Wednesday, March 24, 2010

Health Care Overhaul

After what seems now like an eternity, health care reform legislation was finally passed by the House late this past Sunday. As the investment team at Pinnacle gathered on Monday, we were eager to watch and observe the market’s opinion of the bill. Some pundits were worried that the stealth taxes increases contained in the bill would roil markets. After all, not only is the Medicaid tax being raised (1.45% to 2.35% on households making more than $250,000), but a new Medicare tax on income will also be assessed going forward. Others were worried that health care stocks might be spooked by the reconciliation process, which will play out in the Senate this week and creates some uncertainty as to the finality of Sunday’s vote.

Well, it’s only been a couple of days, but so far the stock market, and health care companies in particular, seems to be taking the bill in stride. Yesterday, the S&P 500 broke out to a new high for this cycle (1,174). As for health care stocks, they are doing just fine. In fact, the pharmaceuticals industry appears to be really celebrating the last few days, presumably loving the fact that there is no reduction in drug patent lives, and that the mandate for coverage should increase the top line more than the fees and other concessions affect the bottom line.

We have been bullish on health care stocks for quite some time, and are overweight the sector (along with technology) within the domestic equity allocation of Pinnacle portfolios. Cheap valuations, positive pricing power, and a number of other positive micro factors embedded within health care industry groups are among the reasons for being overweight. Our stance regarding legislation and its impact on the stock market has been that it would likely be more bark than bite. Admittedly, the reconciliation piece of the bill is not passed, we are only a few days out from the passage of the bill, and some states are threatening to fight the mandate for coverage on the grounds that it’s unconstitutional. We’ll keep watching and assessing the situation, but so far, it appears the market agrees with our thesis.

Chart: iShares Pharmaceuticals ETF (Symbol: IHE)