This ETF Is Looking Healthy (For Now)

After meandering through the first half of the year not doing much of anything, the Health Care Select Sector SPDR XLV, the largest health care exchange traded fund by assets, is surging to start the third quarter.

Highlighting the newfound strength in the S&P 500's third-largest sector weight, XLV rallied Monday even after President Trump targeted Dow component Pfizer Inc. PFE in a tweet about high pharmaceuticals prices. Pfizer is XLV's third-largest holding at a weight of 6.49 percent

What Happened

“U.S. governmental reforms addressing drug pricing should not have a material impact on the most profitable region of the world, which should ease pricing concerns that are weighing on the drug and biotechnology industries,” said Morningstar in a recent note.

The $15.72 billion XLV features 63 holdings, providing exposure to pharmaceuticals companies, health care equipment and supplies; health care providers and services; biotechnology; life sciences tools and services; and health care technology firms.

Why It's Important

With earnings season afoot, XLV and rival healthcare ETFs could be worth monitoring. Before the end of July, a slew of XLV's marquee names deliver second-quarter results. At least seven of the ETF's top 10 holdings step into the earnings confessional before the end of this month. Political rhetoric has pushed the sector's valuations lower.

“U.S. governmental rhetoric on bringing drug pricing down will not likely have a major impact on the largest drug market in the world, despite concerns that we believe have weighed on valuations,” according to Morningstar.

What's Next

Following the Trump Administration's tax reform effort passed late last year, large- and mega-cap health care companies are flush with repatriated cash, which could be deployed in a variety of ways, including higher dividends, share repurchases and mergers and acquisitions. Year-to-date, mergers and acquisitions activity in the sector is running well ahead of last year's pace.

“The strong cash flows of the largest healthcare companies continue to focus on acquisitions and share repurchases and we expect an acceleration of acquisitions through the reminder of the year,” said Morningstar.

XLV yields just 1.45 percent, implying ample room for dividend growth among the fund's 60-plus constituents.

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