The stock market is silently screaming “watch out.”
Yes, the S&P 500 is back at its highs, but as I’ve noted repeatedly, defensive stocks are driving those gains. Utility stocks have been ringing the risk-off bell since February, and other parts of the marketplace show that it’s a broader defensive shift. Throw into the mix gold, the classic safe-haven asset, and suddenly you start questioning if the market is setting up bulls for a period of increased volatility just as retail investors pile in.
If you dig beneath the surface, though, you’ll notice that another area of the market could soon show some meaningfully strength: healthcare.
Typically, when long-only investors are bearish and exposed to equities, the best they can do to mitigate downside risk is to enter overweight positions in lower-beta, higher-dividend stocks, many of which tend to be in the utilities, consumer staples, and healthcare sectors. Typically, you’ll see these three areas of the market outperform and underperform in unison. When investors are nervous, these stocks tend to outperform as riskier bets are taken off the table.
There are several strong reasons to think that healthcare should be not just a part of, but a leader of, the rotational defense taking place beneath the surface right now. The key is ultimately how the technology sector performs going forward. Tech has been the darling of markets for most of the past decade because of high growth rates. But, in times of market turbulence, valuations and volatility can migrate across sectors, leaving tech especially exposed to a corrective stock market environment.
Why Healthcare Stocks Are Gearing Up to Outperform
Of the three defensive sectors that Big Money can position into, healthcare is the only one large enough to absorb capital moving away from technology. Utilities and consumer staples are small sector weightings in the S&P 500 at 2.45% and 6.02%, respectively. Long-only equity managers can’t do much in terms of relative overweight positions there. But they can position into healthcare with its 12.1% allocation in the S&P 500. In other words, there’s more room to maneuver defensively in healthcare stocks, as healthcare has a larger starting weighting in passive, market-cap-weighted averages.
If healthcare started to display similar relative strength to tech, this would foreshadow even more the idea that money is turning defensive. Healthcare brings together defensive stability and growth in a way that could become more enticing to investors who want to navigate higher expected volatility.
Bottom line? A sizeable move higher in healthcare stocks would force a reevaluation of who is really in control of the market now. It would confirm the defensive rotation has started in earnest and that investors need to dial up their skepticism over news highs. It’s the laggard of the defensive sectors of the market, and it can play catch up to utilities much more quickly than people may realize.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.