Health Care and Utilities: Not So Safe?

For a stock market in turmoil, wild price swings are nothing new. But in the last few weeks volatility has hit health-care and utilities stocks, parts of the market usually known for their quiet and calm.

Scott Jacobson, an expert on volatility and chief investment strategist at Capstone Sales Advisors, says volatility "rose significantly" in these two sectors. New policy proposals from the Obama Administration are behind investors' uncertainty, he says. Health care and utilities are traditionally defensive sectors, investments that hold up well in recessions. After all, medical care and power are necessities, not luxuries, for most.

On Feb. 24, President Barack Obama gave a speech to Congress that made clear he would get serious about two policy goals with a direct impact on investors: health-care reform and regulations fighting climate change. Obama's positions on the issues aren't new, but many weren't expecting him to tackle the goals so early in his administration. And the scope of the policies, contained in his proposed 2010 budget, surprised some. The President proposed "an historic commitment to comprehensive health-care reform—a down payment on the principle that we must have quality, affordable health care for every American." And he asked Congress "to send me legislation that places a market-based cap on carbon pollution and drives the production of more renewable energy in America."

Health-Care Stocks Swoon

Until Feb. 24, health-care stocks—measured by the Dow Jones U.S. Health Care Providers Index—were down just 1.65% for the year. Compared with the 14.4% drop in the Standard & Poor's 500-stock index, the sector was a refuge. Then between Feb. 24 and Mar. 5, the health-care sector dropped 22%, compared with an 8% decline for the S&P 500. Health-care shares have since rebounded 11%, roughly in line with the market.

Movements of utility stocks were less extreme, but shares in the sector have swung more wildly than usual. As measured by the Dow Jones U.S. Utilities Index, utilities performed about 4 percentage points better than the market in the first two months of 2009. Then, after Obama proposed climate change regulations, utilities fell 11.2%. Since Mar. 9 they have rebounded 9.5%.

Health-care sector analyst Cindy Axelrod of Glenmede Investment Management says the main problem for investors is that Obama's plans for health care are still rather vague. The Administration has laid out broad goals but is letting Congress fill in many of the details. "The market hates uncertainty," she says. "We don't have a lot to sink our teeth into at this point. That's what's really scaring Wall Street."

Uncertainty About Climate Change Rules

Investors expect federally mandated cost-cutting to shrink profits at large pharmaceutical and insurance companies. But by how much? There could also be winners in any reform effort, Axelrod says, citing companies involved in the cheaper generic drug business like Express Scripts (ESRX), which manages pharmacy benefits (Glenmede owns shares.)

Among utilities, climate change regulations create a similar degree of uncertainty. "There are a lot of proposals floating around that could be good and could be bad for utilities, depending on how politicians decide to implement them," says Morningstar (MORN) analyst Travis Miller.

Restricting carbon emissions could be expensive for utilities, but the companies may be able to pass those costs through to consumers in the form of rate increases. Electricity rates are usually set by state regulators, so utility investors are already used to dealing with political uncertainty. "If you're a regulated business, you're used to being at the whim of politicians," Miller says. Now, however, "Washington is getting involved in a big way."

Whatever the merits of climate change or health-care reform efforts, it's obvious Washington policymakers could be a main factor in how the two stock sectors perform. But other influences such as the economy are at play, too.

"Not Immune to the Recession"

At least some of the regulatory threat to health-care and utility profits has been reflected in stock prices for months—and even years. Investors have worried about health-care regulation since Democrats took control of Congress in 2006. Republican Presidential nominee John McCain also proposed climate change regulations. "Electric utilities have for years known there was increased pressure on cutting emissions," says Justin McCann, a senior industry analyst at Standard & Poor's Equity Research (S&P, like BusinessWeek, is owned by The McGraw-Hill Companies (MHP).).

Also, though health-care companies and utilities have a reputation for resisting broader economic forces, that has been less true lately, especially in this economy. "While the [health-care] sector is generally defensive, it's not immune to the recession," Axelrod says. She sees consumer spending on health care falling faster than in past downturns.

Because of the recession, electricity usage is down and utilities also worry about customers' uncollectible bills, McCann says. And since deregulation in the 1990s, many utility stocks have been less reliable and more sensitive to swings in the price of oil and gas. "You now have a segment of the industry"—so-called merchant utilities, as opposed to regulated utilities—"that is a very volatile, commodity-based business," Miller says.

Utilities used to be valued for their steady, consistent dividends. But a wave of dividend cuts in the last month shattered many illusions, McCann notes. Great Plains Energy (GXP), Ameren (AEE), and Constellation Energy (CEG) all slashed payouts. "The whole market is extremely edgy," McCann says.

More detailed proposals from Congress and the Administration could eventually lessen the swings in utility and health-care stocks, as investors get a sense of who will win or lose in the Obama era. But tranquility is unlikely to return to the sectors until the economy stops sliding.