Healthcare Sector Shows Signs of Undervaluation
Aging population and non-cyclical demand could drive a rebound.
The health care sector, as indicated by the Health Care Select Sector SPDR ETF (XLV), has been underperforming compared to the S&P 500. However, with an aging population driving demand, a potential rebound may be on the horizon.
Discounted Valuations
The health care sector’s underperformance is considerable, trailing the S&P 500 by 58% since the pre-pandemic highs of February 2020, and by 23.7% since April 8. Consequently, health care stocks are trading at a discount, with a 2025 forward price-to-earnings (P/E) ratio of 14, compared to the 10-year average of 18.
Some of the index’s largest constituents contribute to this discount. For instance, UnitedHealth‘s P/E is at 13, half its previous multiple. Despite successful obesity drugs, Eli Lilly has also underperformed.
Demographic Trends
An aging U.S. population is expected to significantly increase health care demand. The U.S. Census Bureau projects that by 2030, all baby boomers will be older than age 65, expanding the size of the older population so that one in every five Americans will be of retirement age. With a growing number of Americans aged 65 and older, health care spending is projected to rise, potentially reaching 20% of GDP within seven to eight years.
Defensive Qualities
Health care is generally a non-cyclical sector, offering stability during economic downturns. Demand remains resilient, providing defensive qualities even when discretionary spending declines. A shift toward commercial payers may enhance profitability, although there could be some initial challenges, as seen with UnitedHealth.
Key Players and Low Volatility
Key XLV holdings include LLY, Johnson & Johnson, AbbVie, UNH, and Abbott Laboratories. Despite tracking a single sector, the ETF’s volatility has been only modestly higher than the diversified S&P 500 over the past 30 days, at approximately 11% versus 10%.
Options Trading Strategy
Low volatility translates to low option prices. Traders interested in a bullish bet with limited risk could consider buying January 137 XLV calls for ~$6.20, with implied volatility of about 14%. They could also look for opportunities to sell nearer-dated puts or upside calls to offset decay.