By Robert Gold On May 28, we at Standard & Poor's lowered our recommended allocation of the health-care sector to underweight, from marketweight. This means investors should decrease their holdings of health-care stocks to below the sector weighting in the S&P 500-stock index.
We believe the federal and state efforts to cut drug prices, competition in many key therapeutic categories, the flood of generic drugs, and a more conservative Food & Drug Administration will continue to pressure the sector. In addition, federal budgetary concerns could jeopardize reimbursements for new medical technologies.
Medicare reimbursements for medical devices could potentially be squeezed, since Medicare is now making decisions for a so-called budget-neutral environment. This indicates Medicare will only add to expenditures (such as a Medicare drug benefit) at the expense of other areas (devices, hospitals, etc.). Since Medicare has already said it will not lower hospital rates this year, we think it may target devices such as defibrillators, pacemakers, and stents. Nothing is concrete yet, but we are certainly watching for this type of development.
AVOID AND SELL. We still like selected hospital, HMO, medical device, and service names, but we have a bearish stance on drug stocks, including Schering-Plough (SGP), Eli Lilly (LLY), and Immunex (IMNX) -- all ranked 1 STAR (sell). Amgen (AMGN) and Merck (MRK) are ranked 2 STARS (avoid). (For a another perspective, see BW Online, 5/29/02, "Feeling Good about Health Care")
We are also bearish on medical-device names Bausch & Lomb (BOL), C.R. Bard (BCR) and Inhale Therapeutics (INHL) -- which are ranked 2 STARS. S&P has a 1-STAR recommendation on Datascope (DCSP).
In the biotechnology area, S&P analyst Frank DiLorenzo recently downgraded Amgen to avoid and Immunex to sell, to recognize that there are risks to their merger. What's more, Immunex' core arthritis drug, Enbrel, will face stiff competition from Abbott Labs (ABT).
BIOTECH BLUES. The problem of oversaturated drug categories is not solely within the large-cap pharmaceutical space: It also extends to biotech. When combined with extreme valuations within biotech -- which has a very narrow line of products -- and the chance for sharp valuation corrections should the FDA reject a drug, the risk that investors will take more money out of the group are quite high.
For these reasons, we believe both pharmaceutical and biotech stocks will underperform the S&P 500 index over the coming six months. There is a chance for some stumbles within the device group as well. Analyst Gold follows health-care stocks for Standard & Poor's