Signs of Life in Small-Cap Health-Care as S&P 500 Floats Higher

  • S&P 600 Health Care Index trading near all-time high
  • Mergers and acquisitions, renewed risk bid lift index

For all the dread surrounding central banks and valuations, risk appetites are being fed in at least one corner of the stock market.

The S&P 600 Health Care Index of small caps posted a fifth-straight gain, surging 2.5 percent to briefly touch an all-time high. Its larger-company counterpart rose 1.1 percent over the same period, and sits 6.5 percent below its record. The outperformance is reason for optimism to JC O’Hara, chief market technician for FBN Securities Inc., who says it’s more evidence investors are being weaned of their defensive obsession.

U.S. stocks closed little changed for a second day following another afternoon fade, as sentiment wavered before key policy decisions Wednesday from the Federal Reserve and Bank of Japan. The S&P 500 Index added less than 0.1 percent to 2,139.76 at 4 p.m. in New York, after climbing as much as 0.6 percent.

“From a top-down point of view, when you have strength in small caps in any particular sector, it’s a sign of risk-on and it’s taken as an offensive signal for the market,” said O’Hara by phone. “The ability to take on risk and buy individual companies is starting to happen again.”

A brightening forecast for biotechnology acquisitions is partially behind the resurgence of small-cap health-care companies. On Tuesday, Allergan Plc agreed to purchase Tobira Therapeutics Inc., while other companies are looking to buy Bayer AG’s dermatology unit. 

Still, it’s an about-face from the sentiment surrounding biotech and health-care stocks to start the year, when stretched valuations and concerns about global growth sent small-cap shares tumbling into a bear market. While it isn’t unusual for the shares to lead equities out of a downturn because they are less liquid and also tend to fall harder, the speed and force of their recovery is what’s notable.

The small-cap health index has outpaced the S&P 500 Health Care Index by 5 percentage points from the start of August through Monday. That’s lifted the gauge to its highest-ever level relative to the large-cap index. Among individual companies, MiMedx Group Inc. and Phibro Animal Health Corp. have surged more than 21 percent in the past month.

In Tuesday’s trading, the Dow Jones Industrial Average rose 9.79 points to 18,129.96, nearly wiping out a gain of more than 100 points for a second day. The Nasdaq Composite Index increased 0.1 percent. About 5.9 billion shares traded hands on U.S. exchanges, 13 percent below the three-month average.

“People are waiting for the Fed and the Bank of Japan,” Jim Davis, regional investment manager for The Private Client Group of U.S. Bank, said by phone. “The overall market is positioned for the Fed not to do anything. We’ve had a reset and we’re back to where we were pre-Brexit. Investors are seeking affirmation that central banks are going to continue to be somewhat friendly.”

Stocks have struggled for direction since Sept. 9, when worries that central bankers may be less committed to further stimulus efforts spurred the biggest slump in more than two months, ending the summer’s calm. Amid swings between gains and losses as investors assessed economic releases and comments by Fed officials, the S&P 500 eked out an advance of 0.5 percent last week. The benchmark is trading at 18.3 times estimated earnings, its highest since 2002.

A report today showed new-home construction fell more than projected in August, representing a pause after a spell of strong gains. Permits, a proxy for future construction, unexpectedly slipped on fewer applications for apartment projects. It’s the last piece of significant data before the Fed announces its rate decision and Chair Janet Yellen holds a press conference tomorrow afternoon. The Bank of Japan will also undertake a review of its monetary policy, with its outcome due before Wednesday’s Fed statement.

The housing starts data added to a recent slew of weaker-than-forecast reports that has lowered trader odds of higher borrowing costs this month to 22 percent, from more than 40 percent in late August. A Bloomberg gauge tracking the degree to which data miss or exceed economists’ estimates is hovering near a two-month low.

“It really is only about central banks,” said Christian Gattiker, the Zurich-based head of research at Julius Baer Group Ltd., which manages about 284 billion Swiss francs ($290 billion). “We’re generally in a bit of wait-and-see mode and it will depend on how much we get in terms of direction. A hike this month is priced out, but the market is waiting for guidance whether it’s going to happen in December or next year.”

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