This Particular Stock Bubble Is Bound to Burst in 2015

The best days for healthcare stocks are now behind them

Nothing lasts forever, and theme-based stock rallies are no exception. Indeed, the entire investment industry is one that relies on a never-ending cycle of booms and busts. The trick is getting out at the peak of the booms, and getting in at the trough of the busts.

With that in mind, the last couple of years have inflated one particular stock bubble that’s ripe to pop in 2015. In fact, the contraction may have already begun as calendar 2014 was being closed out. That bubble? Healthcare stocks, and biotech stocks in particular. An Obamacare-driven rally from these names looks like it has more than run its course, and that pendulum is now poised to swing in the other direction for a while.

2014 Was a Banner Year for Healthcare Companies

Healthcare Stocks PerformanceJust for perspective, the iShares Dow Jones US Healthcare ETF (IYH) gained 24% in 2014. It wasn’t actually the top-performer last year.

That honor belongs to the utility sector. Healthcare stocks were the second-best performer in 2014, though, doubling overall market’s 12% gain for the same timeframe.

The onset of the Affordable Care Act gets a great deal of the credit for last year’s heroic run from the healthcare sector. Millions of newly-insured individuals decided they may as well utilize the insurance they were mandated to have. Obamacare wasn’t the only wind blowing in the industry’s favor, however.

In 2014, the biopharmaceutical industry really started to shrug off the ill effects of falling off the so-called patent cliff with the introduction of a plethora of new revenue-bearing drugs.

As of the most recent look, the Food & Drug Administration approved 41 new molecular entities/novel medicines for 2014. That’s the highest number in over a decade, and leaves 2013’s 27 NME approvals in the dust. An inordinate number of those 41 approved drugs were biologics, a more advanced and more effective category of pharmaceuticals.

The market rewarded that success, too. The iShares NASDAQ Biotechnology Index ETF (IBB) was up a whopping 35% last year, doing the bulk of the heavy lifting for the entire healthcare sector in 2014.

All told (and assuming analysts’ targets for Q4 are relatively on target), healthcare companies pumped up income to the tune of nearly 16% in 2014. That’s second-best for all sectors last year. Healthcare stocks are also projected to lead income growth in 2015, with Standard & Poor’s suggesting an earnings growth outlook of 23% for the industry over the next twelve months.

So with all this drug approval momentum against a backdrop of the fact that Obamacare isn’t going away anytime soon, what not to like about healthcare stocks in 2015?

In simplest terms, expectations are too high, and opportunities are shrinking. Those are two ingredients for a dangerous stock bubble.

Healthcare Stocks Look Pricy, All Things Considered

While healthcare stocks may look poised for another year of big growth, investors are also paying an equally big price for them — perhaps too big.

As of the latest data from Standard & Poor’s, the S&P 500’s healthcare stocks are priced at an average trailing P/E of 21.3 and a forward-looking (2015) P/E of 17.3. The former is the highest among all ten major sectors at this point, versus the current marketwide average of 17.8. The latter is also among the highest forward-looking P/E ratios, versus a projected marketwide P/E of 15.9.

While earnings growth has been undeniable for these names, a multiple of 21.3 or a projected multiple of 17.3 suggests there’s no margin of error from expectant investors. Against a backdrop of expectations of accelerating earnings growth in 2015, even the slightest of shortcomings could pull the rug out from underneath these stocks.

And, the red flags of disappointment may already be waving.

In December, pharmacy benefits manager Express Scripts (ESRX) sucker-punched Gilead Sciences (GILD) shareholders by dropping one of its hepatitis C drugs altogether from its list of reimbursable treatments. Instead, Express Scripts reached a deal with AbbVie (ABBV) that gave the benefits provider a much better price on a comparable hepatitis C therapy in exchange for making the AbbVie drug the only hep-C treatment on its list of reimbursed therapies.

What does any of this have to do with other healthcare stocks? While pharmaceutical companies and other healthcare companies have largely been able to charge what they want, when they want, and how they want for years now, 2014 was the year their customers and the industry’s middlemen started to push back in earnest, in an organized way.

Look for other insurers and service providers to be emboldened by the alliance AbbVie and Express Scripts made, and to start making similar alliances that force pharma companies and other healthcare service/product suppliers to price themselves more competitively.

Bottom Line

Between a banner year in the sheer number of approved drugs, and consumers and customers that have finally balked at the largely-unchecked rise in healthcare costs, the odds of healthcare stocks posting more big gains in 2015 are notably low. There just aren’t enough bullish catalysts in the cards.

Indeed, between unbridled optimism and newly-brewing industry impasses, the bubble that pumped up so many healthcare stocks in 2014 could burst this year … and soon.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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