Sizing Up the Health-Care Haven

The U.S. economy seems to find itself in a gloomier place day by day. After all, even Federal Reserve Chairman Ben Bernanke does not rule out the possibility of a recession, and a growing number of investors are frantically searching for a safe haven within the stock market--a sector that would allow them to weather the upcoming storm without having to resort to stuffing their hard-earned dollars under the mattress.

We've decided to aid investors in their quest by examining the long-held belief that health care provides that safe haven. Not surprisingly, the data we dug up reaffirmed that notion.

Do We Spend Less on Our Health When the Economy Sours?
To answer the question, we decided to compare the growth in the U.S. Gross Domestic Product (GDP) over the past five decades with the rise in the national health-care expenditure, as provided by the Centers for Medicare and Medicaid Services (the most recent recessionary periods highlighted).

The analysis of this data by and large supported our initial presumption that consumer spending on health is not overly influenced by the state of the economy--GDP growth and the rise in health-care spending appeared to periodically move in similar directions, but the magnitude of such moves, particularly over the past 20 years, had a very low degree of correlation (to eliminate the inflation impact on our model, we adjusted our growth rates by the fluctuations in the Consumer Price Index). Health-care spending also never turned negative, even during the prolonged recessionary periods in the late 1970s and early 1980s. Furthermore, we observed a particularly intriguing pattern: The gap between economic growth and the rise in health-care spending widened drastically in such periods. For example, over the past three recessions, inflation-adjusted spending on health care increased by 5.2% on average, while real GDP dipped 0.5%--a much wider spread than in "healthier" years. In contrast, the periods of rampant economic growth did not always translate into booming health-care spending. We've concluded that the nation's consumption of health products and services not only held up during economic slowdowns, but actually rose, albeit at a slower pace in certain years.

What Explains This Sector's Independence?
Following up on our first question, why is health care so resilient to economic doldrums? Some explanations are fairly self-evident--after all, not many of us are going to postpone an emergency appendectomy simply because the economy is not doing well. One might even suggest that individuals are more prone to stress-related health problems when steady employment or life savings are at risk. We decided to delve deeper and look for more subtle trends that may have contributed to this phenomenon.

We broke down the national health expenditure data by source of spending, and one item that particularly stood out was the drop-off in consumer out-of-pocket spending since the 1960s. The U.S. government's rollout of Medicare in the early 1960s and the rise of managed-care plans in the 1980s had drastic effects on patient payments, which went from 47% of total spending in 1960 to a meager 12% in 2006. In the meantime, government-funded spending increased from 23% to 46%, and private spending (primarily employer and managed-care plans) rose from 28% to 42%. As a result, lower out-of-pocket payments have made deciding whether or not to obtain medical care less dependent on consumer wealth, which has further separated health spending from discretionary spending.

The expansion of private insurance also had an indirect effect on consumer spending habits in areas closely aligned with quality of life. Spending on prescription drugs has nearly tripled as a percentage of GDP over the past two decades, and dental care has shifted from a luxury goods category into a more common consumption--per capita annual dental expenditures doubled since 1994. Advancements in technology--including new drug discoveries, changing demographics, and greater emphasis on overall well-being--all served as catalysts for rising health-care expenditures over the past few decades.

Where Are the Biggest Buying Opportunities?
While empirical evidence seems to support the conventional wisdom that health care provides a stable environment during recessions, an investor should exercise caution when factoring this into future expectations. While the aging of the population should accelerate demand for health-related services, certain areas of health care are more prone to government intervention and regulation, and a prolonged downturn in the economy could curtail spending on items deemed discretionary. However, my colleague Jeff Viskjo points out in another recent article that even some health-care companies that rely on discretionary spending look attractive.

Nonetheless, for investors seeking to reduce their exposure to the reverberations of the overall economy, we have compiled a list of companies from various industries within the health-care sector that we believe are fairly immune to recessions. We think these firms could present bargains for investors seeking to remain in the stock market.

 Schering-Plough  is well positioned for growth regardless of the direction of the economy. Schering holds one of the best late-stage pipelines relative to its size. We are particularity excited about the company's new anesthesia drug sugammadex, which brings patients out of their deep sleep quicker. A slowing economy should not dim the prospects for this drug or the majority of the company's other drugs. Further, the recent overreaction to the ENHANCE data offers an excellent entry point for the stock.

 Novartis' (NVS) diversified operating platform and industry-leading number of new potential blockbuster drugs offer robust growth in a slowing economy. This juggernaut holds strong intellectual property supporting multibillion-dollar products combined with a plethora of late-stage pipeline products. Further, Novartis markets drugs that tend to be the last purchase consumers cut in recessionary times, and the company's generic division offers low-cost alternatives to treat diseases.

 Quest Diagnostics (DGX) is benefiting from a steady rise in demand for preventive and diagnostic services driven by the aging population and payors' desire to cut costs. The state of the economy has very little bearing on the company's business, and its ever-growing lineup of specialized testing products provides opportunities for growth in an otherwise mature industry.

 Mylan (MYL) is the third-largest generic drug maker following its recent acquisition of Germany-based Merck KGaA. An aging population favors Mylan, and demand for its products varies little in a recession. Unlike many health-care companies, Mylan should benefit from any new cost containment regulation, including a legislative pathway for generic biologics. Mylan's profitability should also improve following the integration of Merck's business and associated cost savings, and interest expense reductions over the next three to five years.