John Manley

Medical marvels

AdvantageVoice® Blog—11-5-12
John Manley, CFA, Chief Equity Strategist

As of this writing, we stand between the inexplicable and the unpredictable. Hurricane Sandy has come and gone, leaving not only a massive path of destruction in its wake but also a terrible wound to the psyche of anyone touched by it. Now nothing seems immutable and nothing is impossible. Our very sense of predictability is bruised and shaken. How can we possibly know what will happen when the options seem to have multiplied before our eyes?

The election stands before us. The vitriol of the campaign advertisements gives us a good sense of the magnitude of the issues at hand. The outcome of this election is going to be very important. Yet, all seems poised on a razor’s edge. Presidential polls in key states are well within their margins of error. If anything, the president may be the only beneficiary of Sandy as his very able handling of the situation (just ask Chris Christie) garners admiration and pushes Governor Romney and his message to the sidelines. In the Congress, while the House seems likely to remain Republican, the control of the Senate may hang on a few arcane issues in hotly contested districts. It is just too close to call.

I believe that this is a good environment to extend the outperformance of a sector that we have favored for some time: health care. The sector is hardly undiscovered, having led the market in the last year. Its valuation, once at a discount, has moved to a reasonable but not record level.

Source: FactSet.
Past performance is no guarantee of future results.

Source: FactSet.
Past performance is no guarantee of future results.

While these facts would argue for a reduced position, I think there are more compelling arguments to extend our overweighting.

  1. The sector is not cyclical. We are not bearish on the economy, but there are risks. We have cyclical exposure in the technology and energy sectors, but we would like a bit of a hedge in an area not linked to smooth global growth. With the large capitalization health care names, we think we have latched onto a vehicle.
  2. There is more visibility in health care than in many other sectors, in my opinion. While there are political issues, pricing issues, and patent issues, there is still an overwhelming factor: demographics. America has an aging population and older people need more healthcare. There may be arguments about who pays or how they pay, but someone will pay. The demand is basic and keen. I do not see how the demand will be ignored in a wealthy democracy like ours.
  3. The large pharmaceuticals and device companies have tremendous flexibility in the re-investment or distribution of their cash flows. Depending on the political landscape, they can cut costs and deal with higher volumes and lower margins or maintain research, development, and marketing levels if pricing is good enough to pay for them. In the first scenario, dividend payouts would rise; in the latter, earnings should accelerate.

Either way, the companies can cope and even prosper. There are not a lot of industries that offer this combination of visibility and flexibility. I think that we will hold on to this one for a while.

The views expressed are as of 11-5-12 and are those of Chief Equity Strategist John Manley, CFA, and Wells Fargo Funds Management, LLC. The information and statistics in this report have been obtained from sources we believe to be reliable but are not guaranteed by us to be accurate or complete. Any and all earnings, projections, and estimates assume certain conditions and industry developments, which are subject to change. The opinions stated are those of the author and are not intended to be used as investment advice. The views and any forward-looking statements are subject to change at any time in response to changing circumstances in the market and are not intended to predict or guarantee the future performance of any individual security, market sector or the markets generally, or any mutual fund. Wells Fargo Funds Management, LLC, disclaims any obligation to publicly update or revise any views expressed or forward-looking statements.


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