent, diversified exposure in this critical growth sector.
Disclosure: Author owns a covered JNJ and ABT